SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
For the Quarterly Period Ended June 30, 2005
Or
For the transition period from to
Commission file number: 000-30975
TRANSGENOMIC, INC.
(Exact name of registrant as specified in its charter)
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
(402) 452-5400
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Securities Exchange Act of 1934) Yes ¨ No x
As of August 15, 2005, the number of shares of common stock outstanding was 34,241,281.
TRANSGENOMIC INC.
INDEX
PART I.
Item 1.
Financial Statements
Unaudited Consolidated Balance Sheets as of June 30, 2005 and December 31, 2004
Unaudited Consolidated Statements of Operations for the Three and Six Months Ended June 30, 2005 and 2004
Unaudited Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2005 and 2004
Notes to Unaudited Consolidated Financial Statements
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
Item 4.
Controls and Procedures
PART II.
OTHER INFORMATION
Legal Proceedings
Unregistered Sales of Equity Securities and Use of Proceeds
Item 6.
Exhibits
Signatures
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
UNAUDITED CONSOLIDATED BALANCE SHEETS
(Dollars in thousands except per share data)
June 30,
2005
CURRENT ASSETS:
Cash and cash equivalents
Accounts receivable (net of allowances for bad debts of $998 and $1,051, respectively)
Inventories
Prepaid expenses and other current assets
Total current assets
PROPERTY AND EQUIPMENT:
Land and buildings
Equipment
Furniture and fixtures
Less: accumulated depreciation
GOODWILL
OTHER ASSETS
CURRENT LIABILITIES:
Accounts payable
Accrued expenses
Accrued compensation
Line of credit
Current portion of long-term debt
Total current liabilities
Long-term debt
Total liabilities
COMMITMENTS AND CONTINGENCIES (Note F)
STOCKHOLDERS’ EQUITY:
Preferred stock, $.01 par value, 15,000,000 shares authorized, none outstanding
Common stock, $.01 par value, 60,000,000 shares authorized, 34,241,281 and 29,330,874 shares outstanding, respectively
Additional paid-in capital
Accumulated other comprehensive income
Accumulated deficit
Total stockholders’ equity
See notes to consolidated financial statements.
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UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS
Three Months Ended
Six Months Ended
Net sales
Cost of goods sold
Gross profit
Operating expenses:
Selling, general and administrative
Research and development
Impairment charges (Note C)
Loss from operations
Other income (expense):
Interest expense (Note E)
Other income (expense), net
Loss before income taxes
Current income tax expense (benefit)
Net loss
Basic and diluted weighted average shares outstanding
Net loss per common share—basic and diluted
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UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
CASH FLOWS FROM OPERATING ACTIVITIES:
Adjustments to reconcile net loss to net cash flows from operating activities:
Depreciation and amortization
Impairment charges
Non-cash financing costs
(Gain)/Loss on sale of securities
Other
Changes in operating assets and liabilities:
Accounts receivable
Net cash flows from operating activities
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from the maturities and sale of available for sale securities
Purchase of property and equipment
Proceeds from sales of property and equipment
Change in other assets
Net cash flows from investing activities
CASH FLOWS FROM FINANCING ACTIVITIES:
Advances on line of credit
Payments on line of credit
Proceeds from long-term debt
Payments on long-term debt
Issuance of common stock, net of expenses
Net cash flows from financing activities
EFFECT OF FOREIGN CURRENCY EXCHANGE RATE CHANGES ON CASH
NET CHANGE IN CASH AND CASH EQUIVALENTS
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR
CASH AND CASH EQUIVALENTS AT END OF PERIOD
SUPPLEMENTAL CASH FLOW INFORMATION
Cash paid during the period for:
Interest
Income taxes, net
Non-cash transactions:
Available for sale securities acquired for goods and services
Conversions of debt to equity
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NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
A. CONSOLIDATED FINANCIAL STATEMENTS
The accompanying unaudited consolidated financial statements of Transgenomic, Inc. and Subsidiaries (the “Company”) have been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and disclosures normally included in annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been omitted pursuant to such rules and regulations. In the opinion of management of the Company, all adjustments (consisting of only normal and recurring items) have been made to present fairly the financial positions, the results of operations and cash flows for the periods presented.
The results of operations for the three and six months ended June 30, 2005 and 2004 are not necessarily indicative of the results to be expected for the full year.
Although the Company believes that the disclosures are adequate to make the information presented not misleading, these financial statements should be read in conjunction with the consolidated financial statements that are included in the Company’s annual report on Form 10-K for the year ended December 31, 2004, as amended.
The Company has experienced recurring net losses and had an accumulated deficit of $110,991 at June 30, 2005. Based on the Company’s operating plan, management believes its existing sources of liquidity will be sufficient to meet its cash needs during 2005. If necessary, the Company’s management believes they can manage costs and expenses at reduced levels to conserve working capital. The need for any such cost and expense reductions would likely delay implementation of the Company’s business plan. Additionally, management may pursue financing alternatives. Ultimately, the Company must achieve sufficient revenue levels to support its cost structure.
Principles of Consolidation.
The consolidated financial statements include the accounts of Transgenomic, Inc. and its wholly-owned subsidiaries. All intercompany balances and transactions have been eliminated in consolidation.
Cash and Cash Equivalents.
For purposes of reporting cash flows, cash and cash equivalents include cash and temporary investments with original maturities at acquisition of three months or less.
Accounts Receivable.
Accounts receivable are shown net of allowance for doubtful accounts. The following is a summary of activity for the allowance for doubtful accounts during of the three and six months ended June 30, 2005 and 2004.
2004
Beginning balance
Charges to income
Deductions from reserves
Ending balance
Revenue Recognition.
Revenue on the sales of products is recognized in accordance with the terms of the sales arrangement. Such recognition is based on receipt of an unconditional customer order and transfer of title and risk of ownership to the customer, typically upon shipment of the product. Our sales terms do not provide for the right of return unless the product is damaged or defective. Revenues from certain services associated with our analytical instruments, to be performed subsequent to shipment of the products, is deferred and recognized when the services are provided. Such
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services, mainly limited to installation and training services that are not essential to the functionality of the instruments, typically are performed in a timely manner subsequent to shipment of the instrument. The Company also enters into various service contracts that cover installed WAVE systems. These contracts cover specific time periods and revenue associated with these contracts is deferred and recognized over the service period. At June 30, 2005 and December 31, 2004, deferred revenue associated with the Company’s service contracts was approximately $1,856 and $1,478 respectively, and is included in “accrued expenses” in the accompanying unaudited consolidated balance sheets.
During the six months ended June 30, 2004, the Company recognized approximately $196 of product sales under bill-and-hold arrangements. Under these arrangements, the customer had accepted title and risk of ownership to the product, but had requested that the Company store the product on behalf of the customer, in a rented freezer, until the six months ended June 30, 2004. There were no sales under bill-and –hold arrangements recognized during the six months ended June 30, 2005.
Stock Based Compensation.
The Company accounts for its employee stock option grants under the provisions of Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, which utilizes the intrinsic value method. Accordingly, compensation cost for stock options is measured as the excess, if any, of the fair market value of the Company’s common stock at the date of grant over the stock option exercise price. Stock option grants to non-employees are accounted for using the fair value method of accounting in accordance with SFAS No. 123, Accounting for Stock-Based Compensation, using the Black-Scholes model.
The following table illustrates the effect on net loss and loss per share if the Company had applied the fair value recognition provisions of SFAS No. 123 to stock based employee compensation.
Net Loss:
As reported
Less pro forma stock-based employee compensation expense determined under fair value method, net of related tax
Pro forma
Basic and Diluted Loss Per Share:
Translation of Foreign Currency.
Financial statements of subsidiaries outside the U.S. are measured using the local currency as the functional currency. The adjustments to translate those amounts into U.S. dollars are accumulated in a separate account in stockholders’ equity and are included in other comprehensive income. Foreign currency transaction gains or losses resulting from changes in currency exchange rates are included in the determination of net income. Foreign currency transaction adjustments adversely affected loss from operations by approximately $228 and $8 for the three months ended June 30, 2005 and 2004, respectively, and by approximately $428 and $128 for the six months ended June 30, 2005 and 2004.
Loss Per Share.
Basic loss per share are calculated based on the weighted-average number of common shares outstanding during each period. Diluted loss per share includes shares issuable upon exercise of outstanding stock options and warrants or conversion of convertible notes, where dilutive. For all periods presented, basic and diluted weighted average shares outstanding and loss per share are identical, since all potentially dilutive securities are antidilutive. Potentially dilutive securities consist of stock options and warrants representing 4,759,547 and 1,159,421 shares of
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common stock at June 30, 2005, respectively. Additionally, certain portions of the Company’s debt are convertible into the Company’s common stock at prices that were greater than the market price of the Company’s common stock at June 30, 2005.
Recently Issued Accounting Pronouncements
On December 16, 2004, the Financial Accounting Standards Board (FASB) issued SFAS No. 123R, Share-Based Payment. SFAS No.123R addresses the accounting for share-based payment transactions in which an enterprise receives employee services in exchange for (a) equity instruments of the enterprise or (b) liabilities that are based on the fair value of the enterprise’s equity instruments or that may be settled by the issuance of such equity instruments. SFAS No. 123R eliminates the ability to account for share-based compensation transactions using Accounting Principles Board Opinion No. 25 and generally requires that such transactions be accounted for using a fair-value-based method. The Company expects to adopt this standard on January 1, 2006. The Company is currently assessing the final impact of this standard on its financial position, results of operations or cash flows. This assessment includes evaluating option valuation methodologies and assumptions as well as potential changes to compensation strategies.
On November 24, 2004, the FASB issued SFAS No. 151, Inventory Costs – an amendment of ARB No. 43. SFAS No. 151 requires idle facility expenses, freight, handling costs, and wasted material (spoilage) costs to be excluded from the cost of inventory and expensed when incurred. It also requires that allocation of fixed production overhead to be based on the normal capacity of the production facilities. SFAS No. 151 will be effective at the beginning of 2006. The Company is currently assessing the final impact of this standard on its financial position, results of operations or cash flows.
Use of Estimates.
The preparation of consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
B. INVENTORIES
Inventories consisted of the following at June 30, 2005 and December 31, 2004:
Finished goods
Raw materials and work in process
Demonstration inventory
Less inventory classified as a long-term asset
Net Inventory
The Nucleic Acids operating segment inventory at June 30, 2005 and December 31, 2004 consisted primarily of chemical building blocks for synthetic nucleic acids (know as phosphoramadites) and the raw materials to produce phosphoramadites which are used and produced at the Company’s facility in Glasgow, Scotland. As of June 30, 2005, the Company has classified a portion of this inventory as a long-term other asset based on its existing sales forecasts for these products.
The Company periodically evaluates its inventory of phosphoramadites to determine whether they continue to meet quality and other specifications and over what time period such products are expected to be sold. Product that does not meet quality and other specifications can generally be re-worked to enhance purity. Costs to purify such product and related yield losses are expensed as incurred.
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C. GOODWILL
Goodwill totaled $638 at June 30, 2005 and December 31, 2004 and related entirely to the BioSystem operating segment. The following summarizes goodwill adjustments for the three and six months ended June 30, 2005 and 2004.
Adjustments
During the three months ended March 31, 2004, the Company’s Board of Directors directed management to explore strategic alternatives for the Nucleic Acids operating segment. The process included significant due diligence by management, its advisors and prospective independent buyers and other interested parties. Based upon information obtained through this process during the three months ended June 30, 2004, management determined that it was more likely than not that the assets of the Nucleic Acids business were impaired. Accordingly, the Company engaged an external valuation firm to assist with the completion of a mid-year impairment test. As a result, the Company recorded a non-cash charge of $11,964 related to its Nucleic Acids segment during the three months ended June 30, 2004. The charge consisted of $9,864 related to the impairment of goodwill and $2,100 related to the impairment of property and equipment.
D. OTHER ASSETS
At June 30, 2005 and December 31, 2004, finite lived intangible assets and other assets consisted of the following:
Accumulated
Amortization
Net Book
Value
Finite Lived Intangible Assets
Capitalized software
Intellectual property
Patents
Other Assets
Long Term Inventory
Deferred Financing Costs
Total
Amortization expense for intangible assets was approximately $245 and $242 during the three months ended June 30, 2005 and 2004, respectively, and $495 and $486 for the six months ended June 30, 2005 and 2004, respectively. Amortization expense for intangible assets is expected to be approximately $518 for the remainder of 2005, $342 in 2006, $331 in 2007, $62 in 2008, $134 in 2009, $134 in 2010 and $26 in 2011.
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E. DEBT
At June 30, 2005 and December 31, 2004, debt consisted of the following:
Credit Line (“Credit Line”) with Laurus Master Funds, Ltd (“Laurus”)
Gross amount due (accruing interest at 2% above prime or 8.00% and 7.25% at June 30, 2005 and December 31, 2004, respectively, due December 2006)
Debt premium
Debt discount - warrants
Debt discount - beneficial conversion premium
Long-Term Debt with Laurus (“Term Note”)
Convertible debt (accruing interest at 2% above prime or 8.00% and 7.25% at June 30, 2005 and December 31, 2004, respectively, due February 2007)
Debt Premium
Less current portion
Funds available under the Credit Line are determined by a borrowing base equal to 90% of eligible accounts receivable balances plus up to $1,000 related to inventory balances. On March 18, 2005, Laurus agreed to extend an existing waiver of the borrowing base until March 31, 2006. In connection with this extension, the Company agreed to allow Laurus to convert $1,879 of the outstanding principal balance under the Credit Line into 3,600,000 shares of its common stock at $0.52 per share. In addition, on March 24, 2005 the Company agreed to allow Laurus to convert $650 of the outstanding principal balance of the Term Note into 1,250,000 shares of common stock at $0.52 per share. Laurus agreed to apply this Term Note conversion against substantially all remaining 2005 scheduled principal payments on such loan. The closing market price of the Company’s common stock the day before each of these conversions was $0.58 per share. No other provisions of the Company’s Credit Line or Term Note (collectively, the “Laurus Loans”) were modified, including the $1.00 conversion price for remaining debt. In conjunction with these conversions, the Company accelerated amortization of $409 of related debt premiums and discounts and recorded a charge of $1,365 related to the fair value of incremental shares received by Laurus.
Interest expense consisted of the following:
Interest paid or accrued on outstanding debt
Amortization of debt premiums
Amortization of debt discounts – warrants
Amortization of debt discount – beneficial conversion feature
Fair value of incremental shares received by Laurus
Principal repayments under the Term Note are scheduled as follows: $0 for the remainder of 2005, $875 in 2006, and $800 in 2007.
F. COMMITMENTS AND CONTINGENCIES
The Company was named as a defendant in a lawsuit filed in Spain by a prospective distributor who claims that the Company breached a promise to grant the plaintiff a distributorship for certain of the Company’s products in a specific geographic area in Europe. The plaintiff was seeking monetary relief of approximately $500. During the three months ended June 30, 2005, a court dismissed this matter in favor of the Company.
The Company is subject to a number of other claims of various amounts, which arise out of the normal course of business. In the opinion of management, the disposition of claims currently pending will not have a material adverse effect on the Company’s financial position, results of operations or cash flows, after considering amounts already reflected in the consolidated financial statements.
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The Company leases certain equipment, vehicles and operating facilities. The Company’s leases related to its operating facilities currently expire on various dates through 2010. At June 30, 2005, the future minimum lease payments required under non-cancellable lease provisions are approximately $858 for the remainder of 2005, $1,230 in 2006, $441 in 2007, $187 in 2008, $191 in 2009, and $165 in 2010. Rent expense related to all operating leases for the three months ended June 30, 2005 and 2004 was approximately $310 and $588, respectively, and $663 and $1,173 for the six months ended June 30, 2005 and 2004, respectively.
At June 30, 2005, the Company had firm commitments totaling $468 to a vendor to purchase components used in WAVE Systems.
G. INCOME TAXES
Income tax recorded during the three and six months ended June 30, 2005 and 2004 related to income taxes in states, foreign countries and other local jurisdictions offset by refunds received.
Due to the Company’s cumulative losses, expected losses in future years and inability to utilize any additional losses as carrybacks, the Company has not provided for an income tax benefit during the three and six months ended June 30, 2005 or 2004 based on management’s determination that it was more likely than not that such benefits would not be realized. The Company will continue to assess the recoverability of deferred tax assets and the related valuation allowance. To the extent the Company begins to generate taxable income in future periods and it determines that such valuation allowance is no longer required, the tax benefit of the remaining deferred tax assets will be recognized at such time. As of June 30, 2005 and December 31, 2004, the Company’s deferred tax assets were offset by a valuation allowance of approximately $39,747 and $38,287, respectively.
H. STOCKHOLDERS’ EQUITY
The following shows changes to the components of stockholders’ equity during the six months ended June 30, 2005.
Additional
Paid in
Capital
Deficit
Accumulated Other
Comprehensive
Income (Loss)
Outstanding
Shares
Par
Balance, January 1, 2005
Other comprehensive income (loss):
Foreign currency translation adjustment
Comprehensive loss
Beneficial conversion premium
Issuance and shares upon conversion of Laurus Loans
Fair value of incremental shares issued
Issuaance of shares for employee stock purchase plan
Balance, June 30, 2005
During the three and six months ended June 30, 2005, the Company issued zero and 4,900,000 shares, respectively of common stock in conjunction with conversions under the Laurus Loans.
Date
Facility
Applied To
January 2005
March 2005
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I. STOCK OPTIONS
No options were granted during the three months ended June 30, 2005. The following table summarizes activity under the 1997 Stock Option Plan during the six months ended June 30, 2005.
Number of
Options
Weighted
Average
Exercise Price
Balance at December 31, 2004
Granted
Forfeited
Balance at June 30, 2005
Exercisable at June 30, 2005
The weighted average fair value of options granted during the six months ended June 30, 2005 was $0.61 per share. The fair value of each stock option granted is estimated at the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions for options granted during the six months ended June 30, 2005: no common stock dividends; risk-free interest rates of 4.14% to 4.79%; 85% volatility; and an expected option life of 3 years. At June 30, 2005, the weighted average remaining contractual life of options outstanding was 4.7 years.
The following table summarizes information about options outstanding as of June 30, 2005:
Range of Exercise Prices
Number
Weighted-Average
Remaining
Contractual Life
Exercisable
$ 1.00—$ 1.30
$ 1.31—$ 2.60
$ 2.61—$ 3.90
$ 3.91—$ 5.20
$ 5.21—$ 6.50
$ 6.51—$ 9.10
$ 9.11—$10.40
$10.41—$13.00
J. OPERATING SEGMENT AND GEOGRAPHIC INFORMATION
The Company operates in two reportable segments, BioSystems and Nucleic Acids. Operations for these segments are evaluated based upon specific identification of revenues and expenses associated with the business activities resulting in a segment operating income. Expenses that cannot be directly identified to an operating activity or are considered corporate overhead are not allocated to the segments in arriving at operating income for the segment. Generally, decisions regarding asset allocation, financing, taxes or other items impacting the Company’s balance sheet are made at the corporate level and, accordingly, operating segment balance sheet information is not typically reviewed by operating decision makers.
The BioSystems operating segment generates revenue from the sale of automated instrument systems and associated consumable products and services. This segment’s products are based upon two of the Company’s three core competencies: separations chemistries and enzymology. Specifically, this segment’s main products are the WAVE system, related bioconsumables and research services.
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The Nucleic Acids operating segment generates revenue from the sale of products and services based upon all three of the Company’s core competencies: nucleic acid chemistries, separations chemistries and enzymology. Specifically, this segment’s main products are nucleic acid building blocks or “phosphoramidites,” fluorescent markers, dyes and associated reagents and novel chemistry and process development services.
The following table sets forth net sales and operating income (loss) by segment.
Net Sales
BioSystems
Nucleic Acids
Income (Loss) from Operations
Corporate
During the three and six months ended June 30, 2005, sales to Novartis Pharmaceuticals, Inc. (“Novartis”) totaled $667 and $1,410, respectively, and represented 9.7% and 10.2%, respectively, of net sales within the Company’s BioSystems operating segment and 8.7% and 9.4%, respectively, of total consolidated net sales. Sales to Novartis are governed by a non-binding master services agreement dated August 22, 2002.
During the three and six months ended June 30, 2005, sales to Geron Corporation (“Geron”) totaled $54 and $105, respectively, and represented 7.3% and 8.8%, respectively, of net sales within the Company’s Nucleic Acids operating segment and less than 1% of total consolidated sales. During the three and six months ended June 30, 2004, sales to Geron totaled $1,174 and $1,896, respectively, and represented 48% and 40%, respectively, of net sales within the Company’s Nucleic Acids operating segment and 13% and 11%, respectively, of total consolidated net sales. Sales to Geron are governed by a non-binding supply agreement dated June 15, 2002, as amended. Under the supply agreement and related addendums, Geron has historically paid the Company for goods and services with its common stock. The terms of each addendum generally provide that Geron pre-pay 50% of the total sales price of goods sold under the addendum upon execution of the addendum and the remaining 50% upon acceptance of the related goods and services. Geron shares received by the Company are restricted for resale until they are registered with the Securities and Exchange Commission. The Company assumes all market risk related to the value of these securities and any selling costs are paid by the Company. Once registered, it has been the Company’s intent and practice to sell such securities as soon as practical.
The following is a summary of Geron shares received and sold during the six months ended June 30, 2005 and 2004.
Date Received
January 2004
March 2004
April 2005
The 101,801 Geron shares received by the Company in April 2005 were a prepayment for products that are expected to be completed and delivered to Geron in the second half of 2005. The related deferred revenue of $608 is included in “accrued expenses” in the accompanying unaudited consolidated balance sheet at June 30, 2005.
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K. RESTRUCTURING PLAN
The Company had accrued expenses associated with its 2004 restructuring plan of $581 and $1,910 at June 30, 2005 and December 31, 2004, respectively. The balance at June 30, 2005 relates primarily to future rents on closed facilities (net of projected sublease rents) of which $283 is expected to be paid during the remainder of 2005 and $272 in 2006 and thereafter.
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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Overview
We provide innovative products and services for the synthesis, purification and analysis of nucleic acids. Our operations fall into two principal business units, BioSystems and Nucleic Acids. Our BioSystems products include our WAVE® automated instrument systems, WAVE associated consumable products and other related consumable products. Our Nucleic Acids products consist principally of chemical building blocks for nucleic acid synthesis. Both business units have service offerings as well, including genetic variation discovery and analysis services and custom synthesis of specialty nucleic acids.
Our technologies center around three core competencies: separation chemistries, enzymology, and nucleic acid chemistries. In our first core competency, separations chemistry, we employ novel chemistries for separating nucleic acids, proteins, peptides, amino acids and carbohydrates. Our most significant separation technology is currently embodied in the WAVE System. The WAVE System is a versatile instrument that can be used for genetic variation detection, size-based double-strand DNA separation and analysis, single-strand DNA separation and analysis and DNA purification. The WAVE System requires the use of various consumable products that we manufacture and sell separately.
Our second core competency is expertise in developing novel enzymes. Enzymes are proteins that act as catalysts for biochemical reactions. Several of these reactions are useful in genomics. The ability to develop enzymes useful in the experimental manipulation of genes provides powerful tools for producing genetic material in the form needed for further analysis or incorporation into diagnostics and therapeutics. These products can also expand the sale of consumable products to WAVE System users and may also be sold for other applications. Our SURVEYOR® product line of mutation detection kits allow for the cleaving of DNA at points where DNA sequence variations exists. The resulting DNA fragments can then be analyzed by our WAVE System, fluorescent capillary electrophoresis or standard gel electrophoresis. SURVEYOR Kits provide a simple and robust method of scanning relatively large DNA fragments for both known and novel sequence variations.
Our third core competency is nucleic acid chemistries. Our synthetic nucleic acid products consist of chemical building blocks of nucleic acids (known as phosphoramidites). We also manufacture related specialty chemicals such as fluorescent markers and molecular tags, dyes, quenchers, linkers, and solvents used to modify nucleic acids for subsequent detection or manipulation. These products are used by research organizations, diagnostic companies and pharmaceutical companies. These products are produced primarily in our Glasgow, Scotland facility. Prior to November 11, 2004, we had also manufactured synthesized segments of nucleic acids (known as oligonucleotides) in a facility in Boulder, Colorado. On November 11, 2004, we sold the assets associated with this facility to a subsidiary of Eyetech Pharmaceuticals, Inc. As a result of this sale, we no longer manufacture and sell these specialized oligonucleotides.
Our operations are managed based upon the nature of the products and services provided. Accordingly, we operate in two reportable segments, BioSystems and Nucleic Acids. Operations for these segments are evaluated based upon specific identification of revenues and expenses associated with the business activities resulting in a segment operating income or loss. See the Notes to the accompanying unaudited consolidated financial statements for detailed segment information.
Since 2000 (the year of our initial public offering), we have incurred net losses of $98.15 million largely related to our Nucleic Acids operating segment. We instituted significant changes during the fourth quarter of 2004 designed to, among other things, better align our cost structure with projected revenues, focus on opportunities in our BioSystems operating segment, and minimize the adverse financial effect of our Nucleic Acids operating segment. Specifically, during the fourth quarter of 2004, we sold our manufacturing facility in Boulder, Colorado and implemented a restructuring plan (the “2004 Restructuring Plan”). While the primarily goals of these changes were to provide the foundation for a self-sustaining, growth-oriented company with positive cash flows and earnings, there can be no assurance that we can achieve these goals.
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Our liquidity and working capital positions improved during the first six months of 2005 due principally to conversions of $2.53 million of borrowings under our credit line (“Credit Line”) and term note (“Term Note”) (collectively, the “Laurus Loans”) with Laurus Master Fund, Ltd. (“Laurus”) into common stock. At June 30, 2005, we had an accumulated deficit of $110.99 million.
Executive Summary
We achieved a number of significant milestones during the second quarter of 2005.
Our loss from operations and net loss during the quarter ended June 30, 2005 of $0.94 million and $1.00 million, respectively, were the best in our public-company history. Year-over-year net sales increases of 5% in our BioSystems operating segment together with cost reductions from our 2004 Restructuring Plan led to our record performance. Recurring sales (consumables plus service contract revenue) associated with our increasing installed base of WAVE systems grew to represent 40% of consolidated net sales and nearly 45% of net sales in our BioSystem operating segment. We expect that we can leverage on our existing cost structure to support annual revenues ranging up to $40.00.
Operating cash flows continue to validate the effectiveness of our 2004 Restructuring Plan. Cash used in operations for the three and six months ended June 30, 2005 totaled $1.03 million and $1.17 million, respectively. This represents significant improvement over historical levels of cash used in operations that have ranged from $1.76 million to $5.73 million and demonstrates significant progress toward a major goal of neutral to positive operating cash flows by the end of 2005.
We completed testing of our new generation WAVE platform and expect to roll it out during the third quarter of 2005. There are significant technical and functional enhancements designed into the WAVE 4500 (our fourth generation WAVE platform) that offer users enhanced flexibility, speed and ease of operation, throughput, and sensitivity. We expect the WAVE 4500 to drive new product and upgrade sales in the second half of 2005 and into 2006.
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Our investment in Discovery Services continues to yield significant growth. For the six months ended June 30, 2005, net sales from Discovery Services totaled $1.45 million compared to $0.89 million for the same period of 2004, an increase of 63%. These contract research service offerings represent a relatively new area of business for us. We plan to continue to seek opportunities to provide genetic variation discovery and analysis services to pharmaceutical and other customers and believe that these services provide us significant opportunities to expand revenue in the future.
Results of Operations Three Months Ended June 30, 2005 and 2004
Amounts in thousands
Bioinstruments
Bioconsumables
Discovery Services
Total BioSystems Business Unit
Chemical Building Blocks
Specialty Oligonucleotides and Services
Total Synthetic Nucleic Acids Business Unit
Total Net Sales
Cost of Goods Sold
Total Cost of Goods Sold
Selling, General and Administrative Expenses
Research and Development Expenses
Impairment Charges
Net Sales. Net sales for the quarter ended June 30, 2005 decreased $1.38 million or 15% from the same period of 2004 as a result of a $0.33 million or 5% increase in sales in our BioSystems operating segment offset by a $1.70 million or 70% decrease in sales in our Nucleic Acids operating segment.
The increase in sales in our BioSystems operating segment resulted from an decrease of $0.23 million or 6% from bioinstruments, increases in sales of bioconsumables of $0.44 million or 21% and increases from Discovery Services of $0.12 million or 23%. WAVE Systems sold totaled 25 during the quarter ended June 30, 2005 compared to 34 during the same period of 2004. The selling prices of our instruments vary based on the specific model and optional accessories. We had an installed base of approximately 1,241 units at June 30, 2005 compared to 1,193 units at December 31, 2004. The increase in the installed base of instruments continues to drive increases in sales of bioconsumables used with these instruments. The increase in Discovery Services revenue during 2005 was primarily attributable to the discovery services agreements that we entered into with Novartis Pharmaceuticals, Inc. (“Novartis”) to support their clinical development of oncology therapeutics. During the three months ended June 30, 2005, Discovery Services sales to Novartis totaled $0.67 million and represented 10% of net sales within the BioSystems operating segment and 9% of total consolidated net sales. We have no long-term agreement with Novartis, therefore, sales will fluctuate and may be zero. Future revenues from our BioSystems operating segment would be substantially reduced if Novartis’s need for our products declined.
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Nucleic Acids operating segment sales decreased by $1.71 million or 70% during the quarter ended June 30, 2005 compared to the same period of 2004 as a result of fewer chemical building block sales to Geron Corporation (“Geron”) and the sale of our specialty oligonucleotides facility in Boulder, Colorado. Sales to Geron during the second quarter of 2005 totaled $0.05 million compared to $1.17 million during the second quarter of 2004. Net sales to Geron during the quarter ended June 30, 2005 represented 7% of net sales in our Nucleic Acids operating segment and did not represent a significant portion of total consolidated net sales. Net sales to Geron during the quarter ended June 30, 2004 represented 48% of net sales within our Nucleic Acids operating segment and 13% of total consolidated net sales. We have no long-term agreement with Geron, therefore, sales will fluctuate and may be zero. Future revenues from our Nucleic Acids operating segment would be substantially reduced if Geron’s need for our products declined. As a result of the sale of our facility in Boulder, Colorado, net sales of specialty oligonucleotides decreased by $0.71 million. We no longer manufacture or sell oligonucleotides.
Costs of Goods Sold. Costs of goods sold include material costs for the products that we sell and substantially all other costs associated with our manufacturing facilities (primarily personnel costs, rent and depreciation). It also includes direct costs (primarily personnel costs and supplies) associated with our Discovery Services operations. Depreciation expense included in costs of goods sold totaled $0.56 million and $0.59 million during the quarters ended June 30, 2005 and 2004, respectively.
Costs of goods sold during the quarter ended June 30, 2005 decreased $1.41 million or 24% from the same period of 2004 as a result of a $0.43 million or 15% increase in our BioSystems operating segment offset by a $1.84 million or 64% decrease in our Nucleic Acids operating segment. The overall decrease was primarily attributable to the sale of our oligonucleotide facility and our 2004 Restructuring Plan.
Gross profit was $3.18 million or 42% of total net sales during the second quarter of 2005 compared to $3.15 million and 35% during the same period of 2004. A summary of gross profit by operating segment follows (dollars in thousands):
BioSystems operating segment
Nucleic Acids operating segment
The increase in BioSystems operating segment gross profit as a percentage of revenue to 46% from 40% for the quarters ended June 30, 2005 and 2004, respectively, is largely attributable to changes in the composition of products sold. Our Nucleic Acids operating segment continues to have excess capacity in its Glasgow, Scotland manufacturing facility that will adversely impact costs of goods sold and gross profit until demand for our Nucleic Acids building block products increase.
Selling, General and Administrative Expenses. Selling, general and administrative expenses primarily include personnel costs, marketing, travel and entertainment costs, professional fees, and facility costs. These costs totaled $3.54 million during the quarter ended June 30, 2005 compared to $4.27 million during the same period of 2004, a decrease of $0.73 million or 17%. This decrease resulted primarily from the 2004 Restructuring Plan, offset by the effects of unfavorable foreign currency transactions that totaled $0.23 million and $0.01 million during the quarters ended June 30, 2005 and 2004, respectively. Depreciation expense included in selling, general and administrative expenses totaled $0.19 million and $0.25 million during the quarters ended June 30, 2005 and 2004, respectively.
As a percentage of revenue, selling, general and administrative expenses totaled just over 46% and 47% during the quarters ended June 30, 2005 and 2004, respectively.
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Research and Development Expenses. Research and development expenses primarily include personnel costs, supplies, and facility costs. These costs totaled $0.58 million during the quarter ended June 30, 2005 compared to $1.67 million during the same period of 2004, a decrease of $1.09 million or 65%. The decrease resulted primarily from the 2004 Restructuring Plan, which resulted in the elimination of substantially all research and development efforts associated with our Nucleic Acids operating segment. Depreciation expense included in research and development expenses included $0.12 million and $0.22 million during the quarters ended June 30, 2005 and 2004, respectively.
As a percentage of revenue, research and development expenses totaled 8% and 19% of revenue during the quarters ended June 30, 2005 and 2004. We expect to continue to invest a substantial portion of our revenues in research and development activities primarily associated with our BioSystems operating segment. Research and development costs are expensed in the period in which they are incurred.
Other Income (Expense). Other income/(expense) during the quarter ended June 30, 2005 of $0.04 million consisted of interest expense of $0.08 million and other income net of $.03 million. Other expense during the quarter ended June 30, 2004 consisted of interest expense of $0.35 million and other expense net of $0.03 million, which consisted primarily of net investment losses associated with sales of Geron stock.
Interest expense consisted of the following (dollars in thousands):
The decrease in interest paid or accrued on outstanding debt resulted from lower average debt balances partially offset by higher interest rates. Gross debt (before related premiums and discounts) totaled $7.79 million at June 30, 2005 compared to $8.50 million at December 31, 2004. Our Laurus Loans had average balances during the quarters ended June 30, 2005 and 2004 of $7.65 million and $8.25 million, respectively, with weighted average interest rates of 8.00% and 6.00%, respectively. The high and low borrowings under our Credit Line during the quarter ended June 30, 2005 were $6.49 million and $5.26 million, respectively.
Income Tax Expense. Income tax recorded during the three months ended June 30, 2005 and 2004 related to income taxes in states, foreign countries and other local jurisdictions, offset by refunds received.
Due to the Company’s cumulative losses, expected losses in future years and inability to utilize any additional losses as carrybacks, the Company has not provided for an income tax benefit during the three months ended June 30, 2005 or 2004 based on management’s determination that it was more likely than not that such benefits would not be realized. The Company will continue to assess the recoverability of deferred tax assets and the related valuation allowance. To the extent the Company begins to generate taxable income in future periods and it determines that such valuation allowance is no longer required, the tax benefit of the remaining deferred tax assets will be recognized at such time. As of June 30, 2005, the Company’s deferred tax assets were offset by a valuation allowance of approximately $39.7 million.
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Results of Operations Six Months Ended June 30, 2005 and 2004
Net Sales. Net sales for the six months ended June 30, 2005 decreased $2.64 million or 15% from the same period of 2004 as a result of a $0.87 million or 7% increase in sales in our BioSystems operating segment offset by a $3.50 million or 75% decrease in sales in our Nucleic Acids operating segment.
The increase in sales in our BioSystems operating segment resulted from a decrease of $0.24 million or 3% from bioinstruments, increases in sales of bioconsumables of $0.54 million or 13% and increases from Discovery Services of $0.57 million or 64%. WAVE Systems sold totaled 48 during the six months ended June 30, 2005 compared to 66 during the same period of 2004. The selling prices of our instruments vary based on the specific model and optional accessories. The increase in the installed base of instruments continues to drive increases in sales of bioconsumables used with these instruments. The increase in Discovery Services revenue during 2005 was primarily attributable to the discovery services agreements that we entered into with Novartis to support their clinical development of oncology therapeutics. During the six months ended June 30, 2005, Discovery Services sales to Novartis totaled $1.41 million and represented 10% of net sales within the BioSystems operating segment and 9% of total consolidated net sales. We have no long-term agreement with Novartis, therefore, Sales will fluctuate and may be zero. Future revenues from our Nucleic Acids operating segment would be substantially reduced if Geron’s need for our products declined. Future revenues from our BioSystems operating segment would be substantially reduced if Novartis’s need for our products declined.
Nucleic Acids operating segment sales decreased by $3.50 million or 75% during the six months ended June 30, 2005 compared to the same period of 2004 as a result of fewer chemical building block sales to Geron and the sale of our specialty oligonucleotides facility in Boulder, Colorado. Net sales to Geron during the six month ended June 30, 2005 totaled $0.10 million compared to $1.90 million during the same period of 2004. Net sales to Geron during the six months ended June 30, 2005 represented 8% of net sales in our Nucleic Acids operating segment and did not represent a significant portion of total consolidated net sales. Net sales to Geron during the six months ended June 30, 2004, represented 18% of net sales within our Nucleic Acids operating segment and 11% of total consolidated net sales. We have no long-term agreement with Geron, therefore, sales will fluctuate and may be zero. As a result of the sale of our facility in Boulder, Colorado, net sales of specialty oligonucleotides decreased by $1.38 million. We no longer manufacture or sell oligonucleotides
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Costs of Goods Sold. Costs of goods sold include material costs for the products that we sell and substantially all other costs associated with our manufacturing facilities (primarily personnel costs, rent and depreciation). It also includes direct costs (primarily personnel costs and supplies) associated with our Discovery Services operations. Depreciation expense included in costs of goods sold totaled $1.14 million and $1.15 million during the six months ended June 30, 2005 and 2004, respectively.
Costs of goods sold during the six months ended June 30, 2005 decreased $2.78 million or 24% from the same period of 2004 as a result of a $1.17 million or 20% increase in our BioSystems operating segment and a $3.95 million or 67% decrease in our Nucleic Acids operating segment. The overall decrease was primarily attributable to the sale of our oligonucleotide facility and our 2004 Restructuring Plan.
Gross profit was $6.16 million or 41% of total net sales during the six months of 2005 compared to $6.01 million and 34% during the same period of 2004. A summary of gross profit by operating segment follows (dollars in thousands):
The increase in BioSystems operating segment gross profit as a percentage of revenue to 46% from 41% for the six months ended June 30, 2005 and 2004, respectively, is largely attributable to changes in the composition of products sold. Our Nucleic Acids operating segment continues to have excess capacity in its Glasgow, Scotland manufacturing facility that will adversely impact costs of goods sold and gross profit until demand for our Nucleic Acids building block products increase.
Selling, General and Administrative Expenses. Selling, general and administrative expenses primarily include personnel costs, marketing, travel and entertainment costs, professional fees, and facility costs. These costs totaled $7.14 million during the six months ended June 30, 2005 compared to $8.51 million during the same period of 2004, a decrease of $1.37 million or 16%. This decrease related primarily to the 2004 Restructuring Plan, offset by the effects of unfavorable foreign currency transactions that totaled $0.43 million and $0.12 million during the six months ended June 30, 2005 and 2004, respectively. Depreciation expense included in selling, general and administrative expenses totaled $0.36 million and $0.52 million during the six months ended June 30, 2004 and 2004, respectively.
As a percentage of revenue, selling, general and administrative expenses totaled just over 48% during the six months ended June 30, 2005 and 2004.
Research and Development Expenses. Research and development expenses primarily include personnel costs, supplies, and facility costs. These costs totaled $1.19 million during the six months ended June 30, 2005 compared to $3.60 million during the same period of 2004, a decrease of $2.41 million or 67%. The decrease related primarily to the 2004 Restructuring Plan, which resulted in the elimination of substantially all research and development efforts associated with our Nucleic Acids operating segment. Depreciation expense included in research and development expenses included $0.25 million and $0.43 million during the six months ended June 30, 2005 and 2004, respectively.
As a percentage of revenue, research and development expenses totaled 8% and 20% of revenue during the six months ended June 30, 2005 and 2004, respectively. We expect to continue to invest a substantial portion of our revenues in research and development activities primarily associated with our BioSystems operating segment. Research and development costs are expensed in the year in which they are incurred.
Other Income (Expense). Other expense during the six months ended June 30, 2005 of $1.70 million consisted of interest expense of $1.74 million and other income net of $.04 million. Other expense during the six months ended June 30, 2004 consisted of interest expense of $0.94 million and other income net of $0.07 million, which consisted primarily of net investment losses associated with sales of Geron stock.
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Valuation charge associated with March 2005 conversions
The increase in interest paid or accrued on outstanding debt resulted from higher average debt balances and interest rates. Gross debt (before related premiums and discounts) totaled $7.79 million at June 30, 2005 compared to $8.50 million at December 31, 2004. During the six months ended June 30, 2005 and 2004, we had average debt of $8.01 million and $7.01 million, respectively, with weighted average interest rates of 7.67% and 6.0%, respectively. The high and low borrowings under our Credit Line during the six months ended June 30, 2005 were $6.90 million and $4.75 million, respectively.
On March 18, 2005, the Company agreed to allow Laurus to convert $1.88 million of the outstanding principal balance under the Credit Line into 3,600,000 shares of its common stock at $0.52 per share. In addition, on March 24, 2005 the Company agreed to allow Laurus to convert $0.65 million of the outstanding principal balance of the Term Note into 1,250,000 shares of common stock at $0.52 per share. Laurus agreed to apply this Term Note conversion against substantially all remaining 2005 scheduled principal payments on such loan. The closing market price of the Company’s common stock the day before each of these conversions was $0.58 per share. No other provisions of our Credit Line or Term Note were modified, including the $1.00 conversion price for remaining debt. In conjunction with these conversions we accelerated amortization of $0.41 million of related debt premiums and discounts and recorded a charge of $1.37 million related to the fair value of incremental shares received by Laurus.
Income Tax Expense. Income tax recorded during the six months ended June 30, 2005 and 2004 related to income taxes in states, foreign countries and other local jurisdictions, offset by refunds received.
Due to the Company’s cumulative losses, expected losses in future years and inability to utilize any additional losses as carrybacks, the Company has not provided for an income tax benefit during the six months ended June 30, 2005 or 2004 based on management’s determination that it was more likely than not that such benefits would not be realized. The Company will continue to assess the recoverability of deferred tax assets and the related valuation allowance. To the extent the Company begins to generate taxable income in future periods and it determines that such valuation allowance is no longer required, the tax benefit of the remaining deferred tax assets will be recognized at such time. As of June 30, 2005, the Company’s deferred tax assets were offset by a valuation allowance of approximately $39.7 million.
Liquidity and Capital Resources
Our working capital positions at June 30, 2005 and December 31, 2004 were as follows (amounts are in thousands):
December 31,
Current assets (1)
Current liabilities
Working Capital
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The improvement in our working capital position during the first six months of 2005 was due primarily to conversions of $2.58 million of borrowings under our Laurus Loans into shares of our common stock.
While we expect our existing sources of liquidity to be sufficient to meet our cash needs for the remainder of 2005 and beyond, there can be no assurances that they will be, especially if we do not generate net positive cash flows from operations. It is essential that we achieve revenue growth in our BioSystems operating segment and manage costs according to our existing plan. Our projected liquidity needs may or may not be realized based upon actual operating results and capital project requirements. Accordingly, if our existing cash balances, cash generated by operations, and available borrowings under the Credit Line are insufficient to satisfy our liquidity requirements, we may need to sell additional equity or debt securities or obtain additional credit arrangements, sell certain assets or further reduce expenses. We are monitoring our liquidity position and are prepared to take appropriate measures, as needed, to address liquidity. We cannot assure you that any financing arrangement will be available in amounts or on terms acceptable to us. Our failure to raise additional capital, if needed, would harm our financial condition, results of operations and our business.
Laurus Loans. The Credit Line is a $7.50 million line of credit that we entered into with Laurus in December 2003. The term of the Credit Line is three years carrying an interest rate of 2.0% over the prime rate or a minimum of 6.0% (8.00% at June 30, 2005). Funds available under the Credit Line are determined by a borrowing base equal to 90% of eligible accounts receivable balances plus up to $1.00 million related to inventory balances. The Credit Line is secured by most of our assets. Prior to amendments to the Credit Line discussed below, payment of interest and principal could, under certain circumstances, be made with shares of our common stock at a fixed conversion price of $2.20 per share. Conversion of this debt to common stock may be made at the election of Laurus or the Company. We could elect to convert only if our shares trade at a price exceeding $2.42 per share for ten consecutive trading days, and such conversion is further subject to trading volume limitations and a limitation on the total beneficial ownership by Laurus of our common stock. Upon entering into the Credit Line, we issued warrants to Laurus to acquire 550,000 shares of the our common stock at an exercise price exceeding the average trading price of our common stock over the ten trading days prior to the date of the warrant.
In February 2004, we entered into the $2.75 million Term Note with Laurus. The Term Note carries an interest rate of 2.0% over the prime rate or a minimum of 6.0% (8.00% at June 30, 2005) and has a term of 3 years. Prior to amendments to the Term Note discussed below, the principal and interest on the Term Note could be converted into our common stock at a fixed conversion price of $2.61 per share. Upon entering into the Term Note, we issued warrants to Laurus to acquire 125,000 shares of our common stock. Borrowings under the Term Note were primarily used to retire the mortgage debt on our Glasgow, Scotland facility. Remaining borrowings of approximately $0.75 million were used to complete the build-out of the Glasgow facility, complete the consolidation our Glasgow operations into the new facility and provide funds for operations.
In February 2004, Laurus waived the borrowing base limitation on the Credit Line, thereby making the full $7.50 million facility available to us regardless of the available collateral. On August 31, 2004, Laurus agreed to extend the borrowing base waiver on the Credit Line through March 19, 2005. In addition, Laurus deferred certain payments due under the Term Note and reduced the interest rate on both of the Laurus Loans to 0% for any day the closing sale price of our common stock is at or above $1.75 per share. In return, we lowered the conversion price on each of the Laurus Loans to $1.00 per share and issued a warrant to Laurus covering an additional 400,000 common shares at an exercise price of $1.25 per share. The closing price of our common stock on August 31, 2004 was $1.20 per share.
On March 18, 2005, Laurus agreed to extend the borrowing base waiver on the Credit Line until March 31, 2006. In connection with this waiver, we agreed to allow Laurus to convert $1.87 million of the outstanding principal balance under the Credit Line into 3,600,000 shares of our common stock at $0.52 per share. In addition, on March 24, 2005, we agreed to allow Laurus to convert $0.65 million of the outstanding principal balance of the Term Note into 1,250,000 shares of our common stock at $0.52 per share. Laurus agreed to apply this Term Note
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conversion against substantially all remaining 2005 scheduled principal payments on such loan. The market price of our common stock on March 18 and 24, 2005 was $0.58. No other provisions of our loans with Laurus were modified, including the $1.00 conversion price on remaining debt.
Analysis of Cash Flows
Net Change in Cash and Cash Equivalents. Cash and cash equivalents increased $0.71 million during the six months ended June 30, 2005 as a result of net cash from investing activities and financing activities of $0.08 million and $1.88 million, respectively, offset by net cash used in operating activities of $1.17 million, and changes in foreign currency exchange rates of $0.08 million.
Cash Flows from Operating Activities. Cash flows used in operating activities totaled $1.17 million during the six months ended June 30, 2005 compared to $7.0 million during the same period of 2004. The use in 2005 related primarily to a net loss of $3.89 million offset by non-cash charges of $3.53 million. Non-cash charges consisted primarily of depreciation and amortization and certain financing costs. Working capital and other adjustments decreased cash flows from operating activities by $0.81 million. We spent $1.33 million during the six months ended June 30, 2005 related to the 2004 Restructuring Plan. We had accrued expenses associated with this plan of $0.58 million at June 30, 2005. This balance relates primarily to future rents on closed facilities (net of projected sublease rents) of which $0.28 million is expected to be paid during the remainder of 2005 and $0.27 million in 2006 and thereafter.
Cash Flows from Investing Activities. Cash flows provided by investing activities totaled $0.84 million during the six months ended June 30, 2005 compared to cash flows used in investing activities of $0.20 million during the same period of 2004. The use in 2005 related primarily to purchases totaling $0.67 million of property and equipment associated with the build out of our Glasgow, Scotland manufacturing facility that is substantially complete, offset by sales of available for sale securities (Geron stock) of $0.62 million. We do not anticipate this level of capital expenditures to recur during any remaining quarter in 2005. We currently estimate that consolidated capital expenditures will not exceed $0.50 million for the remainder of 2005.
Cash Flows from Financing Activities. Cash flows from financing activities totaled $1.88 million during the six months ended June 30, 2005 compared to $6.65 million during 2004. The source in 2005 related primarily to net draws on our Credit Line that were offset by payments on our Term Note. There are no scheduled principal payments for the remainder of 2005 on our Term Note.
Obligations and Commitments
Our ongoing capital commitments consist of debt service requirements and obligations under capital leases. The following table sets forth our contractual obligations as of June 30, 2005 along with cash payments due in each period indicated:
Credit Line (1)
Term Note (1)
Operating lease payments (2)
Purchase obligations
Total contractual obligations
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Off Balance Sheet Arrangements
At June 30, 2005 and December 31, 2004, we did not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.
Critical Accounting Policies
Accounting policies used in the preparation of the consolidated financial statements may involve the use of management judgments and estimates. Certain of the Company’s accounting policies are considered critical as they are both important to the portrayal of the Company’s financial statements and they require significant or complex judgments on the part of management. Our judgments and estimates are based on experience and assumptions that we believe are reasonable under the circumstances. Further, we evaluate our judgments and estimates from time to time as circumstances change. Actual financial results based on judgment or estimates may vary under different assumptions or circumstances. The Company’s critical accounting policies are discussed in our annual report on Form 10-K, as amended, for the year ended December 31, 2004. There have been no significant changes with respect to these estimates during the six months ended June 30, 2005.
On December 16, 2004, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (“SFAS”) No. 123R, Share-Based Payment. SFAS No.123R addresses the accounting for share-based payment transactions in which an enterprise receives employee services in exchange for (a) equity instruments of the enterprise or (b) liabilities that are based on the fair value of the enterprise’s equity instruments or that may be settled by the issuance of such equity instruments. SFAS No. 123R eliminates the ability to account for share-based compensation transactions using Accounting Principles Board Opinion No. 25 and generally requires that such transactions be accounted for using a fair-value-based method. We expect to adopt this standard on January 1, 2006. We are currently assessing the final impact of this standard on our financial position, results of operations or cash flows. This assessment includes evaluating option valuation methodologies and assumptions as well as potential changes to compensation strategies.
On November 24, 2004, the FASB issued SFAS No. 151, Inventory Costs – an amendment of ARB No. 43. SFAS No. 151 requires idle facility expenses, freight, handling costs, and wasted material (spoilage) costs to be excluded from the cost of inventory and expensed when incurred. It also requires that allocation of fixed production overhead to be based on the normal capacity of the production facilities. SFAS No. 151 will be effective at the beginning of 2006. We are currently assessing the final impact of this standard on our financial position, results of operations or cash flows.
Impact of Inflation
We do not believe that price inflation had a material adverse effect on our financial condition or results of operations during the periods presented.
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Foreign Currency Rate Fluctuations
During the last three fiscal years, our international sales have represented approximately 50-65% of our net sales. These sales of products in foreign countries are mainly completed in either British Pounds Sterling or the Euro. Additionally, we have two wholly owned subsidiaries, Transgenomic, LTD., and Cruachem, LTD., whose operating currency is British Pounds Sterling and the Euro. Results of operations for the Company’s foreign subsidiaries are translated using the average exchange rate during the period. Assets and liabilities are translated at the exchange rate in effect on the balance sheet dates. As a result we are subject to exchange rate risk. The operational expenses of our foreign subsidiaries help to reduce the currency exposure we have based on our sales denominated in foreign currencies by converting foreign currencies directly into goods and services. As such, we feel do not have a material exposure to foreign currency rate fluctuations at this time.
Forward-looking Information
This report contains a number of “forward-looking statements” as that term is defined in the Private Securities Litigation Reform Act of 1995. Many of these forward-looking statements refer to our plans, objective, expectations and intentions, as well as our future financial results. You can identify these forward-looking statements by forward-looking words such as “expects,” “anticipates,” “intends,” “plans,” “may,” “will,” “believes,” “feels,” “seeks,” “estimates,” and similar expressions. Because these forward-looking statements involve risks and uncertainties, there are important factors that could cause our actual results to differ materially from those expressed or implied by these forward-looking statements. Such factors would include the growth of the markets for DNA analysis technology and consumable products, the acceptance of our technology, our ability to continue to improve our products, the development of competing technologies, and our ability to protect our intellectual property rights.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Our Laurus Loans carry a variable interest rate of 2% over the prime rate or a minimum of 6% (8.00% at June 30, 2005), and therefore, expose us to interest rate risk. Based on the outstanding balance of these loans at June 30, 2005 of $6.91 million, a 1% increase in the prime rate would increase our interest expense by approximately $0.07 million annually.
Item 4. Controls and Procedures
A review and evaluation was performed by the Company’s management, including the Company’s Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), of the effectiveness of the design and operation of the Company’s disclosure controls and procedures as of the end of the period covered by this quarterly report. Based on that review and evaluation, the CEO and CFO concluded that the Company’s current disclosure controls and procedures, as designed and implemented, were effective. There have been no changes in the Company’s internal control over financial reporting subsequent to the date of their evaluation. There were no material weaknesses identified in the course of such review and evaluation and, therefore, no corrective measures were taken by the Company.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
The Company is subject to a number of other claims of various amounts, which arise out of the normal course of its business. In the opinion of management, the disposition of claims currently pending will not have a material adverse effect on the Company’s financial position, results of operations or cash flows after considering amounts already reflected in the consolidated financial statements.
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Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
The Company made no repurchases of its common stock during the second quarter of 2005; therefore, tabular disclosure is not presented.
Item 6. Exhibits
(a) Exhibits
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
/s/ MICHAEL A. SUMMERS
Michael A. Summers
Chief Financial Officer
(authorized officer and principal financial officer)
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