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SQNM > SEC Filings for SQNM > Form 10-K on 2-Apr-2013All Recent SEC Filings

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Form 10-K for SEQUENOM INC


2-Apr-2013

Annual Report


Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Introduction
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the consolidated financial statements and the notes to such statements included elsewhere in this report. This discussion and analysis may contain forward-looking statements that involve risks and uncertainties. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of certain factors, such as those set forth under the heading "Risk Factors," and elsewhere in this report.
All references to 2012, 2011 and 2010 refer to our calendar years ended December 31, 2012, 2011, and 2010, respectively.
Overview
We are a life sciences company providing innovative genetic analysis solutions to improve healthcare through our two operating segments:
Molecular Diagnostics, in which our wholly-owned molecular diagnostic reference laboratory, Sequenom Center for Molecular Medicine, LLC or Sequenom CMM performs molecular diagnostic testing services utilizing its laboratory-developed tests (LDTs) which are currently focused on noninvasive prenatal and women's health related diagnostics and ophthalmology-related diagnostics and plans to develop or acquire additional diagnostic tests in those and other fields including autoimmunity, neurology and oncology. Patient samples are collected by health care professionals and submitted to Sequenom CMM for testing and test results are reported back to the ordering physician. Sequenom CMM's first LDT was launched in 2009.

Genetic Analysis, which currently provides research use only products, services and applications that translate the results of genomic science into solutions for biomedical research, translational research, molecular medicine applications, and other areas of research, including agricultural and livestock.

Our Molecular Diagnostics segment, through our subsidiary Sequenom CMM, has validated and currently offers to physicians four LDTs: MaterniT21 PLUS LDT (MaterniT21 PLUS test) to detect fetal aneuploidies or trisomies by determining the relative amount of chromosome 21, 18, and 13 material present in circulating cell-free DNA in a maternal blood sample; SensiGene Fetal RHD Genotyping LDT (SensiGene RHD test) to determine the presence or absence of fetal Rhesus D factor; SensiGene Cystic Fibrosis Carrier Screening Test (SensiGene CF test) to help identify individuals who may have an increased risk of having certain cystic fibrosis genetic mutations; and RetnaGene AMD (Age-Related Macular Degeneration ) LDT (RetnaGene AMD test) to predict the genetic risk of a patient with "dry" or early stage age-related macular degeneration, or AMD, progressing to "wet" or advanced choroidal neovascular disease within 2, 5, and 10 years. Our Molecular Diagnostics segment grew significantly in 2012 due primarily to the rapid market adoption of the MaterniT21 PLUS test since its launch in October 2011.
We depend upon third-party payors to provide reimbursement for our tests. Accordingly, Sequenom CMM has and expects to continue to focus substantial resources on obtaining reimbursement coverage from third-party payors. In December 2012, the American Congress of Obstetricians and Gynecologists (ACOG) and the Society for Maternal Fetal Medicine Specialists (SMFM) issued a joint committee opinion on noninvasive prenatal testing for fetal aneuploidy, which supported the use of circulating cell-free fetal DNA as a basis for noninvasive prenatal testing in pregnant women at high risk of carrying a fetus with fetal aneuploidy. We believe these guidelines will drive further adoption of Sequenom CMM's MaterniT21 PLUS test and strengthen our efforts to obtain insurance reimbursement. We continue to invest in Sequenom CMM's diagnostic services infrastructure to support and expand its operations to effectively meet increasing demand for our laboratory developed tests.
Currently, Sequenom CMM performs its LDTs testing services primarily as an out-of-network laboratory with most insurance companies. As an out-of-network laboratory, Sequenom CMM bills insurance companies and bills patients for deductibles and copayment amounts. Due to Sequenom CMM's current out-of-network provider status associated with the lack of existing contracts with most payors and the current level of adoption rates, we expect amounts billed will fluctuate until these factors are resolved. Sequenom CMM's diagnostic testing services revenues are primarily recognized on a cash basis, until we can reliably estimate the amount that would be ultimately collected for each of its LDTs. Sequenom CMM performs its LDTs tests in two sites, San Diego, California, for its MaterniT21 PLUS test, and Grand Rapids, Michigan, for its other tests. Sequenom CMM will continue efforts to ensure that office and laboratory space is adequate to accommodate the necessary capacity requirements to meet Sequenom CMM's current and expanding business needs. Sequenom CMM has begun to staff its new site in Raleigh-Durham, North Carolina, which is expected to begin commercial operations performing its MaterniT21 PLUS test by mid-2013. Subsequent to the year ended December 31, 2012, we entered into a lease for a new facility with an additional approximately 49,000 square feet of office space in San Diego, California, into which we will relocate corporate functions to enable expansion of the San Diego lab in our existing facility and expand our customer service, billing and other support functions. We believe these expansion efforts will be enough to meet our and Sequenom CMM's needs for 2013. Our Genetic Analysis segment revenues declined 9% in 2012, with approximately 200 basis points of that decline due to the effects of foreign currency fluctuations. Funding in the research market in 2012 was constrained in the beginning of the year, and some customers shifted their research to different technologies. We have developed additional test panels for the research market to improve the utility of our instruments.
We have a history of recurring losses from operations and we expect to incur additional operating losses in 2013 as we continue to expand our commercial infrastructure to serve the prenatal and ophthalmology markets, expand Sequenom CMM's laboratory capacity, further develop existing tests, conduct clinical studies and develop additional products and tests. The timing of becoming profitable is dependent upon a number of factors, including the timing of reimbursement payments from third party payors; our and Sequenom CMM's costs to expand our test capacity; the timing and costs related to research and development projects; selling and marketing efforts; and administrative support to support the growing company. Our capital requirements to sustain operations have been and will continue to be significant. In 2012, we completed a private placement of our common stock for net proceeds of $58.2 million, and issued $130.0 million of senior convertible notes for net proceeds of


$124.7 million. As of December 31, 2012, we had available cash and cash equivalents and current marketable securities totaling $175.9 million and working capital of $146.2 million.
Our strategic focus in 2013 will be to continue to accelerate the growth of our diagnostic testing business, grow our revenue through obtaining contracts with payors and increasing our market penetration, and growing our genetic analysis business, to create a sustainable, profitable business model for the future. We will continue to invest in our commercial operations to expand our relationships with physicians who order our tests and in our research and development programs to develop additional or enhanced tests and additional products for sale within the genetic analysis market.
2012 Highlights
For the first time, revenues from our Molecular Diagnostic segment, which we began to commercialize LDTs in 2009, exceed revenues from product sales and services in our genetic analysis business. Total revenues during 2012 increased $33.8 million, or 60%, to $89.7 million when compared to $55.9 million during 2011.

?         Diagnostic services revenues during 2012 increased $38.1 million, or
          458%, to $46.5 million when compared to $8.3 million during 2011.


?         Genetic analysis product sales and services revenues during 2012
          decreased $4.3 million, or 9%, to $43.2 million when compared to $47.6
          million during 2011. Approximately $1.1 million of the decline is due
          to the effects of foreign currency fluctuations.


      Total accessions for all Sequenom CMM tests in our Molecular Diagnostics
       segment during 2012 increased 68,700, or 295%, to 92,000 when compared to
       23,300 during 2011. Sequenom CMM accessioned 61,000 MaterniT21 PLUS tests
       in 2012, the first full year since launch, and ended the year with an
       annual run rate exceeding 120,000 tests.


      Sequenom CMM expanded its MaterniT21 PLUS test to include trisomies 18 and
       13 following publication of clinical study results for those aneuploidies.


      We completed tenant improvements on laboratory space in Raleigh-Durham,
       North Carolina, where Sequenom CMM plans to operate an additional site
       following completion of validation and certification of the laboratory
       operations at the site, which is expected in the first half of 2013.


      In September 2012, we issued $130 million aggregate principal amount of
       Senior Convertible Notes, maturing in 2017, in a private offering to
       qualified institutional buyers. We received net proceeds of $124.7
       million, which we intend to use to fund Sequenom CMM's commercialization
       of its MaterniT21 PLUS test, as well as for other general corporate
       purposes, which may include research and development expenses, capital
       expenditures, working capital, and general and administrative expenses.


      In January 2012, we closed an underwritten public offering of 14,950,000
       shares of our common stock at $4.15 per share and received net proceeds of
       $58.2 million intended for general corporate purposes, including research
       and development expenses, capital expenditures, working capital, and
       general administrative expenses.


      During 2012, we completed international distribution agreements that
       expand access to Sequenom CMM's MaterniT21 PLUS testing service outside
       the United States to foreign countries, including Japan, Hong Kong, the
       Czech Republic, Slovakia, the Netherlands, and Israel and licensed our
       technology for use in Germany and certain other countries.


      We introduced new research use only panels for the MassARRAY platform in
       our Genetic Analysis business.


Results of Operations

Revenues
We derive our revenues primarily from diagnostic services and product sales and
services related to our genetic analysis products. We operate our business in
two segments, Molecular Diagnostics, which comprises our laboratory testing
services business conducted by our subsidiary, Sequenom CMM, and Genetic
Analysis, which sells and services our MassARRAY system and related products and
provides contract services to our customers.
Our revenues and accessions were as follows:
                                                                 Year Over Year Increase (Decrease)
                         Years ended December 31,             2012 from 2011           2011 from 2010
(dollars in
thousands)            2012         2011         2010       $ Change     % Change     $ Change     % Change
Diagnostic
services           $ 46,457     $  8,319     $  2,554     $  38,138       458%     $    5,765       226%
Genetic analysis
product sales and
services             43,240       47,588       44,905        (4,348 )     (9)%          2,683        6%
Total revenues     $ 89,697     $ 55,907     $ 47,459     $  33,790       60%      $    8,448       18%

% of Total
Revenues:
Diagnostic
services                 52 %         15 %          5 %
Genetic analysis
product sales and
services                 48 %         85 %         95 %
Total                   100 %        100 %        100 %
                                                           # Change     % Change     # Change     % Change
Total accessions
(for all Sequenom
CMM tests)           92,000       23,300        9,200        68,700       295%         14,100       153%

Diagnostic Services
Diagnostic services revenues are derived primarily from payments for providing testing services for Sequenom CMM's LDTs and are primarily recognized on a cash basis as payments are received. Sequenom CMM will continue to account for this revenue on a cash basis until further experience and third party contracts are gained and additional internal controls are established that will allow a reasonable estimate of collectible amounts to be made before moving to the accrual method of accounting. Each test performed relates to a patient specimen collected by a health care professional, and received by the laboratory. Such specimen encounter is commonly referred to as an "accession" in the laboratory sector. Although accessions are not billed until the test is complete and results are reported to the ordering physicians, we believe that the number of accessions received is useful to understand the volume of Sequenom CMM's business. These tests are typically completed within approximately six business days from the date of accession. Revenues for diagnostic services are generated primarily from customers located within the United States. During 2012, we completed international distribution agreements that expand access to Sequenom CMM's MaterniT21 PLUS testing service outside the United States. The international customers collect and ship patient samples to the laboratory, and Sequenom CMM processes the samples in its laboratory in the United States. We also have a royalty agreement with an international customer whom we have licensed our technology to for certain countries. During 2012, international customers accounted for less than 5% of our revenues.
The $38.1 million, or 458%, increase in diagnostic services revenues during 2012, when compared to 2011, is primarily attributable to the 295% increase in the number of accessions during 2012. The increase in accessions during 2012 is primarily attributable to the introduction of the MaterniT21 PLUS test in the fourth quarter of 2011 and expansion of Sequenom CMM's prenatal sales force and its advisory board efforts to expand the awareness of the clinical utility of this test. The increase in diagnostic services revenues during 2012 also reflects an increase in volume and the sales price of Sequenom CMM's SensiGene CF test, which increased revenue by $4.5 million, and increased volume of the RetnaGene AMD test, which increased revenue by $2.4 million.
The $5.8 million, or 226%, increase in diagnostic services revenues during 2011, when compared to 2010, is primarily attributable to the 153% increase in the number of accessions during 2011. Higher SensiGene CF test accessions during 2011 and the number of tests collected during 2011 accounted for the majority of the increase in diagnostic services revenues. The introductions of the MaterniT21 PLUS test and the RetnaGene AMD test in the fourth and second quarters of 2011, respectively, also contributed to the increase in accessions and revenues.


We believe that our diagnostic services revenues will continue to be affected by our current revenue recognition policy of generally recognizing revenue upon cash collection, the overall acceptance and demand for our new and existing commercial products and services, the adoption rates of Sequenom CMM's existing LDTs and any future LDTs, and payment patterns of third-party payors and patients.
Genetic Analysis Product Sales and Services Our genetic analysis product sales and services revenues were as follows:

                                                                         Year Over Year Increase (Decrease)
                                  Years ended December 31,             2012 from 2011          2011 from 2010
(dollars in thousands)         2012          2011         2010       $ Change    % Change    $ Change    % Change
System sales                $  14,132     $ 14,765     $ 15,361     $   (633 )     (4)%     $   (596 )     (4)%
Consumables                    21,726       24,944       22,027       (3,218 )    (13)%        2,917       13%
Maintenance services            5,277        5,227        5,034           50        1%           193        4%
Contract research and other     2,105        2,652        2,483         (547 )    (21)%          169        7%
Total                       $  43,240     $ 47,588     $ 44,905     $ (4,348 )     (9)%     $  2,683        6%

Genetic analysis product sales and services revenues are derived from sales of research use only consumables, including our SpectroCHIP used with our iPLEX assay and other assays, MassARRAY systems, maintenance agreements, sales and licensing of our proprietary software, and contract research services. Revenues for genetic analysis products and services are generated from customers primarily located in North America, and customers and distributors located in Europe and Asia.
The $4.3 million, or 9%, decrease in our genetic analysis product sales and services revenues during 2012, when compared to 2011, is primarily attributable to the decrease in consumables revenue orders from our customers in the translational research and agricultural biology markets, fewer MassARRAY system placements during 2012, the effects of foreign currency, which reduced revenues by $1.1 million in 2012, and lower contract research revenues.
The $2.7 million, or 6%, increase in our genetic analysis product sales and services revenues during 2011, when compared to 2010, is primarily attributable to our larger installed base of MassARRAY systems against the comparative period. This larger installed base contributed to an increase in consumables orders from our customers in the translational research and agricultural biology markets. This increase was partially offset by a decrease in the number of MassARRAY systems sold during 2011.
Our revenues have historically fluctuated from period to period and, we believe, will likely continue to fluctuate substantially in the future based upon the unpredictable sales cycle for the MassARRAY system and consumables, general economic conditions, and the overall acceptance and demand for our new and existing commercial products and services.


Cost of Revenues and Gross Margins
Cost of revenues consists of material, direct labor of our laboratory,
manufacturing and service personnel, outside laboratory costs, royalties and
overhead. Gross margin consists of our revenues less cost of revenues.
Our costs of revenues and gross margins were as follows:
                                                                           Year Over Year Increase (Decrease)
                                 Years ended December 31,                2012 from 2011          2011 from 2010
(dollars in thousands)    2012           2011             2010
                                     As Restated      As Restated      $ Change    % Change    $ Change    % Change
Cost of Revenues
Diagnostic services    $ 47,283     $     10,031     $      3,965     $ 37,252       371%     $  6,066       153%
Genetic analysis
product sales and
services                 15,025           16,360           18,306       (1,335 )     (8)%       (1,946 )    (11)%
Total                  $ 62,308     $     26,391     $     22,271     $ 35,917       136%     $  4,120       18%

Gross Margin
Diagnostic services    $   (826 )   $     (1,712 )   $     (1,411 )   $    886       52%      $   (301 )    (21)%
Genetic analysis
product sales and
services                 28,215           31,228           26,599       (3,013 )    (10)%        4,629       17%
Total                  $ 27,389     $     29,516     $     25,188     $ (2,127 )     (7)%     $  4,328       17%

Gross Margin as a % of
Revenues
Diagnostic services       (2)%          (21)%            (55)%
Genetic analysis
product sales and
services                  65%            66%              59%
Total                     31%            53%              53%

Diagnostic Services
Cost of diagnostic services revenues represents the cost of materials, direct labor, equipment and infrastructure expenses associated with accessioning patient specimens (including quality control analyses and shipping charges to transport patient specimens), royalties, and license fees. Infrastructure expenses include allocated facility occupancy and information technology costs. Costs associated with performing tests are recorded as tests are processed. Costs recorded for patient specimen processing represent the cost of all the tests processed during the period regardless of whether revenue was recognized with respect to that test. Royalties for licensed technology calculated as a percentage of product revenues are recorded as license fees in cost of product revenues at the time product revenues are recognized or in accordance with other contractual obligations. While license fees are generally calculated as a percentage of product revenues, the percentage increase in license fees does not correlate exactly to the percentage increase in product revenues because certain agreements contain provisions for fixed annual payments and other agreements have tiered rates and payments that may be capped at annual minimum or maximum amounts. License fees represent a significant component of our cost of product revenues and are expected to remain so for the foreseeable future.
Cost of diagnostic services revenues during the years presented was affected by increased test volumes and the increase in headcount and laboratory operational costs to support increased production capacity for Sequenom CMM's diagnostic services. Negative gross margin as a percentage of diagnostic services revenue during all three years was also affected by our current revenue recognition policy of generally recognizing revenue upon cash collection, which may result in costs being incurred in one period that relate to revenue recognized in a later period.
We expect that gross margin for our diagnostic services will continue to be affected by the adoption rates of Sequenom CMM's diagnostic tests, our revenue recognition policy, the levels of reimbursement, and payor and other contracts we may enter into for our tests.
We expect the cost of product revenues to increase in future periods to the extent we process more tests, and to expand capacity within Sequenom CMM's laboratory, including its additional site in Raleigh-Durham, North Carolina. Sequenom CMM currently has the physical capacity to conduct 200,000 MaterniT21 PLUS tests per year and plans to expand to an aggregate capacity of 300,000 tests per year by the end of 2013. The North Carolina site can be expanded if, and when, additional capacity is needed.


Genetic Analysis Product Sales and Services Gross margin as a percentage of genetic analysis product sales and research use only services revenues remained relatively flat at 65% during 2012 from 66% in 2011. The increase in gross margin as a percentage of genetic analysis product sales and services revenue from 59% during 2010 to 66% during 2011 was due to changes in product mix, including increased consumables, which typically have higher margins, as well as higher gross margin on systems sales related to a higher average selling price and lower service costs due to improved reliability of the MassARRAY system compared with systems sold in previous periods. We expect that gross margin for our genetic analysis product sales and services will fluctuate on a quarterly basis and be affected by, among other things, the selling price for MassARRAY systems and consumables, consumable sales per MassARRAY system sold, the mix of product sales and the type of services, competitive conditions, sales volumes, discounts offered, sales through distributors, as well as our manufacturing costs, inventory reserves and obsolescence charges required, and royalty payment obligations on in-licensed technologies.
Selling and marketing expenses
Selling and marketing expenses consisted primarily of compensation and related departmental expenses for sales and marketing, customer support, and business development personnel.

                                                                                Year Over Year Increase (Decrease)
                                  Years ended December 31,                   2012 from 2011            2011 from 2010
(dollars in thousands)    2012            2011              2010
                                       As Restated       As Restated       $ Change     % Change     $ Change     % Change
Selling and marketing  $  48,587     $      28,224     $      25,112     $   20,363       72%      $    3,112       12%

The $20.4 million, or 72%, increase in selling and marketing expenses during 2012, when compared to 2011, was primarily related to increased headcount to support our Molecular Diagnostics operations resulting in higher labor and related costs of $13.0 million, increased facilities and other expenses of $2.2 million related to the increase in headcount, increased personnel and travel expenses of $3.2 million and third-party marketing of $1.4 million attributable to promoting the MaterniT21 PLUS LDT.
The $3.1 million, or 12%, increase in selling and marketing expenses during 2011, when compared to 2010, is primarily related to higher labor costs of $2.8 million associated with the expansion of Sequenom CMM's laboratory, and higher travel and marketing expense of $1.3 million associated with the expansion of Sequenom CMM's sales force and support of the MaterniT21 PLUS test commercialization; partially offset by lower bad debt expense of $0.9 million in 2011 and lower consulting costs of $0.6 million related to the elimination of a third-party sales force in 2010.
We expect selling and marketing expenses will continue to increase in future periods due to our efforts to increase penetration of our markets and reimbursement for our tests, continued investment in our commercial infrastructure and increases in our sales force. Research and development expenses
Research and development expenses consisted primarily of compensation and related personnel expenses, product development costs, quality and regulatory costs, and expenses relating to licensing costs and work performed under research and development contracts.

                                                                                  Year Over Year Increase (Decrease)
                                    Years ended December 31,                   2012 from 2011           2011 from 2010
(dollars in thousands)      2012            2011              2010
                                         As Restated       As Restated      $ Change     % Change     $ Change     % Change
Research and development $  50,525     $      53,313     $      43,431     $  (2,788 )     (5)%     $    9,882       23%

The $2.8 million, or 5%, decrease in research and development expenses during 2012, when compared to 2011, was primarily related to increased headcount to support our research and development efforts resulting in higher labor costs of $0.8 million and an increase of $3.0 million in facilities and other business expenses related to expansion of Sequenom CMM's laboratory facilities, offset by a $5.5 million decrease in research-related intellectual property licensing and . . .

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