ITEM 1.
BUSINESS
OVERVIEW
Third Wave Technologies, Inc. develops and markets molecular diagnostics for a variety of DNA and RNA analysis applications, providing our clinical, research and agricultural customers with superior molecular solutions. Our products are based on our proprietary Invader chemistry. It is a novel, molecular chemistry that we believe is easier to use, more accurate and cost-effective than competing technologies. Third Wave was incorporated in California in 1993 and reincorporated in Delaware in 2000.
We believe the market of greatest application and commercial opportunity for Third Wave’s Invader chemistry is clinical molecular diagnostics. We estimate that this market is approximately $2.1 billion worldwide today and will grow by 10-15% annually over the next five years. Within this market, there are a number of diverse segments for which our chemistry is well suited, including women’s health testing including tests for the human papillomavirus (HPV), genetics and pharmacogenetics, infectious disease and oncology. In addition to the molecular diagnostics market, the utility of the Invader chemistry has been extended to research and agricultural applications.
THIRD WAVE MISSION AND CORPORATE STRATEGY
Our mission is to be a leading provider of superior molecular solutions. We seek to achieve our mission by continuing to convert our proprietary Invader molecular chemistry into valuable molecular diagnostic products.
We have implemented a strategy to:
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Grow our global clinical molecular diagnostic revenue through our expanding product menu by using our strong distribution and thought-leader networks;
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Continue to expand our pipeline of molecular diagnostic products and enhance our product capabilities; and
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Partner when appropriate to optimize our opportunities in molecular diagnostics and in markets where the Invader chemistry can create unique competitive advantages.
TECHNOLOGY
Invader Chemistry
The Invader chemistry is a simple and scalable DNA and RNA analysis solution designed to provide accurate results more quickly than competing technologies. It is an isothermal, DNA-probe-based reaction that detects specific genomic sequences or variations.
The performance and flexibility of Invader chemistry can be coupled with the sensitivity of a rudimentary form of polymerase chain reaction (whose patents have expired). We call this combination Invader Plus and believe that it will bring the advantages of both chemistries to our customers, enabling them to perform molecular testing more easily and more rapidly.
We have developed, and will to continue to develop, a line of clinical molecular diagnostic products based on our Invader chemistry. Clinical applications of the Invader chemistry include detecting genetic variations associated with inherited conditions such as cystic fibrosis, hemostasis and cardiovascular risk factors, and those associated with drug efficacy and adverse drug reactions. They also include confirming diagnosis, quantifying viral load and genotyping for infectious diseases such as hepatitis B and C, and for detecting human papillomavirus (HPV). We have received in vitro diagnostic device clearance from the U.S. Food and Drug Administration (FDA) for our Invader UGT1A1 molecular assay. The Invader UGT1A1 molecular assay is cleared for use to identify patients who may be at increased risk of adverse reaction to the chemotherapy drug Camptosar® (irinotecan) by detecting and identifying specific mutations in the UGT1A1 gene. Camptosar, marketed in the U.S. by Pfizer, Inc., is used to treat colorectal cancer and was relabeled in 2005 to include dosing recommendations based on a patient’s genetic profile.
In addition to our growing menu of clinical products, there are a number of other Invader chemistry applications, including research, agriculture, and other potential industrial applications, including food and water testing.
INDUSTRY BACKGROUND
Prior to the late 1990s, many diagnostic testing methods had limited accuracy and served primarily as guides to analysis. This has changed with the emergence of nucleic acid testing, also referred to as NAT or molecular diagnostic testing.
Nucleic acid testing is the direct analysis of DNA or RNA. It is accomplished through genotyping, the determination of whether a variation or series of variations are present in an individual, or gene expression analysis, the determination of the level of activity of a specific gene by quantitating the messenger RNA, or mRNA, it is producing. The advantage of this testing method is that it directly detects DNA or RNA rather than monitoring antigens or antibodies. Initially NAT was used primarily for HIV and blood screening, but it is rapidly displacing conventional testing methods as the industry standard for a variety of applications. For example, the need to perform accurate blood screening and tests for infectious diseases/viral loads has resulted in NAT replacing immunotechnology (immunoassays) as the solution of choice among many clinical laboratories.
Ongoing scientific research has helped determine that a majority of human diseases have genetic components. The monumental feat of mapping and sequencing of the entire human genome, through the Human Genome Project and subsequent research initiatives, are being translated into precise clinical applications to diagnose and treat disease. As a result, hundreds of molecular diagnostic tests based on NAT technology are now being used to identify variations in DNA sequence to detect disease or highlight genetic predispositions. Furthermore, researchers’ continuing progress in understanding disease and definitively linking particular diseases to an individual’s DNA and RNA have caused key medical thought leaders to introduce new screening guidelines that incorporate NAT.
The availability of the human genome sequence, combined with an ever-growing list of known variations in DNA sequence and advances in our understanding of the cause and progression of disease, will likely result in the emergence of additional NAT applications. As a result, we believe that a significant increase in demand for gene-based tests will occur in the coming years.
LIMITATIONS OF CONVENTIONAL METHODS VERSUS THE THIRD WAVE SOLUTION
A limited number of chemistry platforms are presently capable of performing NAT, including the following:
Many of today’s methods for analyzing nucleic acids are based on hybridization in combination with polymerase chain reaction (“PCR”).
We believe the Invader and Invader Plus chemistries offer competitive advantages compared to the other forms of NAT, including:
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Accuracy - In the study submitted to the FDA as part of the Company’s application for clearance of its Invader UGT1A1 Molecular Assay, it was 100% accurate compared to DNA sequencing, the standard for genotype determination.
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Ease of Use - Invader products are extremely easy to use for technicians of any skill level. Assay setup requires a simple addition of the reagents to the prepared sample and can be completed with minimal hands-on time. During the incubation at a single temperature, technicians are free to perform other duties.
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Flexibility/Scalability - The Invader chemistry is highly scalable and automation-friendly, allowing any Clinical Laboratory Improvement Amendments (CLIA) certified high complexity lab, regardless of size, to take advantage of its benefits.
PRODUCTS AND PRODUCT CANDIDATES
We have applied our proprietary Invader chemistry to a number of molecular diagnostic, research and other applications. We have a pipeline of new products under development and are assessing the technical feasibility and commercial viability of a number of other applications.
Molecular Diagnostics
PRODUCTS ON THE MARKET - UNITED STATES
InVitro Diagnostic (IVD) Devices
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Invader UGT1A1 Molecular Assay
Analyte Specific Reagents/Research Use Only (ASRs/RUO)
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Hepatitis C virus genotyping (HCVg)
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Cystic Fibrosis Transmembrane Conductance Regulator gene (CFTR InPlextm)
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Human Papillomavirus (HPV)
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Connexin 26 (35delG)
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Connexin 26 (167delT)
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Factor V (Leiden)
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Factor II (prothrombin)
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Apolipoprotein E (ApoE) (C112R)
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Apolipoprotein E (ApoE) (R158C)
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Plasminogen Activator Inhibitor-1 (PAI-1) (4G/5G)
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Platelet Glycoprotein IIIa (PL A1/A2) (Leu 33 Pro, T1565C)
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Warfarin (VKORC1 (-1639)), (CYP2C9*2), (CYP2C9*3)
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Rett (McCP2)
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Methylenetetrahydrofolate Reductase (MTHFR)
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CYP2C19
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CYP2C9
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CYP450
PRODUCTS ON THE MARKET - EUROPEAN ECONOMIC AREA (EEA)
InVitro Diagnostic Devices - CE Mark
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HPV High Risk Molecular Assay
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Factor V Leiden (G1691A)
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Factor II (FII G20210A)
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Methylenetetrahydrofolate Reductase (MTHFR) (C677T)
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Methylenetetrahydrofolate Reductase (MTHFR) (A1298C)
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Apolipoprotein E (ApoE) (C112R)
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Apolipoprotein E (ApoE) (R158C)
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Plasminogen Activator Inhibitor-1 (PAI-1) (4G/5G)
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Platelet Glycoprotein IIIa (PL A1/A2) (Leu 33 Pro, T1565C)
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Connexin 26 (35delG)
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Connexin 26 (167delT)
PRODUCTS IN DEVELOPMENT OR BEING ASSESSED FOR TECHNICAL FEASIBILITY AND COMMERCIAL VIABILITY
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Additional HPV offerings
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Additional CFTR offerings
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HBV Viral Load
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Herpes simplex virus (HSV 1 & 2)
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Cytomegalovirus (CMV)
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Microbacterium
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Methicillin-resistant Staphylococcus aureus (MRSA)
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Chlamydia
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Gonorrhea
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Additional infectious disease targets
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Hepatitis B virus
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Micro RNA panels
We also have developed a number of DNA and RNA analysis products for the research and agricultural biotechnology markets.
MANUFACTURING
We manufacture products at our facility in Madison, Wisconsin and source certain components from various contract manufacturers. We work closely with the vendors of these components to optimize the manufacturing process, monitor quality control and ensure compliance with our product specifications. Together with our component contract manufacturers, we have scalable manufacturing systems, possess the expertise necessary to manufacture our products and have sufficient capacity to meet our customer requirements.
Certain key components of our products may be sourced from a single supplier or a limited number of suppliers. In addition, some of the components incorporated into our products may be proprietary and unavailable from secondary sources.
We have registered the facility used for manufacturing our clinical products with the FDA as a Device Manufacturer and believe we are in substantial compliance with the FDA’s quality system requirements or QSRs. We have also achieved ISO 13485:2003 Certification, a stringent, globally-recognized standard of quality management for medical device manufacturers.
See Part I, Item 1A
ITEM 1A.
RISK FACTORS
RISKS RELATED TO OUR BUSINESS
WE HAD AN ACCUMULATED DEFICIT OF $194.6 MILLION AT DECEMBER 31, 2007, AND EXPECT TO CONTINUE TO INCUR SUBSTANTIAL OPERATING LOSSES FOR THE FORESEEABLE FUTURE.
We have had substantial operating losses since our inception, and we expect our operating losses to continue over the foreseeable future. We experienced net losses of $16.8 million in 2007, $18.9 million in 2006, and $22.3 million in 2005. In order to further develop our products and technologies, including development of new products for the clinical market, we will need to incur significant expenses in connection with our internal research and development and commercialization programs. As a result, we expect to incur annual operating losses for the foreseeable future.
In addition, there is no assurance that we will ever become profitable or that we will sustain profitability if we do become profitable.
FLUCTUATIONS IN OUR QUARTERLY REVENUES AND OPERATING RESULTS MAY NEGATIVELY IMPACT OUR STOCK PRICE.
Our revenues and results of operations have fluctuated significantly in the past and we expect significant fluctuations to continue in the future due to a variety of factors, many of which are outside of our control. These factors include:
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the volume and timing of orders for our products;
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changes in the mix of our products offered;
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the timing of payments we receive under collaborative agreements, as well as our ability to recognize these payments as revenues;
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the number, timing and significance of new products and technologies introduced by our competitors;
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third-party intellectual property, which may require significant investments in licensing or royalties, or which may materially impede our ability to sell products;
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our ability to develop, obtain regulatory clearance, market and introduce new and enhanced products on a timely basis;
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changes in the cost, quality and availability of equipment, reagents and components required to manufacture or use our products; and
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availability of third-party reimbursement to users of our clinical products.
The company has an established infrastructure of operating expenses. There is a risk that if our revenues decline or do not grow as anticipated, we will not be able to reduce our operating expenses quickly in the short-term which will result in significant harm to our operating results for one or more fiscal periods.
OUR TECHNOLOGIES AND COMMERCIAL PRODUCTS MAY NOT BE COMMERCIALLY VIABLE OR SUCCESSFUL, WHICH COULD ADVERSELY AFFECT OUR BUSINESS.
We are currently developing and commercializing a limited number of products based on our technologies. We plan to develop additional products. We cannot assure you that we will be able to complete development of our products that are currently under development or that we will be able to develop additional new products. In addition, for our genetic and pharmacogenetic products, some of the genetic variations for which we develop our products may not be useful or cost effective in assisting therapeutic selection, patient monitoring or diagnostic applications. In this event, our sales of products for these genetic variations would diminish significantly or cease, and we would not be able to recoup our investment in developing these products. Accordingly, if we fail to successfully develop our products and technologies or if our technologies are not useful in the development of commercially successful products, we may not achieve a competitive position in the market. Market acceptance of our products will depend on widespread acceptance of such products by doctors and clinicians. The use of products to assess genetic variation, gene expression or identify infectious diseases is relatively new and remains uncertain. If clinicians and doctors fail to adopt our products, our ability to grow our revenues would be impaired which would have a material adverse effect on our business, financial condition and results of operations.
WE ARE RELIANT ON OUR ABILITY TO MANUFACTURE AND DEVELOP PRODUCTS. IF THERE IS A DISRUPTION TO THE MANUFACTURING OF OUR PRODUCTS, IT MAY HAVE AN ADVERSE AFFECT TO OUR BUSINESS.
If we fail to meet our manufacturing needs, we may not be able to provide our customers with the quantity of products they require, which would damage customer relations and result in reduced revenues. Additionally, some of our products must be manufactured in accordance with the FDA’s QSRs, and we cannot guarantee that our manufacturing and production systems will always be in compliance with the QSRs. Failure to comply with regulatory requirements or any adverse regulatory action could have a material adverse effect on us.
Key components of our products may be sourced from a single supplier or a limited number of suppliers. In addition, some of the components incorporated into our products may be proprietary and unavailable from secondary sources. Finally, to comply with QSRs, we must verify that our suppliers of key components are in compliance with all applicable FDA regulations and meet our standards for quality. Should we be unable to continue to obtain needed components from our existing suppliers on commercially reasonable terms, if at all, it could be time consuming and expensive for us to seek alternative sources of supply. Consequently, if any events cause delays or interruptions in the supply of our components, we may not be able to supply our customers with our products on a timely basis which would adversely affect our results of operations.
WE MAY NOT BE ABLE TO CONTINUE TO OUTSOURCE THE MANUFACTURE OF COMPONENTS FOR OUR PRODUCTS ON FAVORABLE TERMS, IF AT ALL, AND EVEN SUCCESSFUL OUTSOURCING CREATES RISK DUE TO OUR RESULTING RELIANCE ON VENDORS.
We currently outsource a portion of our manufacturing, and may pursue additional outsourcing opportunities in the future where economically advantageous. For example, we outsource the manufacture of select components for the microfluidics card format and components of certain assays intended for research applications. However, we may be unable to successfully outsource additional manufacturing in the near term, if at all. The selection and ultimate qualification of vendors to manufacture components for our products could be costly and increase our cost of revenues. In addition, we do not know if we will be able to negotiate long-term contracts with subcontractors to manufacture components for our products at acceptable prices or volumes. Further, even if we find suitable vendors, creation of such arrangements carries risks since we have to rely on the vendor to provide an uninterrupted source of
high quality product. Because our customers have high quality and reliability standards and our components require sophisticated testing techniques, we may have difficulty in the future in obtaining sufficiently high quality or timely manufacture and testing of outsourced components. Whenever a subcontractor is not successful in adopting such techniques, we may experience increased costs, including warranty and product liability expense and costs associated with customer support, delays, cancellations or rescheduling of orders or shipments, damage to customer relationships, delayed qualification of new products with our customers, product returns or discounts and lost revenues, any of which could harm our business, financial condition and results of operations.
OUR LIMITED SALES AND MARKETING EXPERIENCE AND CAPACITY MAY ADVERSELY AFFECT OUR ABILITY TO GROW AND TO COMPETE SUCCESSFULLY IN COMMERCIALIZING OUR POTENTIAL PRODUCTS.
Our sales force consists of 17 individuals focused on direct sales and 17 individuals focused on service and support in the clinical market. We may need to increase the size of our sales force as we further commercialize our products, and we may not be able to recruit, hire and train a sufficient number of sales personnel as needed. We may also market our products through collaborations and distribution agreements with diagnostic, biopharmaceutical and life science companies. We cannot guarantee that we will be able to establish and maintain a successful sales force or establish collaboration or distribution arrangements to market our products. Our failure to implement an effective marketing and sales strategy could impair our ability to grow our revenues and execute our business plan which could have a material adverse effect on our business, financial condition and results of operations.
We have limited experience with sales of our clinical molecular diagnostics products outside of the U.S. We cannot guarantee that we will successfully develop sales, distribution, product and customer support capabilities internationally that will enable us to generate significant revenue from sales outside the U.S. In addition, sales made outside the U.S. are subject to foreign regulations typical to the sale and marketing of our products that may pose an additional risk for us. Our failure to increase our revenues from sales outside of the U.S. could have an adverse effect on our business, financial condition and results of operations.
OUR CUSTOMER BASE IS DOMINATED BY A SMALL NUMBER OF LARGE CLINICAL TESTING LABORATORIES AND MANY OF OUR CONTRACTS WITH KEY CUSTOMERS ARE SHORT-TERM CONTRACTS AND/OR SUBJECT TO EARLY TERMINATION.
Our customer base is dominated by a small number of large clinical testing laboratories (Quest Diagnostics, Inc., Mayo Medical Laboratories, Kaiser Permanente, Spectrum Laboratory Network and Berkeley Heart Laboratories) and research customers (University of Tokyo/RIKEN and Pioneer Hi-Bred International, Inc.). We regularly experience pricing and other competitive pressures in these accounts. Many of our contracts with key customers are short-term contracts and/or subject to early termination. Our customers are not obligated to renew contracts after they expire. If, for any reason, we are unable to maintain or renew our contracts, particularly our contracts with key customers, or if, for any reason, we are unable to maintain current pricing levels and/or volumes with our customers, our revenues and business may suffer materially.
WE MAY REQUIRE ADDITIONAL FINANCING FOR OUR FUTURE OPERATING PLANS. FINANCING MAY NOT BE AVAILABLE ON ACCEPTABLE TERMS, IF AT ALL.
We may need to raise additional capital in the future. We have expended significant resources and expect to continue to expend significant resources in our research and product development and commercialization activities and to improve production processes, litigate intellectual property disputes, and seek FDA clearances or approvals. In December 2006 we sold $20,000,000 (at maturity) of Convertible Senior Subordinated Zero-Coupon Promissory Notes which will mature on December 19, 2011. In December 2007 we entered into a facility agreement under which we may borrow up to an aggregate of $25,000,000 for a term of five years from the lenders.
The amount of additional capital we will need to raise will depend on many factors, including:
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our progress with our research and development programs;
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the need we may have to pursue FDA clearances or approvals of our products;
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our level of success in selling our products and technologies;
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our ability to establish and maintain successful collaborations;
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the costs we incur in securing intellectual property rights, whether through patents, licenses or otherwise;
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the costs we incur in enforcing and defending our patent claims and other intellectual property rights;
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the timing of debt repayment obligations and additional capital expenditures;
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the need to respond to competitive pressures; and
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the possible acquisition of complementary products, businesses or technologies.
If we raise additional funds through the sale of equity, convertible debt or other equity-linked securities, our shareholders’ percentage ownership in the Company will be reduced. In addition, these transactions may dilute the value of our outstanding stock. We may issue securities that have rights, preferences and privileges senior to our common stock. If we raise additional funds through collaborations or licensing arrangements, we may relinquish rights to certain of our technologies or products, or grant licenses to third parties on terms that are unfavorable to us. If future financing is not available to us or is not available on terms acceptable to us, we may not be able to fund our future needs which would have an adverse effect on our business, financial condition and results of operations.
COMMERCIALIZATION OF OUR TECHNOLOGIES MAY DEPEND ON STRATEGIC PARTNERSHIPS AND COLLABORATIONS WITH OTHER COMPANIES, AND IF OUR CURRENT OR FUTURE PARTNERSHIPS AND COLLABORATIONS ARE NOT SUCCESSFUL, WE MAY EXPERIENCE DIFFICULTY COMMERCIALIZING OUR TECHNOLOGIES AND PRODUCTS.
In order to augment our internal sales and marketing efforts and to reach additional product and geographic markets, we have entered into or may enter into strategic partnerships and collaborations for the development, marketing, sales or distribution of our products. These agreements provide us, in some instances, with distribution of our products, access to products and technologies that are complementary to ours and funding for development of our products. We may also be dependent on collaborators for regulatory approvals and clearances, and manufacturing in particular geographic and product markets. If our strategic partnerships and collaborations are not successful, we may not be able to develop or successfully commercialize the products that are the subject of the collaborations on a timely basis, if at all, or effectively distribute our products. In addition, if we do not enter into additional partnership agreements, or if these agreements are not successful, our ability to develop, commercialize and distribute products could be negatively affected which would harm our future operating results.
We have no control over the resources that any partner or collaborator may devote to our products. Any of our present or future partners or collaborators may not perform their obligations as expected. These partners or collaborators may breach or terminate their agreements with us or otherwise fail to meet their obligations or perform their collaborative activities successfully and in a timely manner. Further, any of our partners or collaborators may elect not to develop products arising out of our partnerships or collaborations or devote sufficient resources to the development, manufacture, commercialization or distribution of these products. If any of these events occur, we may not be able to develop our products and technologies and our ability to generate revenues will decrease.
WE ARE IN A HIGHLY COMPETITIVE INDUSTRY AND MARKETPLACE. COMPETITIVE DEVELOPMENTS, INCLUDING NEW TECHNOLOGIES THAT RENDER OURS LESS COMPETITIVE OR OBSOLETE, COULD SERIOUSLY HARM OUR BUSINESS.
The biotechnology and life sciences industries generally and the genetic analysis and molecular diagnostics markets specifically are highly competitive, and we expect the intensity of competition to increase. We compete with organizations in the U.S. and abroad that develop and manufacture products and provide services for the analysis of genetic information for research and/or clinical applications. These organizations include:
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diagnostic, biotechnology, pharmaceutical, healthcare, chemical and other companies;
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academic and scientific institutions;
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governmental agencies;
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public and private research organizations; and
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clinical laboratories.
Many of our competitors have greater financial, technical, research, marketing, sales, distribution, service and other resources than we have. Moreover, our competitors may offer broader product lines and have greater name recognition than we have, and may offer discounts as a competitive tactic. In addition, several development stage companies are currently making or developing technologies, products or services that compete with or are being designed to compete with our technologies and products. Our competitors may develop or market technologies, products or services that are more effective or commercially attractive than our current or future products, or that may render our technologies or products less competitive or obsolete. Competitors may make rapid technological developments which may result in our technologies and products becoming obsolete before we recover the expenses incurred to develop them or before they generate significant revenue or market acceptance. Competitors may also obtain regulatory advances or approvals of their diagnostic products more rapidly than we do.
In addition, many of our competitors may be more successful than we are at obtaining third-party reimbursement for their products.
We may not be able to compete effectively against competitors that hold such advantages which may have a material adverse effect on our business, financial condition and results of operations.
WE MAY BE UNABLE TO PROTECT OUR PROPRIETARY METHODS AND TECHNOLOGIES AND MAY BE SUBJECT TO CLAIMS OF INFRINGEMENT OF THE INTELLECTUAL PROPERTY RIGHTS OF OTHERS.
Our commercial success will depend, to a significant degree, on our ability to obtain patent protection on many aspects of our business, including the products, methods and services we develop. Patents issued to us may not provide us with substantial protection or be commercially beneficial to us. The issuance of a patent is not conclusive as to its validity or its enforceability. In addition, our patent applications or those we have licensed, may not result in issued patents. If our patent applications do not result in issued patents, our competitors may obtain rights to commercialize our discoveries which would harm our competitive position.
We also may apply for patent protection on novel genetic variations in known genes and their uses, as well as novel uses for previously identified genetic variations discovered by third parties. In the latter cases or in the area of new product development, we may need licenses from the holders of patents with respect to such genetic variations in order to make, use or sell any related products. We may not be able to acquire such licenses on terms acceptable to us, if at all.
Certain parties are attempting to rapidly identify and characterize genes and genetic variations through the use of sequencing and other technologies. To the extent any patents are issued to other parties on such partial or full-length genes or genetic variations or uses for such genes or genetic variations, the risk increases that the sale of products developed by us or our collaborators may give rise to claims of patent infringement against us. Others may have filed and, in the future, are likely to file patent applications covering many genetic variations and their uses. Others have filed and, in the future, may file, patent applications covering improvements to our technologies. Any such patent application may have priority over our patent applications and could further restrict our ability to market our products. We cannot assure you that any license that we may require under any such patent will be made available to us on commercially acceptable terms, if at all.
While we believe our technology does not infringe any third party rights, we have in the past been party to and are currently party to litigation involving patents and intellectual property rights. See Part I, Item 3 - Legal Proceedings. We may in the future become party to other litigation involving claims of infringement of intellectual property rights. We could also become involved in disputes regarding the ownership of intellectual property rights that relate to our technologies. These disputes could arise out of collaboration relationships, strategic partnerships or other relationships. Any such litigation could be expensive, take significant time, and could divert management’s attention from other business concerns. If we do not prevail in any pending or future legal proceeding, we may be
required to pay significant monetary damages. In addition, we could also be required to cease using certain processes or prevented from selling certain configurations of our products which could require us to obtain licenses from the other party or modify some of our products and processes to design around the patents. Licenses could be costly or unavailable on commercially reasonable terms. Designing around patents or focusing efforts on different configurations could be time consuming, and we could be forced to remove some of our products from the market while we complete redesigns. Accordingly, if we are unable to settle pending or future intellectual property disputes through licensing or similar arrangements, or if any such pending or future disputes are determined adversely to us, our ability to market and sell our products could be impaired which could have a material adverse effect on our business, financial condition and results of operations.
In addition, in order to protect or enforce our patent rights or to protect our ability to operate our business, we may need to initiate patent litigation against third parties. These lawsuits could be expensive, take significant time, and could divert management’s attention from other business concerns. These lawsuits could result in the invalidation or limitation in the scope of our patents or forfeiture of the rights associated with our patents. We cannot assure you that we would prevail in any such proceedings or that a court will not find damages or award other remedies in favor of the opposing party in any of these suits. During the course of any future proceedings, there may be public announcements of the results of hearings, motions and other interim proceedings or developments in the litigation. Securities analysts or investors may perceive these announcements to be negative, which could cause the market price of our stock to decline.
OTHER RIGHTS AND MEASURES THAT WE RELY UPON TO PROTECT OUR INTELLECTUAL PROPERTY MAY NOT BE ADEQUATE TO PROTECT OUR PRODUCTS AND COULD REDUCE OUR ABILITY TO COMPETE IN THE MARKET.
In addition to patents, we rely on a combination of trade secrets, copyright and trademark laws, nondisclosure agreements and other contractual provisions and technical measures to protect our intellectual property rights.
While we require employees, collaborators, consultants and other third parties to enter into confidentiality and/or non-disclosure agreements where appropriate, any of the following could still occur:
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the agreements may be breached;
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we may have inadequate remedies for a breach;
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the employees, collaborators, consultants and other third parties may apply for patents on improvements to our technologies without assigning ownership rights to us;
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proprietary information could be disclosed to our competitors; or
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others may independently develop substantially equivalent proprietary information and techniques or otherwise gain access to our trade secrets or disclose such technologies.
If for any of the above reasons our intellectual property is disclosed, invalidated or misappropriated, it would harm our ability to protect our rights and our competitive position.
IF WE FAIL TO RETAIN OUR KEY PERSONNEL AND HIRE, TRAIN AND RETAIN QUALIFIED EMPLOYEES, WE MAY NOT BE ABLE TO COMPETE EFFECTIVELY, WHICH COULD RESULT IN REDUCED REVENUES.
Our future success will depend on the continued services and on the performance of our senior management, scientific staff, and key employees.
If a competitor hired members of our senior management staff, scientific staff, or key employees, or if for any reason these employees do not continue to work for us, we may have difficulty hiring employees with equivalent skills.
In addition, our researchers, scientists and technicians have significant experience in research and development related to the analysis of genetic variations. If we were to lose these employees to our competitors or otherwise, we could spend a significant amount of time and resources to replace them, which could impair our
research and development efforts. Further, in order to scale up our commercialization activity and to further our research and development efforts, we will need to hire, train and retain additional sales, marketing, research, scientific, and technical personnel. If we are unable to hire, train and retain the personnel we need, we may experience delays in the research, development and commercialization of our technologies and products which could have a material adverse effect on our business, financial condition and results of operations.
IF WE FAIL TO MAINTAIN REGULATORY APPROVALS AND CLEARANCES, OR ARE UNABLE TO OBTAIN, OR EXPERIENCE SIGNIFICANT DELAYS IN OBTAINING, FDA CLEARANCES OR APPROVALS FOR OUR FUTURE PRODUCTS OR PRODUCT ENHANCEMENTS, OUR ABILITY TO COMMERCIALLY DISTRIBUTE AND MARKET THESE PRODUCTS COULD SUFFER. THERE IS NO GUARANTEE THAT THE FDA WILL GRANT 510(K) CLEARANCE OR PMA APPROVAL OF OUR FUTURE PRODUCTS AND FAILURE TO OBTAIN NECESSARY CLEARANCES OR APPROVALS FOR OUR FUTURE PRODUCTS WOULD ADVERSELY AFFECT OUR ABILITY TO GROW OUR BUSINESS.
The majority of our current clinical diagnostic products are sold as ASRs. The FDA restricts the sale of these products to clinical laboratories certified under CLIA to perform high complexity testing and also restricts the types of products that can be sold as ASRs. We believe most of our products currently marketed pursuant to FDA regulations as ASRs, as well as many products we intend to market in the future as ASRs, are exempt from the 510(k) premarket notification and premarket approval requirements. However, as discussed immediately below, the regulatory status of some of these products may change.
In 2006, followed by additional clarification in 2007, the FDA issued guidance concerning acceptable examples of IVD reagents that meet the threshold of the ASR regulations. In this guidance, the FDA outlined examples of products and marketing practices that go beyond the scope of the ASR regulations making the reagent part of a test system potentially subject to premarket review. These examples include combining, or promoting for use, a single ASR with another product such as other ASRs, general purpose reagents, controls, laboratory equipment, software, etc., or promoting an ASR with specific analytical or performance claims, instructions for use in a particular test, or instructions for validation of a specific test using the ASR. As a result of this recent guidance, the FDA may require that we obtain, or we may choose to obtain, regulatory clearances or approvals for certain of our products or their applications, as was done for our Invader UGT1A1 Molecular Assay. While we believe our ASR products are in substantial compliance with this guidance, the FDA may disagree. In that event, we could experience significant revenue loss, additional expense and loss of our clinical customer base which would cause the market price of our stock to decline.
In general, our clinical diagnostic products other than those exempt under the ASR regulations, require either a premarket notification clearance, known as a 510(k), or a premarket approval, known as a PMA from the FDA.
With respect to products reviewed through the 510(k) process, we may not market a product until an order is issued by the FDA finding our product to be substantially equivalent to a legally marketed product known as a predicate device. A 510(k) submission may involve the presentation of a substantial volume of data, including clinical data, and may require a substantial review. The FDA may agree that the product is substantially equivalent to a predicate device and allow the product to be marketed in the U.S. The FDA, however, may determine that the device is not substantially equivalent and require a PMA, or require further information, such as additional test data, including data from clinical studies, before it is able to make a determination regarding substantial equivalence. If, after reviewing the 510(k), the FDA determines there is no predicate device, we may request that the FDA use the process known as de novo classification and clear the device through that process, rather than a PMA. De novo classification is intended to be used for lower-risk products. By requesting additional information, the FDA can further delay market introduction of our products.
A PMA must be submitted to the FDA if the device cannot be cleared through the 510(k) process. A PMA must be supported by extensive data, including but not limited to, technical, preclinical, clinical trials, manufacturing and labeling to demonstrate to the FDA’s satisfaction the safety and effectiveness of the device for its intended use. No device that we are marketing to date has required premarket approval. During the review period, the FDA will typically request additional information or clarification of the information already provided. Also, an advisory
panel of experts from outside the FDA may be convened to review and evaluate the application and provide recommendations to the FDA as to the approvability of the device. The FDA may or may not accept the panel’s recommendation. In addition, the FDA will generally conduct a pre-approval inspection of the manufacturing facility or facilities to ensure compliance with the Good Manufacturing Practice regulations, known as the Quality System Regulation, or QSR.
Clinical trials are generally required to support a PMA application and are sometimes required for 510(k) clearance. Such trials generally require an investigational device exemption application, or IDE, approved in advance by the FDA for a specified number of patients and study sites, unless the product is deemed a nonsignificant risk device eligible for more abbreviated IDE requirements. Clinical trials are subject to extensive monitoring, recordkeeping and reporting requirements. Clinical trials must be conducted under the oversight of an institutional review board, or IRB, for the relevant clinical trial sites and must comply with FDA regulations, including but not limited to those relating to good clinical practices. To conduct a clinical trial, we also are required to obtain the patients’ informed consent in form and substance that complies with both FDA requirements and state and federal privacy and human subject protection regulations. We, the FDA or the IRB could suspend a clinical trial at any time for various reasons, including a belief that the risks to study subjects outweigh the anticipated benefits. Even if a trial is completed, the results of clinical testing may not adequately demonstrate the safety and efficacy of the device or may otherwise not be sufficient to obtain FDA approval to market the product in the U.S. Failure to comply with FDA requirements could result in the FDA’s refusal to accept the data and/or the imposition of regulatory sanctions. As most in-vitro diagnostic devices are exempt from FDA’s IDE regulations, we do not believe that our future products will require an IDE clinical study.
To date, we have applied for FDA clearance with respect to two of our clinical diagnostic products. We obtained clearance for our Invader UGT1A1 Molecular Assay in August 2005. Currently, one of our key strategic initiatives is the commercialization of our Human Papillomavirus (HPV) offering. In August 2006, we began clinical trials for two HPV premarket approval submissions to the FDA. We expect to spend $17-18 million on these submissions over three years. If for any reason these trials are not successful or are substantially delayed or for any other reason we are unable to successfully commercialize our HPV offering, our business and prospects would likely be materially adversely impacted.
We plan to seek additional FDA approvals or clearances in the future, however, we cannot predict the likelihood of obtaining those approvals or clearances. There can be no assurance that regulatory approval or clearance of any clinical products for which we seek such approvals will be granted by the FDA on a timely basis, if at all. Delays in receipt or failure to receive approvals, the loss of previously received approvals, or the failure to comply with existing or future regulatory requirements could reduce our sales, profitability and future growth prospects.
EVEN IF OUR PRODUCTS ARE APPROVED OR CLEARED BY REGULATORY AUTHORITIES, IF WE FAIL TO COMPLY WITH ONGOING FDA OR OTHER FOREIGN REGULATORY AUTHORITY REQUIREMENTS, OR IF WE EXPERIENCE UNANTICIPATED PROBLEMS WITH OUR PRODUCTS, THESE PRODUCTS COULD BE SUBJECT TO RESTRICTIONS OR WITHDRAWAL FROM THE MARKET.
As a medical device manufacturer, we are required to register our facility and list our products with the FDA. In addition, we are required to comply with the FDA’s Quality System Regulation (QSR), which requires our devices be manufactured and records be maintained in a prescribed manner with respect to design and development, manufacturing, testing and control activities. Further, we are required to comply with FDA requirements for labeling and promotion. For example, the FDA prohibits cleared or approved devices from being promoted for uncleared or unapproved uses, otherwise known as “off-label” promotion. In addition, the medical device reporting regulation requires that we provide information to the FDA whenever there is evidence to reasonably suggest that one of our devices may have caused or contributed to a death or serious injury or that a product has malfunctioned in such a way that it would be likely to cause or contribute to a death or serious injury if the malfunction were to recur. Under FDA regulatory requirements, we may not make claims about the performance, intended clinical use or efficacy of ASR products, and we may provide only limited information to laboratories concerning these products.
There also are restrictions on the concurrent marketing of components that can be used to develop an assay and other restrictions as well.
Our manufacturing facility is subject to periodic and unannounced inspections by the FDA for compliance with QSR. Additionally, the FDA often will conduct a preapproval inspection for PMA devices. If the FDA believes we are not in compliance with applicable laws or regulations, the agency can institute a wide variety of enforcement actions, ranging from issuance of warning letters or untitled letters; fines and civil penalties; unanticipated expenditures to address or defend such actions; delaying or refusing to clear or approve our products; withdrawal or suspension of approval of products or those of our third-party suppliers by the FDA or other regulatory bodies; product recall or seizure; orders for physician notification or device repair, replacement or refund; interruption of production; operating restrictions; injunctions; and criminal prosecution.
Any customers using our products for clinical use in the U.S. are regulated under CLIA. CLIA is intended to ensure the quality and reliability of clinical laboratories in the U.S. by mandating specific standards in the areas of personnel qualifications, administration, participation in proficiency testing, patient test management, quality control, quality assurance and inspections. We cannot assure you that the CLIA regulations and future administrative interpretations of CLIA will not have a material adverse impact on us by limiting the potential market for our products. The regulations promulgated under CLIA establish three levels of clinical tests and the standards applicable to a clinical laboratory depend on the level of the tests it performs. CLIA requirements may prevent some clinical laboratories, including those laboratories that do not comply with those requirements, from using some or all of our products. In addition, CLIA regulations and future administrative interpretations of CLIA could harm our business by limiting the potential market for some or all of our products.
MODIFICATIONS TO OUR PRODUCTS MAY REQUIRE NEW REGULATORY CLEARANCES OR APPROVALS OR MAY REQUIRE US TO RECALL OR CEASE MARKETING OUR PRODUCTS UNTIL CLEARANCES OR APPROVALS ARE OBTAINED.
Any modification to a 510(k)-cleared device that would constitute a major change in its intended use, or any change that could significantly affect the safety or effectiveness of the device, requires a new 510(k) clearance and may, in some circumstances, require a PMA, if the change raises complex or novel scientific issues or the product has a new intended use. The FDA requires every manufacturer to make the determination regarding the need for a new 510(k) submission in the first instance, but the FDA may review any manufacturer’s decision. The FDA on its own initiative may determine that a new clearance or approval is required. We have made modifications to our products in the past and may make additional modifications in the future that we believe do not or will not require additional clearances or approvals. If the FDA disagrees and requires new clearances or approvals for the modifications, we may be required to recall and to stop marketing our products as modified, which could require us to redesign our products and harm our operating results. In these circumstances, we may be subject to significant enforcement actions.
New PMAs or PMA supplements are required for modifications that affect the safety or effectiveness of the device, including, for example, certain types of modifications to the device’s indication for use, manufacturing process, labeling and design. PMA supplements often require submission of the same type of information as a PMA, except that the supplement is limited to information needed to support any changes from the device covered by the original PMA and may not require extensive clinical data or the convening of an advisory panel. There is no guarantee that the FDA will grant PMA approval of our future products, if required, and failure to obtain necessary approvals for our future products would adversely affect our ability to grow our business. Delays in receipt or failure to receive approvals, the loss of previously received approvals, or the failure to comply with existing or future regulatory requirements could reduce our sales, profitability and future growth prospects.
FEDERAL REGULATORY REFORMS MAY ADVERSELY AFFECT OUR ABILITY TO SELL OUR PRODUCTS PROFITABLY.
From time to time, legislation is drafted and introduced in Congress that could significantly change the statutory provisions governing the marketing approval, manufacture and marketing of a regulated product. In addition, FDA regulations and guidance are often revised or reinterpreted by the agency in ways that may
significantly affect our business and our products. It is impossible to predict whether legislative changes will be enacted or FDA regulations, guidance or interpretations changed, and what the impact of such changes, if any, may be.
Without limiting the generality of the foregoing, Congress has recently enacted, and the President has signed into law, the Food and Drug Administration Amendments Act of 2007 (the “FDA Amendments”). The FDA Amendments require certain information about clinical trials for drugs, biologics, and medical devices, including a description of the trial, participation criteria, location of trial sites, and contact information, to be sent to the National Institutes of Health (“NIH”) for inclusion in a publicly-assessable database. We also are now required to submit to the NIH the results of certain clinical trials, other than Phase I studies, if any of our products are required to undergo clinical evaluation. Compliance with those regulations may require us to take additional steps in the development and manufacture of our products and labeling. These steps may require additional resources and could be costly.
In addition, as discussed above, in 2006 and 2007 the FDA issued guidance documents concerning regulation of ASRs that may have an adverse impact on our ability to sell certain of our ASR products.
OUR INTERNATIONAL SALES ARE SUBJECT TO CURRENCY, MARKET AND REGULATORY RISKS THAT ARE BEYOND OUR CONTROL.
In 2007 we derived approximately 11% of our product revenues from sales to international end-users and we expect that international sales will continue to account for a portion of our sales. Changes in the rate of exchange of foreign currencies into U.S. dollars have and will continue to impact our revenues and results of operations.
The extent and complexity of medical products regulation are increasing worldwide, with regulation in some countries nearly as extensive as in the U.S. Further, we must comply with import and export regulations when distributing our products to foreign nations. Each foreign country’s regulatory requirements for product approval and distribution are unique and may require the expenditure of substantial time, money and effort. As a result, we may not be able to successfully commercialize our products in foreign markets at or beyond the level of commercialization we have already achieved.
OUR FAILURE TO COMPLY WITH ANY APPLICABLE ENVIRONMENTAL, HEALTH, SAFETY AND RELATED GOVERNMENT REGULATIONS MAY AFFECT OUR ABILITY TO DEVELOP, PRODUCE OR MARKET OUR POTENTIAL PRODUCTS AND MAY ADVERSELY AFFECT OUR RESULTS OF OPERATIONS.
Our research, development and manufacturing activities involve the use, transportation, storage and disposal of hazardous materials and are subject to related environmental and health and safety statutes and regulations as regulated by various government agencies such as the Federal Aviation Administration, or FAA, and the U.S. Environmental Protection Agency, or EPA. As we expand our operations, our increased use of hazardous substances will lead to additional and more stringent requirements. This may cause us to incur substantial costs to maintain compliance with applicable statutes and regulations. In addition, we are obligated to file a report to the EPA regarding specified types of microorganisms we use in our operations. The EPA could, upon review of our use of these microorganisms, require us to discontinue their use. If this were to occur, we would have to substitute a different microorganism from the EPA’s approved list. We could experience delays or disruptions in production while we convert to the new microorganism. In addition, any failure to comply with laws and regulations and any costs associated with unexpected and unintended releases of hazardous substances by us into the environment, or at disposal sites used by us, could expose us to substantial liability in the form of fines, penalties, remediation costs or other damages and could require us to shut down our operations. Any of these events would seriously harm our business and operating results.
WE MAY BE HELD LIABLE FOR ANY INACCURACIES ASSOCIATED WITH NUCLEIC ACID TESTS PERFORMED USING OUR PRODUCTS, WHICH MAY REQUIRE US TO DEFEND OURSELVES IN COSTLY LITIGATION.
We may be subject to claims resulting from incorrect results of analysis of nucleic acid tests performed using our products. Litigating any such claims could be costly. We could expend significant funds during any litigation proceeding brought against us. Further, if a court were to require us to pay damages to a plaintiff, the amount of such damages could significantly harm our business, financial condition and results of operations.
WE HAVE VARIOUS MECHANISMS IN PLACE THAT A STOCKHOLDER MAY NOT CONSIDER FAVORABLE AND WHICH MAY DISCOURAGE POTENTIAL ACQUISITIONS.
Certain provisions of our certificate of incorporation and bylaws, Section 203 of the Delaware General Corporation Law, and certain provisions in our executive compensation plans, long-term incentive plans and employment and similar agreements may discourage, delay or prevent potential acquisition transactions for our Company, including, in particular, unsolicited acquisition proposals. These provisions include:
•
authorizing our Board of Directors to issue preferred stock and to determine the price, privileges and other terms of these shares without any further approval of our stockholders, which could increase the number of outstanding shares or thwart an unsolicited takeover attempt;
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a shareholders rights plan under which rights holders (except the acquirer) would be entitled to acquire Third Wave common stock at a significant discount upon the occurrence of a person or group acquiring 15 percent or more of Third Wave’s common stock and which discourages acquisitions of 15 percent or more of Third Wave’s common stock without negotiation with the Board of Directors;
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establishing a classified Board of Directors with staggered, three-year terms, which may lengthen the time required to gain control of our Board of Directors;
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requiring super-majority voting to effect certain amendments to our certificate of incorporation and bylaws;
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limiting who may call special meetings of stockholders;
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prohibiting stockholder action by written consent, which requires all actions to be taken at a meeting of stockholders;
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establishing advance notice requirements for nominations of candidates for election to the Board of Directors or for proposing matters that can be acted upon by stockholders at stockholder meetings; and
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payments due to executive officers and other employees under executive compensation plans, long-term incentive plans and employment and similar agreements that could be triggered by certain change of control events.
A change of control could be beneficial to stockholders in a situation in which the acquisition price being paid by the party seeking to acquire us represented a substantial premium over the prevailing market price of our common stock. If our board of directors were not in favor of such a transaction, the provisions of our certificate of incorporation and bylaws described above could be used by our board of directors to delay or reduce the likelihood of completion of the acquisition.
OUR PRINCIPAL STOCKHOLDERS WILL HAVE SUBSTANTIAL CONTROL OVER OUR AFFAIRS.
As of December 31, 2007, stockholders that owned 5% or more of our outstanding shares owned, in the aggregate, approximately 17% of our common stock on a fully diluted basis. These stockholders, acting together, will have the ability to exert substantial influence over all matters requiring approval by our stockholders. These matters include the election and removal of directors and any merger, consolidation or sale of all or substantially all of our assets. In addition, they may dictate the management of our business and affairs. This concentration of ownership could have the effect of delaying, deferring or preventing a change in control, or impeding a merger or consolidation, takeover or other business combination of which you might otherwise approve.
RISKS RELATED TO THE BIOTECHNOLOGY INDUSTRY
PUBLIC OPINION REGARDING ETHICAL ISSUES SURROUNDING THE USE OF GENETIC INFORMATION MAY ADVERSELY AFFECT DEMAND FOR OUR PRODUCTS.
Public opinion regarding ethical issues related to the confidentiality and appropriate use of genetic testing results may influence governmental authorities to call for limits on, or regulation of the use of, genetic testing. In addition, such authorities could prohibit testing for genetic predisposition to certain conditions, particularly for those that have no known cure. Furthermore, adverse publicity or public opinion relating to genetic research and testing, even in the absence of any governmental regulation, could harm our business. Any of these scenarios could reduce the potential markets for our products, which could materially and adversely affect our revenues.
GOVERNMENT REGULATION OF GENETIC RESEARCH OR TESTING MAY ADVERSELY AFFECT THE DEMAND FOR OUR PRODUCTS AND IMPAIR OUR BUSINESS AND OPERATIONS.
Federal, state, local and foreign governments may adopt further regulations relating to the conduct of genetic research and genetic testing. These new regulations could limit or restrict genetic research activities as well as genetic testing for research or clinical purposes. In addition, if state and local regulations are adopted, these regulations may be inconsistent with, or in conflict with, regulations adopted by other state or local governments. Foreign regulations may be inconsistent with, or in conflict with U.S. regulations. Regulations relating to genetic research activities could adversely affect our ability to conduct our research and development activities. Regulations restricting genetic testing could adversely affect our ability to market and sell our products. Accordingly, any regulations of this nature could harm our business.
HEALTH CARE COST CONTAINMENT INITIATIVES COULD LIMIT THE ADOPTION OF GENETIC TESTING AS A CLINICAL TOOL, WHICH WOULD HARM OUR REVENUES AND PROSPECTS.
In recent years, health care payors as well as federal and state governments have focused on containing or reducing health care costs. We cannot predict the effect that any of these initiatives may have on our business, and it is possible that they will adversely affect our business. Health care cost containment initiatives focused on genetic testing could cause the growth in the clinical market for genetic testing to be curtailed or slowed. In addition, health care cost containment initiatives could also cause pharmaceutical companies to reduce research and development spending. In either case, our business and our operating results would be harmed. In addition, genetic testing in clinical settings is often billed to third-party payors, including private insurers and governmental organizations. If our current and future clinical products are not considered cost-effective by these payors, reimbursement may not be available to users of our products. In this event, potential customers would be much less likely to use our products, and our business and operating results would be seriously harmed.
REIMBURSEMENT FOR USE OF OUR PRODUCTS
Sales of our products will depend, in large part, on the availability of adequate reimbursement to users of those products from government insurance plans, managed care organizations and private insurance plans. Physicians’ recommendations to use our products are likely to be influenced by the availability of reimbursement by insurance companies and other third-party payors. There can be no assurance that insurance companies or third-party payors will provide or continue to provide coverage for our products or that reimbursement levels will be adequate for the reimbursement of the providers of our products. In addition, outside the U.S., reimbursement systems vary from country to country and there can be no assurances that third-party reimbursement will be made available at an adequate level, if at all, for our products under any other reimbursement system. Lack of or inadequate reimbursement by government or other third-party payors for our products would have a material adverse effect on our business, financial condition and results of operations.
ITEM 1B.
ITEM 1B.
UNRESOLVED STAFF COMMENTS.
None.
ITEM 2.
ITEM 2.
PROPERTIES
Our facility consists of space for research and development, manufacturing, product support operations, marketing and corporate headquarters and administration. Our facility is located in Madison, Wisconsin. Our facility is leased and described by the following:
We believe that our current facility will be adequate to meet our near-term space requirements. We also believe that suitable additional space will be available to us, if needed, on commercially reasonable terms.
ITEM 3.
ITEM 3.
LEGAL PROCEEDINGS
In October 2005, we filed a declaratory judgment suit in the United States District Court for the Western District of Wisconsin against Digene Corporation seeking a ruling that our HPV ASRs do not infringe any valid claims of Digene’s human papillomavirus related patents. In January 2006, we reached an agreement with Digene to dismiss the suit without prejudice. We also agreed that neither party would file a suit against the other relating to the human papillomavirus patents for one year. After this period expired, on January 11, 2007, Digene Corporation filed suit against us in the United States Court for the Western District of Wisconsin. The complaint alleged patent infringement of unidentified claims of a single patent related to HPV type 52 by the Company’s HPV ASR product. We filed our response to Digene’s complaint on February 28, 2007, which, in addition to denying the alleged infringement, also asserted that certain Digene sales practices violate certain antitrust laws. After conducting a hearing on June 22, 2007, the court released its claim construction order on July 23, 2007 adopting all of Third Wave’s proposed construction. On July 31, 2007, Digene filed a motion to reconsider the court’s claim construction. On September 26, 2007, the court issued an order denying Digene’s motion for reconsideration in its entirety and upheld the earlier claim construction ruling. In response, in a filing to the court, Digene stated that it “believes it will not be able to sustain its claim of infringement.” On October 19, 2007 Digene filed a motion for summary judgment on Third Wave’s antitrust counterclaims. On November 23, 2007 the court issued an order dismissing Digene’s patent infringement claims. On January 11, 2008, the court issued an order granting Digene’s motion for summary judgment on Third Wave’s antitrust counterclaims. Both the court’s Markman and summary judgment orders may be appealed to the Court of Appeals for the Federal Circuit.
While no assurance can be given regarding the outcome of the above matters, based on information currently available, the Company believes that the resolution of these matters will not have a material adverse effect on the financial position or results of future operations of the Company. However, because of the nature and inherent uncertainties of litigation, should the outcome of any of the actions be unfavorable, the Company’s business, financial condition, results of operations and cash flows could be materially adversely affected.
ITEM 4.
ITEM 4.
SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
ITEM 5.
ITEM 5.
MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Our common stock is quoted on the NASDAQ Stock Market under the symbol “TWTI”. The following table sets forth for each quarter in 2007 and 2006 the high and low sales prices per share, based on closing prices, for our common stock as reported on the NASDAQ Stock Market.
As of March 1, 2008, approximately 302 shareholders of record held our common stock.
We have never declared or paid any dividends on our capital stock. We currently expect to retain future earnings, if any, to support the development of our business and do not anticipate paying any cash dividends in the foreseeable future.
STOCKHOLDER RETURN PERFORMANCE GRAPH
The following graph compares the percentage change in the cumulative return on our common stock against the NASDAQ Stock Market U.S. Index (the “NASDAQ Index”) and a peer group composed of the companies listed below (the “Peer Group”). The graph assumes a $100 investment on December 31, 2001 in each of our common stock, the NASDAQ Index and the Peer Group and assumes that all dividends, if paid, were reinvested. This table does not forecast future performance of our common stock.
The Former Peer Group consists of the following companies: Gen-Probe Incorporated, Celera Diagnostics, LLC, Ventana Medical Systems, Inc., Qiagen N.V., Bio-Rad Laboratories, Inc.
The Current Peer Group consists of the following companies: Gen-Probe Incorporated, Celera Diagnostics, LLC, Ventana Medical Systems, Inc., Qiagen N.V., Bio-Rad Laboratories, Inc., Nanogen, Inc., Luminex Corporation.
The Company changed its peer group to account for companies that have been acquired and add companies of a similar size.
ITEM 6.
ITEM 6.
SELECTED FINANCIAL DATA
The following table summarizes certain selected financial data that is derived from our audited financial statements. All the information should be read in conjunction with our audited financial statements and notes thereto and with Management’s Discussion and Analysis of Financial Condition and Results of Operations, which are included elsewhere in this Form 10-K.
ITEM 7.
ITEM 7.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with “Selected Financial Data” and our financial statements, including the notes thereto, included elsewhere in this Form 10-K.
OVERVIEW
Third Wave Technologies, Inc. is a leading molecular diagnostics company. We believe our proprietary Invader chemistry, a novel, molecular chemistry, is easier to use and more accurate than competing technologies. These and other advantages conferred by our chemistry are enabling us to provide clinicians and researchers with superior molecular solutions.
More than 215 clinical laboratory customers are using Third Wave’s molecular diagnostic reagents. Other customers include pharmaceutical and biotechnology companies, academic research centers and major health care providers. The Company has consistently grown its core clinical diagnostic revenues for the last ten consecutive quarters and in 2007, the clinical revenues grew 25% over prior year.
Currently, one of our key strategic initiatives is the commercialization of our Human Papillomavirus (HPV) offering. In August 2006, we began clinical trials for two HPV premarket approval submissions to the FDA. We expect to spend $17-18 million on these submissions over three years. If for any reason these trials are not successful or are substantially delayed or for any other reason we are unable to successfully commercialize our HPV offering, our business and prospects would likely be materially adversely impacted. Additionally, we anticipate significant competition in the HPV market as additional large competitors have announced plans to enter the market in the near future. This competition may have a significant impact on the success of our commercialization of our HPV offering.
We market a growing number of products, including analyte specific reagents (ASRs). These ASRs allow certified clinical reference laboratories to create assays to perform hepatitis C virus genotyping, inherited disorders testing (e.g., Factor V Leiden), and a host of other mutations associated with genetic predispositions and other diseases (e.g. Cystic Fibrosis). We have developed or plan to develop a menu of molecular diagnostic products for clinical applications that include women’s health applications, hospital acquired infections, genetics and pharmacogenetics, and oncology. We also have a number of other Invader products including those for research, agricultural and other applications.
The FDA has issued a guidance document regarding the sale of ASRs. This guidance document may negatively impact our ability to continue to successfully market and sell our ASR products.
In August 2005, we received clearance from the FDA for our Invader UGT1A1 Molecular Assay. The Invader UGT1A1 Molecular Assay is cleared for use to identify patients who may be at increased risk of adverse reaction to the chemotherapy drug Camptosar® (irinotecan) by detecting and identifying specific mutations in the UGT1A1 gene that have been associated with that risk. Camptosar, marketed in the U.S. by Pfizer, Inc., is used to treat colorectal cancer and was relabeled in 2005 to include dosing recommendations based on a patient’s genetic profile. In December 2006, we submitted a cystic fibrosis product to the FDA.
Our financial results may vary significantly from quarter to quarter due to fluctuations in the demand for our products, timing of new product introductions and deliveries made during the quarter, the timing of research, development and grant revenues, and increases in spending, including expenses related to our product development submissions for FDA clearances or approvals and intellectual property litigation.
CRITICAL ACCOUNTING POLICIES
Management’s discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the U.S. We review the accounting policies we use in reporting our financial results on a regular basis. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates, including those related to accounts receivable, inventories, equipment and leasehold improvements and intangible assets. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Results may differ from these estimates due to actual outcomes being different from those on which we based our assumptions. These estimates and judgments are reviewed by management on an ongoing basis, and by the Audit
Committee at the end of each quarter prior to the public release of our financial results. We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements.
REVENUE RECOGNITION
Revenue from product sales is recognized upon delivery which is generally when the title passes to the customer, provided that the Company has completed all performance obligations and the customer has accepted the products. Customers have no contractual rights of return or refunds associated with product sales. Consideration received in multiple element arrangements is allocated to the separate units based upon their relative fair values. The multiple element arrangements involve contracts with customers in which the Company is selling reagent products and leasing equipment to the customer for use during the term of the contract. Based upon the guidance in paragraph 9 of Emerging Issues Task Force (EITF) No. 00-21 “Revenue Arrangements with Multiple Deliverables,” both the reagents and equipment have value to the customer on a standalone basis, there is objective and reliable evidence of fair value for both the reagents and equipment and there are no rights of return. The Company has sold both the reagents and equipment separately, and therefore is able to determine a fair value for each. The respective fair values are used to allocate the proceeds received to each of the elements for purposes of recognizing revenue.
Grant revenues consist primarily of research grants from agencies of the federal government, the revenue from which is recognized as research is performed. Payments received which are related to future performance are deferred and recorded as revenue when earned.
License and royalty revenue includes amounts earned from third parties for licenses of the Company’s intellectual property and are recognized when earned under the terms of the related agreements. License revenues are generally recognized upon receipt unless the Company has continuing performance obligations, in which case the license revenue is recognized ratably over the period of expected performance.
LONG-LIVED ASSETS - IMPAIRMENT
Equipment, leasehold improvements and other intangible assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. For assets held and used, if the sum of the expected undiscounted cash flows is less than the carrying value of the related asset or group of assets, a loss is recognized for the difference between the fair value and carrying value of the asset or group of assets. For assets removed from service and held for sale, we estimate the fair market value of such assets and record an adjustment if fair value less costs to sell is lower than carrying value. There was no impairment in 2007 and 2006. An impairment loss of $203,000 was recorded in 2005 related to the write-down of certain equipment to its fair value.
Goodwill is not amortized, but is subject to an annual impairment test under Statement of Financial Accounting Standards (“SFAS”) No. 142, Goodwill and Other Intangible Assets. We completed annual impairment tests in the quarters ended September 30, 2007, 2006, and 2005 and concluded that no goodwill impairment existed.
INVENTORIES - SLOW MOVING AND OBSOLESCENCE
Significant management judgment is required to determine the reserve for obsolete or excess inventory. Inventory on hand may exceed future demand either because of process improvements or technology advancements, the amount on hand is more than can be used to meet future need, or estimates of shelf lives change. We currently consider all inventory that we expect will have no activity within one year or within the period defined by the expiration date of the product, as well as any additional specifically identified inventory (including inventory that we determine to be obsolete based on criteria such as changing manufacturing processes and technologies) to be excess inventory. At December 31, 2007 and 2006, our inventory reserves were $616,000, or 11% of our $5.6 million total gross inventories, and $655,000 or 16% of our $4.2 million total gross inventories, respectively.
STOCK-BASED COMPENSATION EXPENSE
Prior to 2006, we accounted for share-based payments to employees using Accounting Principles Board (APB) Opinion No. 25’s intrinsic value method and, as such, generally recognized no compensation cost for employee stock options when granted. On January 1, 2006 we adopted SFAS No. 123(R) “Share-Based Payments” as a result of which we recognize expense for all share-based payments to employees, including grants of employee stock options and restricted stock units, based on their fair values. We have adopted the modified prospective transition method as permitted by SFAS No. 123(R).
In October 2006, our audit committee concluded a voluntary investigation of the Company’s historical stock option granting practices and related accounting. This investigation, which was conducted with the assistance of outside legal counsel, covered the timing, pricing and authorization of all our stock option grants made since our initial public offering in February 2001. Based on this review, it was determined that incorrect measurement dates were used with respect to the accounting for certain previously granted stock options, primarily during the years 2002 through 2004. The audit committee concluded that deficiencies in the grant process were the result of administrative errors and misunderstanding of applicable accounting rules, and were not attributable to fraud or intentional misconduct.
We recorded an additional stock-based compensation charge totaling $176,000 in the quarter ended September 30, 2006, representing the effect of the immaterial adjustment resulting from the charges discussed above that relate to 2006. Additionally, we recorded a reclassification between accumulated deficit and additional paid in capital, within the equity section of the consolidated balance sheet as of December 31, 2006, of approximately $731,000. This reclassification represents the effect of the immaterial adjustment resulting from the charges discussed above that related to fiscal year 2005 and prior years. There were no significant income tax effects relating to this adjustment for the Company.
RESULTS OF OPERATIONS
Years Ended December 31, 2007 and 2006
Revenues. Revenues for the year ended December 31, 2007 of $31.1 million represented an increase of $3.1 million as compared to revenues of $28.0 million for the year ended December 31, 2006. Following is a discussion of changes in revenues:
Clinical molecular diagnostic product revenues increased to $26.3 million in 2007 from $20.9 million in 2006. The increase in revenue is due to an increase in the number of customers buying our products and growth in purchases from current customers. We expect our clinical molecular diagnostic revenues to continue to increase in 2008.
Research product revenues decreased significantly to $4.6 million in the year ended December 31, 2007 from $6.8 million in the year ended December 31, 2006. The decrease in research product sales during 2007 resulted from a significant decrease in genomic research product sales to a Japanese research institute for use by several end users compared to the prior year.
License and royalty revenue was $0.3 million in 2007 compared to $0.2 million in 2006.
Significant Customers. We generated $8.9 million, or 29% of revenues, from sales to a small number of large clinical testing laboratories (Quest Diagnostics, Inc., Mayo Medical Laboratories, Kaiser Permanente, Spectrum Laboratory Network, and Berkeley Heart Laboratories) during the year ended December 31, 2007, compared to $8.5 million, or 30% of revenues, in 2006.
Cost of Goods Sold. Cost of goods sold consists of materials used in the manufacture of product, depreciation on manufacturing capital equipment, salaries and related expenses for management and personnel associated with our manufacturing and quality control departments and amortization of licenses and other intangible assets. Cost of goods sold remained consistent despite increased revenue at $8.4 million for the years ended December 31, 2007 and December 31, 2006 due to operating improvements in manufacturing.
Research and Development Expenses. Our research activities are focused on moving our technology into broader markets. Our development activities are focused on new products to expand our molecular diagnostics menu. Research and development expenses consist primarily of salaries and related personnel costs, material costs for assays and product development, fees paid to consultants, depreciation and facilities costs and other expenses related to the design, development, testing, (including clinical trials to validate the performance of our products) and enhancement of our products, and acquisition of technologies used in our products. Research and development costs are expensed as they are incurred. Research and development expenses were $22.8 million for the year ended December 31, 2007, an increase of $10.4 million, compared to $12.4 million for the year ended December 31, 2006. The increase in research and development expenses was primarily due to an increase in personnel related expenses, and an increase in product development expense (including clinical trial costs incurred by us in pursuit of FDA premarket approval for our HPV offerings) of $8.5 million. We will continue to invest in research and development, and expenditures in this area will increase as we expand our product development efforts.
Selling and Marketing Expenses. Selling and marketing expenses consist primarily of salaries and related personnel costs for our sales and marketing management and field sales force, commissions, office support and related costs, and travel and entertainment. Selling and marketing expenses for the year ended December 31, 2007 were $11.5 million, an increase of $0.4 million, as compared to $11.1 million for the year ended December 31, 2006. The increase is mainly attributable to increase in consulting and personnel related expenses.
General and Administrative Expenses. General and administrative expenses consist primarily of salaries and related expenses for executive, finance and other administrative personnel, legal and professional fees, office support and depreciation. General and administrative expenses decreased to $14.3 million for the year ended December 31, 2007, from $14.8 million for the year ended December 31, 2006. The decrease in general and administrative expenses was primarily due to a decrease in personnel related expenses, sales tax charges and consulting fees totaling $1.6 million, offset by an increase in stock-based compensation of $1.1 million.
Litigation Expense. Litigation expense consists of legal fees and other costs associated with patent infringement and other lawsuits. Litigation expense increased to $5.3 million in the year ended December 31, 2007 from $1.6 million in 2006. The increase was due primarily to costs associated with the successful patent infringement lawsuit against Stratagene Corporation and the increased litigation activity in the patent infringement lawsuit with Digene Corporation.
Restructuring. In the year ended December 31, 2006 a restructuring adjustment credit of $0.2 million was recorded to account for changes in the building lease payments.
Interest Income. Interest income for the year ended December 31, 2007 was $2.0 million, compared to $1.5 million for the year ended December 31, 2006.
Interest Expense. Interest expense for the years ended December 31, 2007 was $1.3 million compared to $0.2 million in 2006. The increase in interest expense was due to the interest accretion on the convertible note payable we issued in December 2006.
Other Income (Expense). Other income was $13.1 million during 2007, compared to an expense of $0.2 million in 2006. Other income for the year ended December 31, 2007 included $10.75 million from the settlement of patent litigation with Stratagene Corporation and the reversal of certain accruals no longer deemed probable of payment.
Minority Interest. Minority interest represents Third Wave Japan’s minority investors’ percentage share of the equity and earnings of the subsidiary. Minority interest for the year ended December 31, 2007 was $0.6 million compared to $0.2 million for the year ended December 31, 2006.
Years Ended December 31, 2006 and 2005
Revenues. Revenues for the year ended December 31, 2006 of $28.0 million represented an increase of $4.1 million as compared to revenues of $23.9 million for the year ended December 31, 2005. Following is a discussion of changes in revenues:
Total clinical molecular diagnostic product revenue increased to $20.9 million in 2006 from $15.7 million in 2005.
Research product revenues decreased to $6.8 million in the year ended December 31, 2006 from $7.5 million in the year ended December 31, 2005. The decrease in research product sales during 2006 resulted from a decrease in genomic research product sales to a Japanese research institute for use by several end users compared to prior year offset by an increase in product sales from Agbio.
License and royalty revenue was $0.2 million in the year ended December 31, 2006 compared to $0.4 million in 2005. In the year ended December 31, 2005, we received royalty revenue of $250,000 from Monogram Biosciences (formerly Aclara), per the license and supply agreement.
Significant Customers. In 2006, we generated $8.5 million, or 30% of our revenue, from sales to a small number of large clinical testing laboratories (Quest Diagnostics, Inc., Mayo Medical Laboratories, Kaiser Permanente, Spectrum Laboratory Network, and Berkeley Heart Laboratories), compared to $6.4 million, or 27% of our revenue, in 2005.
In addition, $2.8 million, or 10% of our revenues, were generated from sales to a major Japanese research institute for use by several end-users during the year ended December 31, 2006, compared to $3.9 million, or 16% of our revenues, in 2005.
Cost of Goods Sold. Cost of goods sold consists of materials used in the manufacture of product, depreciation on manufacturing capital equipment, salaries and related expenses for management and personnel associated with our manufacturing and quality control departments and amortization of licenses and settlement fees. For the year ended December 31, 2006, cost of goods sold increased to $8.4 million, compared to $7.1 million for the year ended December 31, 2005. The increase was due to increased sales volume and amortization of new licenses obtained in 2006.
Research and Development Expenses. Research and development expenses for the year ended December 31, 2006 were $12.4 million, compared to $8.4 million for the year ended December 31, 2005. The increase in research and development expenses was primarily due to an increase in personnel, product development expense (including costs incurred by us in pursuit of FDA premarket approval for our HPV offering), and an increase in stock based compensation expense of $1.1 million compared to 2005.
Selling and Marketing Expenses. Selling and marketing expenses consist primarily of salaries and related personnel costs for our sales and marketing management and field sales force, commissions, office support and related costs, and travel and entertainment. Selling and marketing expenses for the year ended December 31, 2006 were $11.1 million, a decrease of $1.7 million, as compared to $12.8 million for the year ended December 31, 2005. The decrease was attributable to a decrease in personnel related expenses and travel, offset by an increase in stock based compensation expense of $0.8 million.
General and Administrative Expenses. General and administrative expenses consist primarily of salaries and related expenses for executive, finance and other administrative personnel, legal and professional fees, office support and depreciation. General and administrative expenses increased to $14.8 million for the year ended December 31, 2006, from $11.8 million for the year ended December 31, 2005. The increase in general and administrative expenses was primarily due to an increase in legal expense related to our patents, a sales tax charge and an increase in stock based compensation expense of $1.9 million.
Litigation Expense. Litigation expense consists of legal fees and other costs associated with patent infringement and other lawsuits. Litigation expense decreased to $1.6 million in the year ended December 31, 2006 from $6.9 million in 2005. The decreases were the result of the decreased Stratagene Corporation litigation
expenses and the resolution of certain lawsuits with Innogenetics, Chiron Corporation, Bayer Corporation, and Digene Corporation.
Impairment Loss. In the year ended December 31, 2005 we recorded an impairment charge of $0.2 million for the loss on equipment that was sold.
Restructuring. In the year ended December 31, 2006 a restructuring adjustment credit of $0.2 million was recorded to account for changes in the building lease payments.
Interest Income. Interest income for the year ended December 31, 2006 was $1.5 million, compared to $1.7 million for the year ended December 31, 2005.
Interest Expense. Interest expense for the year ended December 31, 2006 was $0.2 million compared to $0.5 million in 2005.
Other Income (Expense). Other expense for the year ended December 31, 2006 was approximately $0.2 million compared to $0.4 million for the same period in 2005. The change in other expense was primarily due to the adjustments related to foreign currency transactions in the periods.
Minority Interest. Minority interest for the year ended December 31, 2006 was $0.2 million. Minority interest represents Third Wave Japan’s minority investors’ percentage share of the equity and earnings of the subsidiary.
LIQUIDITY AND CAPITAL RESOURCES
Since our inception, we have financed our operations primarily through private placements of equity securities, research grants from federal and state government agencies, payments from strategic collaborators, equipment loans, capital leases, sale of products, a convertible note and our initial public offering.
In April 2006 we raised $5.1 million from the sale of a minority equity investment in our Japan subsidiary. In May 2007 we raised an additional $5.3 million from the sale of additional minority equity investments in our Japan subsidiary. The proceeds from the equity investment are required to be used in the operations of our Japan subsidiary.
In December 2006 we sold $20,000,000 (at maturity) of Convertible Senior Subordinated Zero-Coupon Promissory Notes (the “Notes”) to an investor for total proceeds of $14,881,878 (the “Purchase Price”). The Notes will mature on December 19, 2011. The Notes do not bear cash interest but accrue original issue discount on the Purchase Price at the rate of 6.00% per year compounded semiannually (the Purchase Price plus such accrued original issue discount, the “Accreted Value”). So long as the Notes remain outstanding, we may not incur indebtedness other than certain Permitted Indebtedness, as such term is defined in the Notes.
The Notes are convertible at the holder’s option into shares of Third Wave common stock at a rate of 124.01565 shares per $1,000 of principal at maturity ($744 of Purchase Price) or a total of 2,480,313 shares. Pursuant to the securities purchase agreement under which we sold the Notes, in January 2007 we filed a registration statement with the Securities and Exchange Commission for resale of the shares of common stock issuable upon conversion of the Notes.
After December 19, 2008, if Third Wave common stock closes above $9.00 (150% of the initial conversion price) for 20 consecutive trading days, we may force the conversion of the Notes so long as there is an effective registration statement covering the Common Stock in place. At any time after December 19, 2009, we may redeem the Notes for an amount equal to their Accreted Value. If either an event of default occurs under the Notes (which would include failure to make any payments due under the Notes and certain defaults under other indebtedness) or a change of control occurs with respect to Third Wave, the holders of the Notes may put the Notes to Third Wave for a purchase price equal to 110% of their Accreted Value.
On May 31, 2007, TWT Japan entered into a Series A Preferred Stock Purchase Agreement with Mitsubishi, CSK, BML, Inc., Daiichi Pure Chemicals Co., Ltd., Toppan Printing Co., Ltd. and Shimadzu Corporation. Under this purchase agreement, these investors purchased (¥)640.1 million (approximately $5.3 million) of TWT Japan Series A convertible preferred stock, representing, approximately 12.9% of TWT Japan’s outstanding shares and
approximately 12.4% of its outstanding equity on a fully-diluted basis. As a result of the transaction and the prior investments made by Mitsubishi and CSK in April 2006, outside investors own approximately 27.5% of TWT Japan prior to the exercise of outstanding warrants or 31% after exercise of the warrants. The proceeds from these equity investments are required to be used in the operations of TWT Japan.
In December 2007, we entered into a five-year $25 million line of credit with Deerfield Capital Management (“Deerfield”), a health care investment fund. We may borrow up to $25 million under the credit facility at an annual fixed interest rate of 7.75%. The credit facility matures in December 2012 at which time all outstanding loans are required to be paid. Interest on outstanding loans is payable quarterly. An annual 2% non-usage fee is assessed on any undrawn portion of the credit facility. The non-usage fee is payable quarterly. As of December 31, 2007, we had not drawn any funds under the credit facility. In consideration for providing the credit facility, we issued the lenders five-year stock warrants to purchase 1,815,000 shares of Third Wave common stock at a price of $8.36 per share. Pursuant to a registration rights agreement entered into in connection with the closing under the line of credit, in January 2008 we filed a registration statement with the Securities and Exchange Commission for resale of the shares of common stock issuable upon exercise of the warrants.
As of December 31, 2007 and 2006, we had cash, cash equivalents and short-term investments of $35.7 million and $44.2 million, respectively.
Net cash used in operations for the year ended December 31, 2007 was $14.1 million, $14.2 million in 2006 and $17.8 million in 2005.
Net cash used in investing activities for the year ended December 31, 2007 was $2.5 million, compared to net cash provided of $8.0 million in 2006, and net cash used of $1.2 million in 2005. Capital expenditures were $2.6 million in the year ended December 31, 2007, compared to $1.1 million in 2006 and $0.4 million in 2005. The increase in capital expenditures in 2007 was due to building improvements to the corporate headquarters. Proceeds from the sale of equipment in 2007 was less than $0.1 million and $0.2 million in 2005. In the year ended December 31, 2007, the net cash provided from the purchases and maturities of short-term investments was $1.4 million, compared to $9.3 million in 2006 and $35,000 in 2005. In 2006 and 2005, we purchased certificates of deposit to collateralize our term loan and letter of credit with a bank. Additionally, in 2005, $0.8 million was transferred to a bank account to collateralize our note with a bank. In the year ended December 31, 2007, $1.3 million was used to purchase licensed technology, compared to $0.9 million in 2006 and $0.2 million in 2005.
Net cash provided by financing activities was $9.1 million in the year ended December 31, 2007, compared to $21.1 million in the year ended December 31, 2006 and net cash used of $9.0 million in 2005. Cash provided by financing activities in the year ended December 31, 2007, consisting of proceeds from the issuance of common stock through stock option exercises and our employee stock purchase plan of $5.7 million, compared to $1.6 million in 2006 and $0.9 million in 2005. Financing activities in the year ended December 31, 2007 and 2006 also included proceeds from a minority equity investment in our Japan subsidiary of $5.3 million and $5.1 million, respectively. Cash used for the repayment of debt in December 31, 2007, 2006 and 2005 was $0.6 million, $0.4 million, and $9.7 million in 2007, 2006, and 2005, respectively. In 2007, 2006 and 2005, $0.1 million was used for capital lease obligation payments. In 2006, financing activities included proceeds from the issuance of long-term debt in the form of zero-coupon convertible promissory notes of $14.9 million, compared to proceeds from debt issued of $0.8 million in 2005. In 2005, $0.9 million was used to repurchase 218,000 shares of common stock. Additionally, in relation to the issuance of the $25.0 million credit facility, $1.1 million of debt issue costs were paid during 2007.
In 2005, we won a $5.29 million judgment against Stratagene Corporation in connection with a patent infringement suit. The Court subsequently tripled that judgment and awarded us interest and attorneys fees of $4.2 million. On January 29, 2007, we entered into an out-of-court settlement with Stratagene regarding this litigation under which Stratagene agreed to pay us $10.75 million in cash to satisfy the outstanding judgment.
As of December 31, 2007 and 2006, a valuation allowance equal to 100% of our net deferred tax assets was recognized since future realization was not assured. At December 31, 2007, we had federal and state net operating loss carryforwards of approximately $160 million. The net operating loss carryforwards will expire at various dates beginning in 2008, if not utilized. Utilization of the net operating losses to offset future taxable income may be
subject to an annual limitation due to the change of ownership provisions of federal tax laws and similar state provisions as a result of our initial public offering in February 2001.
We cannot assure you that our business or operations will not change in a manner that would consume available resources more rapidly than anticipated. We also cannot assure you that we will not require substantial additional funding before we can achieve profitable operations. Our capital requirements depend on numerous factors, including the following:
•
our progress with our research and development programs;
•
the needs we may have to pursue FDA clearances or approvals of our products;
•
our level of success in selling our products and technologies;
•
our ability to establish and maintain successful collaborations;
•
the costs we incur in securing intellectual property rights, whether through patents, licenses or otherwise;
•
the costs we incur in enforcing and defending our patent claims and other intellectual property rights;
•
the timing of additional capital expenditures;
•
the need to respond to competitive pressures; and
•
the possible acquisition of complementary products, businesses or technologies.
CONTRACTUAL OBLIGATIONS
The following summarizes our contractual obligations at December 31, 2007 and the effect those obligations are expected to have on our liquidity and cash flow in future periods (in thousands):
In December 2007, we entered into a five-year $25 million line of credit with Deerfield Capital Management (“Deerfield”), a health care investment fund. We may borrow up to $25 million under the credit facility at an annual fixed interest rate of 7.75%. The credit facility matures in December 2012 at which time all outstanding loans are required to be repaid. Interest on outstanding loans is payable quarterly. An annual 2% non-usage fee is assessed on any undrawn portion of the credit facility. The non-usage fee is payable quarterly. As of December 31, 2007, we had not drawn any funds under the credit facility.
OFF-BALANCE SHEET ARRANGEMENTS
We had no off-balance sheet arrangements as of December 31, 2007.
ITEM 7A.
ITEM 7A.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our exposure to market risk is currently confined to changes in foreign exchange and interest rates. The securities in our investment portfolio are not leveraged and, due to their short-term nature, are subject to minimal interest rate risk. We currently do not hedge interest rate exposure. Due to the short-term maturities of our investments, we do not believe that an increase in market rates would have any negative impact on the realized value of our investment portfolio.
Our earnings are affected by fluctuations in the value of the U.S. Dollar against foreign currencies as a result of the sales of our products in foreign markets. From time to time we may purchase forward foreign exchange contracts to hedge against the effects of such fluctuations. At December 31, 2007, we did not hold any forward foreign exchange contracts. Our policy prohibits the trading of financial instruments for profit. A discussion of our accounting policies for derivative financial instruments is included in the notes to the financial statements.
ITEM 8.
ITEM 8.
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
CONSOLIDATED FINANCIAL STATEMENTS
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Shareholders
Third Wave Technologies, Inc.
We have audited Third Wave Technologies, Inc.’s (a Delaware Corporation) internal control over financial reporting as of December 31, 2007, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Third Wave Technologies, Inc.’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Controls Over Financial Reporting. Our responsibility is to express an opinion on Third Wave Technologies, Inc.’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, Third Wave Technologies, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2007, based on criteria established in Internal Control - Integrated Framework issued by COSO.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Third Wave Technologies, Inc. and subsidiaries as of December 31, 2007 and 2006, and the related consolidated statements of operations, shareholders’ equity and comprehensive income (loss), and cash flows for the years then ended, and our report dated March 7, 2008 expressed an unqualified opinion on those financial statements.
GRANT THORNTON LLP
Madison, Wisconsin
March 7, 2008
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Shareholders
Third Wave Technologies, Inc.
We have audited the accompanying consolidated balance sheets of Third Wave Technologies, Inc. (a Delaware corporation) and its subsidiaries as of December 31, 2007 and 2006, and the related consolidated statements of operations, shareholders’ equity and comprehensive income (loss), and cash flows for each of the three years in the period ended December 31, 2007. Our audit of the basic financial statements included the financial statement schedule listed in the index appearing under Item 15(a)(2). These consolidated financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Third Wave Technologies, Inc. as of December 31, 2007 and 2006, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2007 in conformity with accounting principles generally accepted in the United States of America.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Third Wave Technologies, Inc.’s internal control over financial reporting as of December 31, 2007, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our report dated March 7, 2008 expressed an unqualified opinion on the effectiveness of Third Wave Technologies, Inc.’s internal control over financial reporting.
GRANT THORNTON LLP
Madison, Wisconsin
March 7, 2008
Third Wave Technologies, Inc.
Consolidated Balance Sheets
See accompanying notes to the consolidated financial statements
Third Wave Technologies, Inc.
Consolidated Statements of Operations
See accompanying notes to the consolidated financial statements
Third Wave Technologies, Inc.
Consolidated Statement of Shareholders’ Equity and Comprehensive Income (Loss)
See accompanying notes to the consolidated financial statements
Third Wave Technologies, Inc.
Consolidated Statements of Cash Flows
See accompanying notes to the consolidated financial statements
Third Wave Technologies, Inc.
Notes to Consolidated Financial Statements
December 31, 2007
1.
NATURE OF OPERATIONS AND PRINCIPLES OF CONSOLIDATION
PRINCIPLES OF CONSOLIDATION
The accompanying consolidated financial statements include the accounts of Third Wave Technologies, Inc. (the Company) and its majority-owned and wholly-owned subsidiaries, Third Wave-Japan KK and Third Wave Agbio, Inc. (Agbio). All significant intercompany balances and transactions are eliminated in the consolidation.
NATURE OF OPERATIONS
The Company is a leading molecular diagnostics company. The Company believes its proprietary Invader chemistry is easier to use and more accurate than competing technologies. These and other advantages conferred by the Company’s chemistry are enabling the Company to provide physicians and researchers with superior molecular solutions for the analysis and treatment of disease.
The Company currently markets products domestically and internationally to clinical and research markets using an internal sales force as well as collaborative relationships with pharmaceutical companies and research institutions. Revenues to a major Japanese research institute for use by several end users during 2007, 2006 and 2005 were 3%, 10% and 16% of total revenues, respectively. Revenues to a small number (5) of large clinical testing laboratories during 2007, 2006, and 2005 were 29%, 30%, and 27% of total revenues, respectively. The Company performs periodic credit evaluations of its customers’ financial condition and generally does not require collateral. The Company evaluates the collectibility of its accounts receivable based on a combination of factors. For accounts greater than 60 days past due, an allowance for doubtful accounts is recorded based on a customer’s ability and likelihood to pay based on management’s review of the facts. For all other accounts, the Company recognizes an allowance based on the length of time the receivable is past due and the anticipated future write offs based on historical experience.
2.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
A summary of the significant accounting policies consistently applied in the preparation of the accompanying financial statements follows.
CASH EQUIVALENTS, SHORT-TERM INVESTMENTS, AND RESTRICTED CASH
The Company considers highly liquid money market investments and short-term investments with original maturities of 90 days or less from the date of purchase to be cash equivalents.
Short-term investments consist of certificates of deposit with original maturities less than one year. The cost of these securities, which are considered “available-for-sale” for financial reporting purposes, approximates fair value at December 31, 2007 and 2006.
In April 2006 and May 2007, Third Wave Japan, KK (TWT Japan) a majority owned subsidiary of the Company, entered into a Series A Preferred Stock purchase agreement (See Note 5). The proceeds from the sale of the stock are required to be used in the operations of TWT Japan.
Significant noncash investing and financing activities are as follows:
•
During the years ended December 31, 2006 and 2005, the Company entered into capital lease obligations of $58,659 and $184,452, respectively.
•
During the year ended December 31, 2005 the Company entered into a license agreement in which the Company will pay $2,000,000 over time through 2010. The estimated present value of the license obtained was $1,772,172.
Third Wave Technologies, Inc.
Notes to Consolidated Financial Statements - (Continued)
•
During the year ended December 31, 2006, the Company entered into a license agreement under which the Company will pay 1,000,000 Euros over two years. The estimated present value of the license was $1,122,338.
•
During the year ended December 31, 2007, the Company entered into a license agreement under which the Company will pay $1,250,000 over three years. The estimated present value of the license was $1,150,700.
•
During the year ended December 31, 2007, the Company issued 79,441 shares of common stock as partial payment of amounts earned by employees under the 2006 incentive plan.
•
During the year ended December 31, 2007, the Company issued 1,815,000 million stock warrants as consideration for a five-year $25 million credit facility. The fair value of the stock warrants on the date of issuance was $9,238,350 which is recorded in Other Assets on the consolidated balance sheet as a debt issuance cost and is being amortized over the term of the credit facility.
INVENTORIES
Inventories are carried at the lower of cost or market using the first-in, first-out method for determining cost and consist of the following:
FOREIGN CURRENCY TRANSLATION
The Company’s Japanese subsidiary uses the local currency as its functional currency. Accordingly, assets and liabilities are translated into U.S. dollars at year-end exchange rates, and revenues and expenses are translated at weighted-average exchange rates. The resulting translation adjustment is recorded as a separate component of shareholders’ equity and will be included in the determination of net income (loss) only upon sale or liquidation of the subsidiary.
EQUIPMENT AND LEASEHOLD IMPROVEMENTS
Equipment and leasehold improvements are recorded at cost less accumulated depreciation and amortization. Depreciation of purchased equipment is computed by the straight-line method over the estimated useful lives of the assets which are three to ten years. Amortization of leasehold improvements and leased equipment is computed by the straight-line method over the shorter of the estimated useful lives of the assets or the remaining lease term.
PATENTS
Patent-related development costs are expensed in the period incurred and are included in general and administrative expenses in the statements of operations. These costs were $1,004,763, $1,207,425, and $1,000,990 in 2007, 2006 and 2005, respectively.
GOODWILL AND OTHER INTANGIBLE ASSETS
Under Statement of Financial Accounting Standards (SFAS) No. 142, Goodwill and Other Intangible Assets, goodwill and intangible assets deemed to have indefinite lives are not amortized, but are subject to annual impairment tests. In 2006, the Company evaluated the other intangible assets with indefinite lives and determined
Third Wave Technologies, Inc.
Notes to Consolidated Financial Statements - (Continued)
that a useful life of ten years should be assigned to these intangible assets. The Company has reclassified these assets to other intangible assets at December 31, 2007 and 2006.
The Company completed its annual impairment tests in the third quarter of 2007, 2006 and 2005. For goodwill, this analysis is based on the comparison of the fair value of its reporting units to the carrying value of the net assets of the respective reporting units. The fair value of the reporting units was determined using a combination of discounted cash flows method and other common valuation methodologies. The Company concluded that no impairment existed at the time of the annual impairment test in 2007, 2006 and 2005.
Amortizable intangible assets consist of the following:
The estimated future amortization expense related to intangible assets for the years subsequent to December 31, 2007 is as follows:
IMPAIRMENT OF LONG-LIVED ASSETS
Equipment and leasehold improvements are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. If the sum of the expected undiscounted cash flows is less than the carrying value of the related asset or group of assets, a loss is recognized for the difference between the fair value and carrying value of the asset or group of assets. Such analyses involve significant judgment. There was no impairment in 2007 and 2006. The Company recorded an impairment loss of $203,000 in 2005, related to a write-down of certain equipment to its fair value.
CAPITALIZED LICENSE FEES
Capitalized license fees at December 31, 2007 and 2006 were $2,875,015 and $2,624,580, respectively, (which is net of accumulated amortization of $4,815,235 and $3,714,968, respectively) for licenses paid to third parties for the use of patented technology. The assets are being amortized to expense over the shorter of the term of the license or the estimated useful lives of the assets (two to ten years).
DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
The Company sells its products in a number of countries throughout the world. During 2007, 2006, and 2005, the Company sold certain products with the resulting accounts receivable denominated in Japanese Yen. The Company may from time to time purchase foreign currency forward contracts to manage the risk associated with collections of receivables denominated in foreign currencies in the normal course of business. These derivative instruments have maturities of less than one year and are intended to offset the effect of currency gains and losses on
Third Wave Technologies, Inc.
Notes to Consolidated Financial Statements - (Continued)
the underlying Yen receivables. There were no contracts outstanding at December 31, 2007, 2006 and 2005. Aggregate losses (gains) from foreign currency transactions are included in other income (expense) and were approximately $127,000, $183,000, and $451,000 in 2007, 2006 and 2005, respectively.
REVENUE RECOGNITION
Revenue from product sales is recognized upon delivery which is generally when the title passes to the customer, provided that the Company has completed all performance obligations and the customer has accepted the products. Customers have no contractual rights of return or refunds associated with product sales. Consideration received in multiple element arrangements is allocated to the separate units based upon their relative fair values. The multiple element arrangements involve contracts with customers in which the Company is selling reagent products and leasing equipment to the customer for use during the term of the contract. Based upon the guidance in paragraph 9 of Emerging Issues Task Force (EITF) No. 00-21 Revenue Arrangements with Multiple Deliverables, both the reagents and equipment have value to the customer on a standalone basis, there is objective and reliable evidence of fair value for both the reagents and equipment and there are no rights of return. The Company has sold both the reagents and equipment separately, and therefore is able to determine a fair value for each. The respective fair values are used to allocate the proceeds received to each of the elements for purposes of recognizing revenue.
Grant revenues consist primarily of research grants from agencies of the federal government, the revenue from which is recognized as research is performed. Payments received which are related to future performance are deferred and recorded as revenue when earned.
License and royalty revenue includes amounts earned from third parties for licenses of the Company’s intellectual property and are recognized when earned under the terms of the related agreements. License revenues are generally recognized upon receipt unless the Company has continuing performance obligations, in which case the license revenue is recognized ratably over the period of expected performance. Royalty revenues are recognized under the terms of the related agreements, generally upon manufacture or shipment of a product by a licensee.
RESEARCH AND DEVELOPMENT
All costs for research and development activities are expensed in the period incurred.
SHIPPING AND HANDLING COSTS
Shipping and handling costs incurred are classified as cost of goods sold in the accompanying statements of operations.
INCOME TAXES
Deferred income taxes are recognized for the tax consequences in future years of differences between the tax bases of assets and liabilities and their financial reporting amounts at each year-end based on enacted tax laws and statutory tax rates applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized. Income tax expense is the current tax payable for the period plus or minus the change during the period in deferred tax assets and liabilities. In 2006 and 2007, no current or deferred income taxes have been provided because of the net operating losses incurred by the Company (see Note 6).
STOCK-BASED COMPENSATION
The Company has stock-based employee compensation plans and an employee stock purchase plan (Purchase Plan) (see Note 5). Prior to January 1, 2006, the Company used the intrinsic value method prescribed in Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations, in accounting for stock options granted to employees under our Plans. Generally, no compensation cost was required
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Notes to Consolidated Financial Statements - (Continued)
to be recognized for options granted to employees because the options had an exercise price equal to the market value per share of the underlying common stock on the date of grant. Prior to 2006, the Purchase Plan was considered noncompensatory under APB Opinion No. 25 and, therefore, no expense was recorded for the 15% discount.
Prior to January 1, 2006, options granted to non-employee consultants were accounted for in accordance with SFAS No. 123 Accounting for Stock-Based Compensation and Emerging Issues Task Force (EITF) Issue No. 96-18, Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services, and therefore were measured based upon their fair value as calculated using the Black-Scholes option pricing model. The fair value of options granted to non-employees was periodically remeasured as the underlying options vested.
On January 1, 2006, the Company adopted SFAS No. 123(R) (revised 2004), Share-Based Payment (SFAS No. 123(R)), to account for its stock option plans, which is a revision of SFAS No. 123 and SFAS No. 95 Statement of Cash Flows. SFAS No. 123(R) permits public companies to adopt its requirements using one of two methods: (1) a “modified prospective” method in which compensation cost is recognized beginning with the effective date (a) based on the requirements of SFAS No. 123(R) for all-share based payments granted after the effective date and (b) based on the requirements of SFAS No. 123 for all awards granted to employees prior to the effective date of SFAS No. 123(R) that remain unvested on the effective date; or (2) a “modified retrospective” method which includes the requirements of the modified prospective method described above, but also permits entities to restate based on the amounts previously recognized under SFAS No. 123 for purposes of pro forma disclosures either (a) all prior periods presented or (b) prior interim periods of the year of adoption. The Company adopted SFAS 123(R) using the modified prospective approach. Under this transition method, compensation cost recognized for the years ended December 31, 2006 and 2007 includes the cost for all stock options granted prior to, but not yet vested as of January 1, 2006. This cost was based on the grant-date fair value estimated in accordance with the original provisions of SFAS No. 123. The cost for all share-based awards granted subsequent to December 31, 2005, represents the grant-date fair value that was estimated in accordance with the provisions of SFAS No. 123(R). Results for prior periods have not been restated. Compensation cost for options will be recognized in earnings, net of estimated forfeitures, on a straight-line basis over the requisite service period. There were no capitalized stock-based compensation costs at December 31, 2007. Consistent with the Company’s treatment of net operating loss carry forwards and offsetting valuation allowance, stock-based compensation expense in the table below does not reflect any income tax effect.
Included in operating expenses are the following stock compensation charges, net of reversals for terminated employees:
The stock-based compensation expense attributable to SFAS No. 123(R) for the year ended December 31, 2007 and 2006 was $2.2 million and $2.7 million, respectively.
Third Wave Technologies, Inc.
Notes to Consolidated Financial Statements - (Continued)
The weighted-average fair value of stock options granted in the years ended December 31, 2007, 2006 and 2005 was $3.97, $2.03, and $2.82, respectively, using the Black-Scholes option-pricing model. The calculations were made using the following assumptions:
The expected volatility is based on the historical volatility of the Company’s stock. The Company uses historical option activity to estimate the expected term of the options and the option exercise and employee termination behavior. The Company considers all employees to have similar exercise behavior and therefore has not identified separate homogeneous groups for valuation. The expected term of the options represents the period of time the options granted are expected to be outstanding. The risk-free interest rate for periods within the contractual term of the options is based on the U.S. Treasury constant maturity interest rate whose term is consistent with the expected life of the stock options.
As prescribed in the modified prospective approach, prior periods have not been restated to reflect the effects of implementing SFAS No. 123(R). The following table illustrates the effect on net loss and net loss per share as if the Company had applied the fair-value recognition provisions of SFAS 123(R) to all stock option plans for the year ended December 31, 2005, for purposes of this pro forma disclosure:
Review of Stock Option Grants and Procedures
In October 2006, the Company’s audit committee concluded a voluntary investigation of the Company’s historical stock option granting practices and related accounting. This investigation, which was conducted with the assistance of outside legal counsel, covered the timing, pricing and authorization of all the Company’s stock option grants made since the Company’s initial public offering in February 2001. Based on this review, the Company determined that it used incorrect measurement dates with respect to the accounting for certain previously granted stock options, primarily during the years 2002 through 2004. The audit committee concluded that deficiencies in the grant process were the result of administrative errors and misunderstanding of applicable accounting rules, and were not attributable to fraud or intentional misconduct.
Based upon the Company’s determination that certain of its historic stock option grants had intrinsic value on the grant date, the Company had unrecorded stock compensation expense. The Company has concluded that the
Third Wave Technologies, Inc.
Notes to Consolidated Financial Statements - (Continued)
additional unrecorded stock compensation expense is not material to its financial statements in any of the periods to which such charges would have related, and therefore did not revise its historic financial statements.
The Company recorded an additional stock-based compensation charge totaling $176,000 in the quarter ended September 30, 2006, representing the effect of the adjustment resulting from the charges discussed above that relate to 2006. Additionally, the Company recorded a reclassification between accumulated deficit and additional paid-in capital, within the equity section of the consolidated balance sheet for the fiscal year ending December 31, 2006, of approximately $731,000. This reclassification represents the effect of the adjustment resulting from the charges discussed above that related to fiscal 2005 and prior years. There were no significant income tax effects relating to this adjustment for the Company.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amounts of the Company’s financial instruments, which include cash and cash equivalents, short-term investments, accounts receivable, accounts payable, capital lease obligations and long-term debt are considered to approximate their respective fair values.
USE OF ESTIMATES
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.
NET LOSS PER SHARE
Basic and diluted net loss per share has been computed using the weighted-average number of shares of common stock outstanding during the respective periods. The effect of stock options is antidilutive for all periods presented due to the existence of net losses.
The following table presents the calculation of basic and diluted net loss per share.
NEW ACCOUNTING PRONOUNCEMENTS
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities - Including an amendment of FASB Statement No. 115 (SFAS No. 159). SFAS No. 159 permits entities to elect to measure financial assets and financial liabilities, and certain other items at fair value. SFAS No. 159 is effective as of the beginning of the first fiscal year that begins after November 15, 2007, and therefore its provisions will be applied for the Company on January 1, 2008. We do not expect the implementation of SFAS No. 159 to have a material impact on the Company’s consolidated financial statements.
Third Wave Technologies, Inc.
Notes to Consolidated Financial Statements - (Continued)
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (SFAS No. 157). This Statement defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. This Statement is effective for financial statements issued for fiscal years beginning after November 15, 2007, and therefore its provisions will be adopted by the Company on January 1, 2008. The Company does not expect the implementation of SFAS No. 157 to have a material impact on the Company’s consolidated financial statements.
In November 2007, the EITF reached a consensus on EITF Issue No. 07-1, Accounting for Collaborative Arrangements (EITF 07-1). EITF 07-1 provides guidance on the identification of collaborative arrangements and establishes reporting requirements for transactions between participants in a collaborative arrangement and between participants in the arrangement and third parties. EITF 07-1 is effective for fiscal years beginning after December 15, 2008, and interim periods within those financial years, and therefore would be effective for the Company beginning January 1, 2009. The Company is evaluating the impact EITF 07-1 will have on its consolidated financial statements.
In December 2007, the FASB issued SFAS No. 141 (revised 2007), Business Combinations (SFAS No. 141(R)). SFAS No. 141(R) revises SFAS No. 141 on establishing the requirements in recognizing and measuring identifiable assets acquired and liabilities assumed within a business combination, any noncontrolling interest, goodwill acquired in a business combination or a gain from a bargain purchase, and any applicable disclosures needed to evaluate the nature and financial effect of a business combination. SFAS No. 141 is effective the first annual reporting period beginning on or after December 15, 2008, and therefore would be effective for the Company beginning January 1, 2009. The Company does not expect the implementation of SFAS No. 141(R) to have a material impact on the Company’s consolidated financial statements.
In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements, an amendment of ARB No. 51 (SFAS No. 160). SFAS 160 amends ARB No. 51 to establish accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary, in which the noncontrolling interest will be reclassified as equity; and the income, expense and comprehensive income from a noncontrolling interest will be fully consolidated. SFAS 160 is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008, and therefore would be effective for the Company beginning January 1, 2009. The Company is evaluating the impact SFAS 160 will have on its consolidated financial statements.
3.
CHANGE IN ACCOUNTING ESTIMATE
The Company has intangible assets for a technology license and trademark related to the purchase of the remaining 50% of Third Wave Agbio in 2001. At the time of purchase, the life of the intangible assets was determined to be indefinite, and therefore, such assets were recorded as indefinite lived intangible assets, subject to annual impairment tests. During the fourth quarter of 2006, the Company in its evaluation of the life on the intangible assets determined that a definite life should be assigned to the assets. The intangible assets have been reclassified as amortizable intangible assets on the balance sheet as of December 31, 2006 with a useful life of ten years. The related amortization expense in 2007 and 2006 was $100,740 and $8,395, respectively.
4.
LONG-TERM DEBT
Long-term debt is as follows:
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Notes to Consolidated Financial Statements - (Continued)
Future long-term debt payments, as of December 31, 2007, by year are as follows:
In December 2006, the Company issued a convertible senior subordinated zero-coupon promissory note with a maturity date of December 19, 2011 for proceeds of $14,881,878. No payments are required on the note until maturity at which time the principal amount of $20,000,000 is due. Original interest discount (OID) accrues at a rate of 6% per year on the accreted value of the note. The holder may convert each $1,000 of principal at maturity into 124.01565 shares of Third Wave common stock or the entire principal amount of the note into a total of 2,480,313 shares. In addition, after the second anniversary of the issue date, the Company has the right to require the holder to convert all or a portion of the balance remaining under the note into shares of common stock, provided that closing price of the Company stock exceeds $9.00 (150% of the initial conversion price) for twenty consecutive trading days. At any time after December 19, 2009, Third Wave may redeem the note for an amount equal to its accreted value. If either an event of default occurs under the note (which would include failure to make any payments due under the note and certain defaults under other indebtedness) or a change of control occurs with respect to Third Wave, the holder of the note may put the note to Third Wave for a purchase price equal to 110% of its accreted value.
At December 31, 2006, the Company had three notes payable to a bank in the original amounts of $200,000, $270,000, and $800,000. These additional notes had respective final maturity dates of July 1, 2007, October 1, 2009, and July 1, 2008, bore annual interest at 4.25%, 4.93%, and 5.2%, respectively, and required monthly principal and interest payments. During 2007, all three outstanding notes payable to the bank were fully paid. The Company also had an available and unused $1,000,000 letter of credit with the same bank that expired on September 1, 2007.
In December 2007, the Company entered into a five-year $25 million line of credit (credit facility) with Deerfield Capital Management, a health care investment fund. Third Wave may borrow up to $25 million under the credit facility at an annual fixed interest rate of 7.75%. The credit facility matures in December 2012 at which time all outstanding loans are required to be repaid. Interest on outstanding loans is payable quarterly. An annual 2% non-usage fee is assessed on any undrawn portion of the credit facility. The non-usage fee is payable quarterly. As of December 31, 2007, the Company has not drawn on any funds under the credit facility. The Company paid a transaction fee of $625,000 and $500,000 of additional closing costs related to the transaction, which have been capitalized as Other Assets on the consolidated balance sheet and will be amortized over the five year term of the credit facility. There was approximately $19,000 of amortization recognized during the year ended December 31, 2007.
Additionally, in consideration for providing the credit facility, the Company issued the lenders five-year stock warrants to purchase 1,815,000 shares of Third Wave common stock at a price of $8.36 per share. The Company valued the warrants using the Black - Scholes option pricing model using the following assumptions: (1) risk-free interest rate of 3.35%, (2) volatility of 60%, (3) expected life of five years, and (4) zero dividend yield. Based upon these assumptions, the fair value of the stock was valued at $9,238,350. The stock warrants were recognized as a liability under EITF 00-19. Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock and are reported within Other Liabilities on the consolidated balance sheet. The fair value has been capitalized under Other Assets on the consolidated balance sheet and will be amortized over the five year term of the credit facility. There was approximately $104,000 of amortization expense recognized during the year ended December 31, 2007. As of December 31, 2007, the warrants have not been exercised.
Third Wave Technologies, Inc.
Notes to Consolidated Financial Statements - (Continued)
5.
SHAREHOLDERS’ EQUITY
The Company purchases shares of its common stock to cover employee related taxes withheld on vested restricted shares. In 2007, the Company repurchased and retired approximately 10,000 shares of its common stock for an aggregate cost of approximately $53,000.
MINORITY INTEREST IN SUBSIDIARY
In April 2006, Third Wave Japan, K.K., (TWT Japan) a wholly-owned subsidiary of the Company, entered into a Series A Preferred Stock and Warrant Purchase Agreement with Mitsubishi Corporation (Mitsubishi) and CSK Institute for Sustainability, LTD. (CSK) (collectively, the Investors). Under the Purchase Agreement, Mitsubishi invested (¥)480 million (approximately $4.2 million) and CSK invested (¥)100 million (approximately $878,000) in TWT Japan in exchange for convertible, Series A preferred stock of TWT Japan and warrants to purchase an additional (¥)100 million (approximately $878,000) worth of TWT Japan common stock. Pursuant to the transaction, the Investors acquired approximately 17% of TWT Japan prior to the exercise of the warrant or 20% after exercise of the warrant.
On May 31, 2007, TWT Japan entered into a Series A Preferred Stock Purchase Agreement with Mitsubishi, CSK, BML, Inc., Daiichi Pure Chemicals Co., Ltd., Toppan Printing Co., Ltd. and Shimadzu Corporation. Under this purchase agreement, these investors purchased (¥)640.1 million (approximately $5.3 million) of TWT Japan Series A convertible preferred stock, representing, approximately 12.9% of TWT Japan’s outstanding shares and approximately 12.4% of its outstanding equity on a fully-diluted basis. As a result of the transaction and the prior investments made by Mitsubishi and CSK in April 2006, outside investors own approximately 27.5% of TWT Japan prior to the exercise of outstanding warrants or 31% after exercise of the warrants. The proceeds from these equity investments are required to be used in the operations of TWT Japan.
At the time of the original investment, minority interest of $704,000 was recorded on the consolidated balance sheet to reflect the share of the net assets of TWT Japan held by minority investors. After the second investment, an additional $210,000 was recorded as minority interest on the consolidated balance sheet to reflect the increased share of the net assets of TWT Japan held by investors. For the year ended December 31, 2007 and 2006, minority interest was reduced by approximately $448,000 and $239,000 for the minority investors’ share of the net losses and change in foreign currency translation adjustments of TWT Japan.
STOCK PURCHASE PLAN
The Company has an Employee Stock Purchase Plan (Purchase Plan) under which an aggregate of 1,256,800 common shares may be issued. All employees are eligible to participate in the Purchase Plan. Eligible employees may make contributions through payroll deductions of up to 10% of their compensation. The price of common stock purchased under the Purchase Plan is 85% of the lower of the fair market value of the common stock at the beginning or end of the offering period. There were 184,133, 124,747, and 114,562 shares sold to employees in the years ended December 31, 2007, 2006, and 2005, respectively. At December 31, 2007, approximately 122,000 shares were available for issuance under the Purchase Plan.
STOCK OPTION PLANS
The Company has Incentive Stock Option Plans for its employees and Nonqualified Stock Option Plans (collectively, the Plans) for employees and non-employees under which stock options and stock purchase rights (including restricted stock units (RSUs)) may be granted to purchase an aggregate of 13,213,183 shares of common stock. Options under the Plans have a maximum life of ten years. Options vest at various intervals, as determined by the compensation committee of the Board of Directors at the date of grant.
Third Wave Technologies, Inc.
Notes to Consolidated Financial Statements - (Continued)
The rollforward of shares available for grant through December 31, 2007, is as follows:
The Company’s option activity is as follows:
Third Wave Technologies, Inc.
Notes to Consolidated Financial Statements - (Continued)
The options outstanding at December 31, 2007 have been segregated into the following ranges for additional disclosure:
The aggregate intrinsic value of options exercised in the years ended December 31, 2007, 2006, and 2005 was $6.1 million, $0.9 million and $0.7 million, respectively. As of December 31, 2007, there was approximately $2.0 million of total unrecognized compensation cost related to the stock options granted under the plans.
During 2007, 2006 and 2005, in connection with employee terminations, the Company extended the exercise period and accelerated vesting for certain option grants. Accordingly, the options had a new measurement date and were expensed based upon their new intrinsic value or fair value. In December 2005, the Company accelerated vesting for all outstanding options with an exercise price per share of $5.00 or above. The options also had a new measurement date and were expensed based upon their new intrinsic value. Also, options granted to non-employee consultants are accounted for in accordance with SFAS No. 123(R) and EITF No. 96-18, and therefore are measured based upon their fair value as calculated using the Black-Scholes option pricing model. The fair value of options granted to non-employees is periodically remeasured as the underlying options vest. Option expense related to such terminations, modifications and consulting arrangements in 2007, 2006, and 2005 was $2,133,760, $866,441 and ($368,977), respectively.
Restricted Stock Units
The Company’s stock plan also permits the granting of restricted stock units (RSUs) to eligible employees, consultants and non-employee directors. Restricted stock units are payable in shares of Company stock upon vesting. The restricted stock units vest at various intervals as determined by the compensation committee of the Board of Directors at the date of grant. The following table presents a summary of the Company’s nonvested restricted stock units granted to employees as of December 31, 2007.
As of December 31, 2007, there was approximately $1.8 million of total unrecognized compensation cost related to the nonvested restricted stock units granted under the plan. The expense is expected to be recognized over
Third Wave Technologies, Inc.
Notes to Consolidated Financial Statements - (Continued)
the vesting period. Compensation expense related to restricted stock units was approximately $381,000 in the year ended December 31, 2007. As of December 31, 2007, there were 555,859 restricted stock units outstanding.
6.
INCOME TAXES
At December 31, 2007, the Company had net operating loss carryforwards of approximately $160 million for U.S. federal and state income tax purposes, which expire beginning in 2008. In the event of a change in ownership greater than 50% in a three-year period, utilization of the net operating losses may be subject to a substantial annual limitation due to the ownership change limitations provided by the Internal Revenue Code of 1986 and similar state provisions.
There was no provision for income taxes in 2007, 2006 and 2005 due to the net operating loss.
The types of temporary differences between tax bases of assets and liabilities and their financial reporting amounts that give rise to the deferred tax asset (liability) and their approximate tax effects are shown below.
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Notes to Consolidated Financial Statements - (Continued)
The Company’s provision for income taxes differs from the expected tax benefit amount computed by applying the federal income tax rate to loss before taxes as a result of the following:
At December 31, 2007, the Company had $39,000 of AMT credits which do not expire. The valuation allowance at December 31, 2007 and 2006 was provided because of the Company’s history of net losses and uncertainty as to the realization of the deferred tax assets. As a result, the Company believes it is more likely than not that the deferred tax assets will not be realized. Through December 31, 2007, the Company’s foreign subsidiary has operated at a loss, and accordingly, no provision for U.S. deferred taxes has been provided. Any earnings of the foreign subsidiary would be considered to be permanently invested.
Effective January 1, 2007, the Company adopted FASB Interpretation No. 48 Accounting for Uncertainty in Income Taxes (FIN No. 48), which clarifies the accounting for uncertainty in income taxes recognized in the financial statement in accordance with FASB Statement No. 109 Accounting for Income Taxes. This interpretation prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken, or expected to be taken, in a tax return. There were no significant matters determined to be unrecognized tax benefits taken or expected to be taken in a tax return that have been recorded on the Company’s consolidated financial statements for the year ended December 31, 2007.
Additionally, FIN No. 48 provides guidance on the recognition of interest and penalties related to income taxes. There were no interest or penalties related to income taxes that have been accrued or recognized as of and for the years ended December 31, 2007, 2006 and 2005.
The Company files income tax returns in the United States federal jurisdiction and in various state and local jurisdictions. The Company has not been examined by any federal, state or local jurisdictions in which it is subject to income tax and therefore would be subject to the statute of limitations for the respective jurisdictions.
7.
LEASE OBLIGATIONS
The Company leases its corporate facility under an operating lease effective through September 2014. The lease agreement required a $1,000,000 upfront payment and required the Company to provide the landlord an irrevocable standby letter of credit of $1,000,000, which is collateralized by a certificate of deposit included in short-term investments. The lease agreement was amended in 2006 to extend the term of the lease on that portion of the leased premises comprising the “New Building Addition” (approximately 70% of leased space) to September 2014, and to reduce the $1,905,502 addition improvement rent balance on such New Building Addition to $1,000,000 payable in four equal installments in 2007. Rent expense is being recorded by the Company on a straight-line basis over the amended lease term. Under the amended lease agreement, at December 31, 2006 the Company recognized $640,000 of prepaid rent and a credit balance of $1,103,000 for deferred rent, reported as other assets on the consolidated balance sheet.
In July 2007, the Company entered into a new lease agreement which supercedes the previous amended lease agreement for its corporate facility. Under the new lease, the Company reduced the total leased space (by approximately 29%) and the required $1,000,000 standby letter of credit requirement was removed in August 2007.
Third Wave Technologies, Inc.
Notes to Consolidated Financial Statements - (Continued)
Rent expense is being recorded by the Company on a straight-line basis over the amended lease term. Under the amended lease agreement, at December 31, 2007, the Company recognized $1,601,000 of prepaid rent and a credit balance of $961,000 for deferred rent, reported as other assets on the consolidated balance sheet.
In 2006, the Company entered into multiple capital leases for computer equipment, office equipment and furniture, totaling approximately $59,000.
Future minimum lease payments as of December 31, 2007 by year are approximately as follows:
Rent expense was approximately $1,407,000, $1,991,000, and $2,167,000 in 2007, 2006 and 2005, respectively.
8.
LONG-TERM ASSETS:
Other long-term assets consist of the following:
Third Wave Technologies, Inc.
Notes to Consolidated Financial Statements - (Continued)
9.
LICENSE AGREEMENTS
The Company entered into an exclusive license agreement (research license) in March 1994 to make, use and sell products utilizing the licensed patents in the research market. The Company also entered into an equity agreement with the licensor in March 1994 whereby it issued 115,200 shares of common stock in exchange for the research license and diagnostic market option, which is an exclusive license agreement to make, use and sell products utilizing the licensed patents in the diagnostic market. In October 1998, the Company issued 103,200 shares to the licensor to exercise the diagnostic market option. The shares issued in 1994 and 1998 were valued at amounts considered to approximate the fair value of common stock at the time of each issuance.
Under this agreement, the Company granted the licensor a put option to sell a specified number of shares back to the Company anytime after March 1, 1998. The total number of shares that can be put to the Company cannot exceed the number of shares necessary to achieve a purchase price of $200,000. At December 31, 2007, the price per share to be paid if the put option is exercised is $11.00. Accordingly, the Company has classified $200,000 of additional paid-in capital outside of shareholders’ equity in other liabilities in the accompanying balance sheets.
In October 2001, the Company entered into a development, license and supply agreement with RIKEN, Inc. (RIKEN). The Company licensed certain patent rights relating to polymorphism in genes that encode drug metabolizing enzymes from RIKEN for a nonrefundable fee which is reported as capitalized license fee on the consolidated balance sheet and is being amortized over its estimated useful life (7.5 years). In 2003, the Company and RIKEN entered into an additional license for similar content. The Company also pays royalties based upon net sales of licensed products in exclusive and nonexclusive territories.
In December 2005, the Company entered into a nonexclusive sublicense agreement for certain patent rights involving multiplex polymerase chain reaction (PCR) technology for a nonrefundable fee of $2,000,000. This technology permits the Company to develop and market multiplex Invader Plus products. The estimated present value of the fee of $1.8 million is reported as capitalized license fee on the consolidated balance sheet and is being amortized over its estimated useful life (8 years). The future payments under this license arrangement are as follows:
In January 2006, the Company entered into a two year nonexclusive license agreement for certain patent rights involving Hepatitis C (HCV) technology for a nonrefundable fee of 1,000,000 Euros. Upon expiration of the initial license period, the Company may extend the license upon payment of a second license fee. This license permits the Company to market and sell HCV Invader products in the U.S. The estimated present value of the fee of $1.1 million is reported as capitalized license fee on the consolidated balance sheet and is being amortized over its estimated useful life (2 years).
In September 2007, the Company entered into a nonexclusive license agreement for certain patent rights involving technology in the detection of cervical chlamydia trachomatis infection (CT) for a nonrefundable fee of $1,250,000. This license permits the Company to develop, manufacture and sell CT Invader products. The estimated
Third Wave Technologies, Inc.
Notes to Consolidated Financial Statements - (Continued)
present value of the fee of $1,150,700 is recorded as capitalized license fee on the consolidated balance sheet and is being amortized over its estimated useful life. The future payments under this license arrangement are as follows:
In addition, the Company licensed rights to patents and/or patent applications covering genetic variations associated with certain diseases for which the Company has designed clinical diagnostic products.
10.
COLLABORATIVE AGREEMENTS
In December 2000, the Company entered into a development and commercialization agreement with BML, Inc. (BML). Under this agreement, the Company developed assays in accordance with a mutually agreed development program for use in clinical applications by BML. In 2007, 2006 and 2005, BML paid the Company $988,000, $854,000 and $575,000 respectively, for product which was recognized as revenue as the product was shipped.
On October 16, 2002, the Company entered into a license and supply agreement with Aclara Biosciences, Inc., which was acquired by Monogram Biosciences in December 2004. Under this agreement, Monogram has the non-exclusive right to incorporate the Company’s Invadertm technology and Cleavase® enzyme with Monograms’s eTagtm technology to offer the eTag Assay System for multiplexed gene expression applications for the research market. In exchange, Monogram made certain upfront payments and will make royalty payments to the Company on sales of eTag-Invader gene expression assays. The Company has also provided Monogram with certain manufacturing materials for use in manufacturing Invader products. The Company received royalty revenue of $250,000 in 2005.
11.
401(k) PLAN
The Company has a 401(k) savings plan (the Plan) which covers substantially all employees. The Plan provides for Company contributions of 50% of employee contributions up to 6% of their compensation. Company contributions to the plan were approximately $372,000, $294,000, and $377,000 in 2007, 2006 and 2005, respectively.
12.
LONG-TERM INCENTIVE PLANS
The Company has Long-Term Incentive Plans (LTIP) in place which compensate certain employees if performance targets are met over the three-year performance period. The amount of compensation is determined by the level of achievement against the performance targets. The compensation earned is paid in the two years following the performance period. The performance targets are based upon revenue, stock price and stock performance as compared to a peer group. The Company estimates for the liability are based on forecasts and other available information, and the likelihood of achieving the performance target levels. The accrual involves significant judgment and estimates, and therefore, it is reasonably possible that a change in estimate may occur in future periods as a result of changes in the achievement or expected achievement of the performance targets. As of December 31, 2007 and 2006, the Company has accrued $2,291,332 and $1,885,989, respectively, for the plans.
The Company recorded expense related to the LTIP plans of $405,344, $573,148 and $434,716 in 2007, 2006, and 2005, respectively.
Third Wave Technologies, Inc.
Notes to Consolidated Financial Statements - (Continued)
13.
SETTLEMENT
In September 2004, the Company filed a suit against Stratagene Corporation alleging patent infringement of two patents concerning the Company’s proprietary Invader chemistry. The case was tried before a jury in August 2005, and the jury found that Stratagene willfully infringed the Company’s patents and that the patents were valid and awarded $5.29 million in damages. The Court subsequently tripled that judgment and awarded the Company interest and attorneys fees of $4.2 million. Stratagene appealed the verdict to the Court of Appeals for the Federal Circuit in Washington, D.C.
On January 29, 2007, the Company and Stratagene entered into an out-of-court settlement regarding this litigation. Under the terms of the settlement Stratagene paid the Company $10.75 million in cash to satisfy the outstanding judgment and dropped its appeal in its entirety. The parties also agreed to dismiss all litigation, including the suit filed by Stratagene against Third Wave in the District of Delaware.
14.
LONG-TERM LIABILITIES
Other long-term liabilities consist of the long-term portion of the following items:
15.
PAYROLL AND RELATED LIABILITIES
Accrued payroll and related liabilities consisted of the following as of December 31, 2007 and 2006:
16.
LITIGATION
In October 2005, we filed a declaratory judgment suit in the United States District Court for the Western District of Wisconsin against Digene Corporation seeking a ruling that our HPV ASRs do not infringe any valid claims of Digene’s human papillomavirus related patents. In January 2006, we reached an agreement with Digene to dismiss the suit without prejudice. We also agreed that neither party would file a suit against the other relating to the Digene human papillomavirus patents for one year. After this period expired, on January 11, 2007, Digene Corporation filed suit against us in the United States Court for the Western District of Wisconsin. The complaint alleged patent infringement of unidentified claims of a single patent related to HPV type 52 by the Company’s HPV ASR product. Our response to Digene’s complaint was filed, denying the alleged infringement and asserting that certain Digene sales practices violate certain antitrust laws. The court released its claim construction order, adopting all of Third Wave’s proposed construction. Digene filed a motion to reconsider the court’s claim construction and the court issued an order denying Digene’s motion for reconsideration in its entirety and upheld the
Third Wave Technologies, Inc.
Notes to Consolidated Financial Statements - (Continued)
earlier claim construction ruling. In response, in a filing to the court, Digene stated that it “believes it will not be able to sustain its claim of infringement.” On November 23, 2007 the court issued an order dismissing Digene’s patent infringement claims. On October 19, 2007 Digene filed a motion for summary judgment on Third Wave’s antitrust counterclaims. On January 11, 2008, the court issued an order granting Digene’s motion for summary judgment on Third Wave’s antitrust counterclaims. Both the court’s Markman and summary judgment orders may be appealed to the Court of Appeals for the Federal Circuit.
Litigation expense consists of legal fees and other costs associated with patent infringement and other lawsuits. Litigation expense for the years ended December 31, 2007 and 2006 were $5,277,108 and $1,610,495, respectively.
17.
SEGMENT DISCLOSURE
The Company operates in one industry segment. Product revenues to international end-users accounted for 11%, 17%, and 27% of product revenues in 2007, 2006 and 2005, respectively. At December 31, 2007 and 2006, approximately $706,000 and $312,000 respectively, of receivables are denominated in Yen. Product revenues by geographic area in 2007, 2006 and 2005, were as follows:
18.
RECLASSIFICATION
Certain reclassifications have been made to the 2006 financial statements to conform to the 2007 presentation.
19.
QUARTERLY FINANCIAL DATA (UNAUDITED)
The following sets forth selected quarterly financial information for the years ended December 31, 2007 and 2006 (in thousands, except per share data). The operating results are not necessarily indicative of results for any future period.
ITEM 9.
ITEM 9.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A.
ITEM 9A.
CONTROLS AND PROCEDURES
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
As required by Rule 13a-15(b) under the Securities Exchange Act of 1934, the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, conducted an evaluation as of the end of the period covered by this report, of the effectiveness of the Company’s disclosure controls and procedures as defined in Rules 13a-15(e) under the Securities Exchange Act of 1934. Based on that evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective as of the end of the period covered by this report. There have been no significant changes during the period covered by this report in the Company’s internal control over financial reporting or in other factors that could significantly affect internal control over financial reporting.
EVALUATION OF INTERNAL CONTROL OVER FINANCIAL REPORTING
The management of Third Wave Technologies is responsible for establishing and maintaining adequate internal control over financial reporting. Third Wave’s internal control system was designed to provide reasonable assurance to the Company’s management and board of directors regarding the preparation and fair presentation of published financial statements.
All internal control systems, no matter how well designed, have inherent limitations. Even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation.
Third Wave’s management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2007, using the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control - Integrated Framework. Based on management’s assessment, management concluded that, as of December 31, 2007, the Company’s internal control over financial reporting was effective.
Third Wave’s independent registered public accounting firm has issued an audit report on the effectiveness of the Company’s internal control over financial reporting, which is included herein.
ITEM 9B.
ITEM 9B.
OTHER INFORMATION
None.
PART III
Items 10 through 14 are incorporated herein by reference to the following sections of the Company’s Proxy Statement for the Annual Meeting of Stockholders to be held on July 22, 2008: Election of Directors, Board of Directors and Committees - Audit Committee, Compensation Committee Interlocks and Insider Participation, Director Compensation, Ratification of Appointment of Independent Registered Public Accounting Firm, Compensation Committee Report, Executive Compensation, Equity Compensation Plan Information, Executive Officers, Security Ownership of Certain Beneficial Owners and Management, Section 16(a) Beneficial Ownership Reporting Compliance, Certain Relationships and Related Transactions and Code of Business Conduct.
PART IV
ITEM 15.
ITEM 15.
EXHIBITS, FINANCIAL STATEMENTS AND SCHEDULES
(a) Documents Filed as a Part of this Report.
1. Financial Statements. The financial statements required to be filed as part of this Report are listed on page 38.
2. Financial Statement Schedules. The following financial statement schedule required to be filed as part of this Report is included on page 70.
Schedule II - Valuation and Qualifying Accounts. Schedules not included have been omitted because they are not applicable.
3. Exhibits. The exhibits required to be filed as a part of this Report are listed in the Exhibit Index.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on March 7, 2008.
THIRD WAVE TECHNOLOGIES, INC.
By:
/s/ Kevin T. Conroy
Kevin T. Conroy
Chief Executive Officer
POWER OF ATTORNEY
We, the undersigned directors and executive officers of Third Wave Technologies, Inc., hereby severally constitute and appoint of Cindy Ahn our true and lawful attorney and agent, with full power to her to sign for us, and in our names in the capacities indicated below, any and all amendments to the Annual Report on Form 10-K of Third Wave Technologies, Inc. filed with the Securities and Exchange Commission, hereby ratifying and confirming our signatures as they may be signed by our said attorney to any and all amendments to said Annual Report on Form 10-K.
Pursuant to the requirements of the Securities and Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated on dates indicated.
EXHIBIT INDEX
*
Indicates a management contract or compensatory plan or arrangement
SCHEDULE II: VALUATION AND QUALIFYING ACCOUNTS
YEARS ENDED DECEMBER 31, 2007, 2006, AND 2005
(1)
Represents amounts written off or disposed, net of recoveries.