e10vq
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
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þ |
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QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
for the quarterly period ended March 31, 2006
OR
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TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
for the transition period from to
Commission File Number 0-22570
Solexa, Inc.
(Exact name of registrant as specified in its charter)
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Delaware
(State or other jurisdiction of
incorporation or organization)
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94-3161073
(I.R.S. Employer
Identification No.) |
25861 Industrial Blvd., Hayward, CA 94545
(Address of principal executive offices)
(510) 670-9300
(Registrants telephone number, including area code)
Indicate by check mark whether the registrant, (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for
such shorter period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes o No þ
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer,
or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in
Rule 12b-2 of the Exchange Act. (Check one):
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Large accelerated filer o
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Accelerated filer o
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Non-accelerated filer þ |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the
Act). Yes o No þ
The number of shares of common stock outstanding as of May 1, 2006 was 36,488,011.
Solexa, Inc.
FORM 10-Q
For the Quarter Ended March 31, 2006
INDEX
2
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
SOLEXA, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except per share amounts)
(Unaudited)
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March 31, |
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December 31, |
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2006 |
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2005 |
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ASSETS |
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Current assets: |
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Cash and cash equivalents |
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$ |
68,768 |
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$ |
38,403 |
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Accounts receivable |
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160 |
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539 |
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Inventory |
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867 |
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754 |
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Other current assets |
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3,492 |
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2,422 |
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Total current assets |
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73,287 |
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42,118 |
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Property and equipment, net |
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3,981 |
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4,378 |
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Intangible assets, net |
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3,401 |
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3,510 |
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Goodwill |
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22,529 |
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22,529 |
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Other non-current assets |
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484 |
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482 |
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Total assets |
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$ |
103,682 |
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$ |
73,017 |
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LIABILITIES AND STOCKHOLDERS EQUITY |
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Current liabilities: |
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Accounts payable |
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$ |
2,175 |
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$ |
2,235 |
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Accrued compensation |
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2,636 |
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2,067 |
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Accrued professional fees |
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574 |
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705 |
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Equipment financing, current portion |
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28 |
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31 |
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Forward loss contingency |
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364 |
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1,028 |
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Deferred revenue current portion |
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1,063 |
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1,518 |
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Deferred rent and lease obligations |
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866 |
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801 |
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Other accrued liabilities |
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624 |
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529 |
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Total current liabilities |
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8,330 |
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8,914 |
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Deferred revenues, net of current portion |
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2,395 |
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1,905 |
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Equipment financing, net of current portion |
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37 |
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44 |
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Deferred rent and lease obligations, net of current portion |
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2,144 |
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2,381 |
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Stockholders equity: |
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Preferred stock: $0.01 par value; 2,000 shares authorized; no shares issued and
outstanding at March 31, 2006 and December 31, 2005 |
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Common stock: $0.01 par value; 60,000 shares authorized; 36,479 shares and 30,027
shares issued and outstanding at March 31, 2006 and December 31, 2005, respectively |
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365 |
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300 |
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Additional paid-in capital |
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149,679 |
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109,575 |
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Deferred compensation |
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(275 |
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(326 |
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Accumulated other comprehensive income |
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2,180 |
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2,064 |
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Accumulated deficit |
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(61,173 |
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(51,840 |
) |
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Total stockholders equity |
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90,776 |
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59,773 |
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Total liabilities and stockholders equity |
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$ |
103,682 |
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$ |
73,017 |
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See accompanying notes.
3
SOLEXA, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
(Unaudited)
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Three Months Ended |
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March 31, |
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2006 |
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2005 |
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Service revenue |
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$ |
768 |
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$ |
605 |
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Operating costs and expenses: |
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Cost of service revenue |
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912 |
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540 |
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Research and development |
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6,332 |
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2,993 |
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Sales, general and administrative |
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3,817 |
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2,333 |
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Total operating costs and expenses |
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11,061 |
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5,866 |
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Loss from operations |
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(10,293 |
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(5,261 |
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Interest income |
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655 |
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136 |
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Interest expense |
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(156 |
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(132 |
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Other (expense), net |
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50 |
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(3 |
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Loss from operations |
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(9,744 |
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(5,260 |
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Income tax benefit related to research and development tax credit |
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(411 |
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Net loss |
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$ |
(9,333 |
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$ |
(5,260 |
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Dividends to A ordinary and B preferred shares |
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522 |
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Net loss attributable to common shareholders |
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$ |
(9,333 |
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$ |
(5,782 |
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Basic and diluted net loss per common share |
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$ |
(0.27 |
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$ |
(0.96 |
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Weighted average shares used to compute basic and diluted net loss per common share |
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35,113 |
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6,007 |
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See accompanying notes.
4
SOLEXA, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
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Three Months Ended |
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March 31, |
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2006 |
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2005 |
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Operating activities: |
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Net loss |
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$ |
(9,333 |
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$ |
(5,260 |
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Adjustments to reconcile net loss to net cash used in operating activities: |
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Depreciation and amortization |
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874 |
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555 |
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Amortization of deferred compensation and stock based compensation expense |
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924 |
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13 |
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Amortization of warrant value related to note payable |
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32 |
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Changes in operating assets and liabilities: |
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Accounts receivable |
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419 |
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118 |
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Inventory |
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(113 |
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26 |
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Other assets |
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(1,093 |
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837 |
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Accounts payable |
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260 |
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(880 |
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Forward loss contingency |
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(664 |
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Other accrued liabilities |
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163 |
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(60 |
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Deferred revenues |
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35 |
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(411 |
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Non-current liabilities |
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(43 |
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Net cash used in operating activities |
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(8,528 |
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(5,073 |
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Investing activities: |
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Purchases of property and equipment |
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(341 |
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(453 |
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Costs paid in connection with the business combination |
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(365 |
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Net cash used in investing activities |
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(341 |
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(818 |
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Financing activities: |
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Issuance of common stock, net of issuance costs |
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37,799 |
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3 |
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Proceeds from the exercise of stock options |
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97 |
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Proceeds from the exercise of warrants |
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1,260 |
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Repayment of equipment loans |
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(11 |
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(5 |
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Net cash provided by (used in) financing activities |
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39,145 |
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(2 |
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Net increase (decrease) in cash and cash equivalents |
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30,276 |
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(5,893 |
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Effect of exchange rate differences on cash and cash equivalents |
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89 |
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(121 |
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Cash and cash equivalents at beginning of period |
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38,403 |
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10,463 |
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Cash and cash equivalents at end of period |
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$ |
68,768 |
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$ |
4,449 |
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Supplemental disclosure of cash flow information: |
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Cash paid during the period for interest |
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$ |
155 |
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$ |
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Supplemental disclosure of non-cash financing activities: |
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Issuance of common stock in payment of board fees |
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$ |
140 |
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$ |
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See accompanying notes.
5
SOLEXA, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2006
1. Description of Business
Solexa, Inc. (Solexa, or the Company) is in the business of developing and commercializing
genetic analysis technologies. We currently generate service revenues in our genomics services
business from processing biological samples supplied to us by customers using our MPSS technology.
We intend to discontinue providing MPSS services in 2006. We are currently developing and
preparing to commercialize a novel instrumentation system for genetic analysis based on our
reversible-terminator Sequencing-by-Synthesis, or SBS, chemistry and based on our Clonal Single
Molecule ArrayTM technology. This platform is expected to support many types of genetic
analyses, including DNA sequencing, gene expression and small RNA analysis. We believe that this
technology, which can potentially generate over a billion bases of DNA sequence from a single
experiment with a single sample preparation, will dramatically reduce the cost, and improve the
practicality, of human re-sequencing relative to conventional technologies. We introduced our
first-generation system, the Solexa Genome Analysis System, to customers at the end of 2005 for
expected delivery in 2006. We believe our new DNA sequencing system will enable us to implement a
new business model based primarily on the sale of genetic analysis equipment, reagents and other
consumables and services to end user customers. Our longer-term goal is to further reduce the cost
of human re-sequencing to a few thousand dollars for use in a wide range of applications from basic
research through clinical diagnostics.
2. Basis of Presentation
On March 4, 2005, Solexa Limited, a privately held United Kingdom company, and Lynx
Therapeutics, Inc., a Delaware corporation, completed a business combination. Solexa Limited became
a wholly owned subsidiary of Lynx as a result of the transaction, and Lynx changed its name to
Solexa, Inc. However, because immediately following the business combination transaction the former
Solexa Limited shareholders owned approximately 80% of the shares of the common stock of Lynx,
Solexa Limiteds designees to the combined companys board of directors represented a majority of
the combined companys directors and Solexa Limiteds senior management represented a majority of
the senior management of the combined company, Solexa Limited is deemed to be the acquiring company
for accounting purposes. Accordingly, the assets and liabilities of Lynx were recorded, as of the
date of the business combination, at their respective fair values and added to those of Solexa
Limited. Results of operations of the combined company for the three months ended March 31, 2005,
reflect those of Solexa Limited, to which the results of operations of Lynx were added from the
date of the consummation of the business combination. The results of operations of the combined
company reflect purchase accounting adjustments, including increased amortization and depreciation
expense for acquired net assets.
In connection with this business combination transaction, Lynx changed its name to Solexa,
Inc. and its symbol to SLXA. Unless specifically noted otherwise, as used throughout these
Consolidated Financial Statements, Lynx Therapeutics or Lynx refers to the business, operations
and financial results of Lynx Therapeutics, Inc. prior to the business combination consummated on
March 4, 2005, Solexa Limited refers to the business of Solexa Limited, a privately held United
Kingdom company prior to the business combination, Solexa refers to the business of the combined
company after the business combination, and we refers to either the business operations and
financial results of Solexa Limited prior to the business combination or the business of the
combined company after the business combination, as the context requires.
6
The accompanying unaudited condensed consolidated financial statements included herein have
been prepared by Solexa without audit, pursuant to the rules and regulations promulgated by the
Securities and Exchange Commission (SEC). Certain information and footnote disclosures normally
included in annual financial statements prepared in accordance with generally accepted accounting principles have
been omitted pursuant to SEC rules and regulations; nevertheless, Solexa believes that the
disclosures are adequate to make the information presented not misleading. In the opinion of
management, the financial statements contain all adjustments, consisting only of normal recurring
adjustments, necessary to present fairly the financial position, results of operations and cash
flows of the Company for the interim periods presented. Revenues, expenses, assets and liabilities
can vary during each quarter of the year. Therefore, the results and trends in these interim
consolidated condensed financial statements may not be indicative of results for any other interim
period or for the entire year. These condensed consolidated financial statements should be read in
conjunction with the audited financial statements and related notes for the year ended December 31,
2005, which are contained in the Companys Annual Report on Form 10-K filed with the SEC on March
31, 2006.
The unaudited condensed consolidated financial statements include all accounts of Solexa and
our wholly owned subsidiaries, Solexa Limited and Lynx Therapeutics GmbH. All intercompany balances
and transactions have been eliminated.
Certain prior year amounts have been reclassified to conform to the current year presentation.
Specifically, certain amounts in the condensed consolidated statements of operations were
reclassified between research and development expense, sales, general and administrative expense,
interest income and interest expense. These reclassifications have no impact on our previously
reported net losses.
3. Summary of Significant Accounting Policies
Use of Estimates
The preparation of financial statements in conformity with U.S. generally accepted accounting
principles requires management to make estimates and assumptions that affect the amounts reported
in the financial statements and accompanying notes. Actual results could differ from those
estimates.
Stock-Based Employee Compensation
Effective January 1, 2006, the Company adopted Statement of Financial Accounting Standard No.
123R, Share Based Payment (Revised 2004) (SFAS 123R) on the modified prospective basis. As a
result, the Company has included stock-based employee compensation costs in its results of
operations for the quarter ended March 31, 2006, as more fully described in Note 4 to the Companys
condensed consolidated financial statements.
Concentrations and Segment Information
For the three months ended March 31, 2006, revenue from two customers represented 48% and 21%
of the Companys revenue, respectively. For the three months ended March 31, 2005, revenue from two
customers accounted for 60% and 21% of the Companys revenue, respectively.
To date, revenues have been derived primarily from contracts with customers located in the
United States and other countries as follows (revenues are attributed to geographic areas based on
the location of the customer, in thousands):
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Three Months Ended |
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March 31, |
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2006 |
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2005 |
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United States |
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$ |
715 |
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$ |
584 |
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United Kingdom |
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23 |
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21 |
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Other |
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30 |
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$ |
768 |
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$ |
605 |
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7
Net Loss Per Share
Basic net loss per share has been computed using the weighted-average number of shares of
common stock for the three months ended March 31, 2006 and of common stock and ordinary shares
outstanding for the three months ended March 31, 2005.
Common stock equivalents were not included in the computation of diluted net loss per share,
as their effect was anti-dilutive for the periods presented. Therefore, both the basic and diluted
net loss per share computations resulted in the same number of shares, and there were no
reconciling items. These common stock equivalents will be included in the calculation at such time
as the effect is no longer anti-dilutive, as calculated using the treasury stock method. Options
and warrants to purchase 11,450,433 and 1,773,014 common shares as of March 31, 2006 and 2005,
respectively, were not considered in the computation of basic and diluted net loss per share.
Recent Accounting Pronouncements
FASB Staff Position No. 123(R)-3
In November 2005, the Financial Accounting Standards Board ( the FASB) issued FASB Staff
Position No. 123(R)-3 (FSP FAS 123(R)-3), Transition Election to Accounting for Tax Effects of
Share-Based Payment Awards. This pronouncement provides an alternative method of calculating the
excess tax benefits available to absorb any tax deficiencies recognized subsequent to the adoption
of SFAS 123R. The Company has until November 2006 to make a one-time election to adopt the
transition method. The Company is currently evaluating FSP FAS 123(R)-3 and whether to make this
election. This one-time election will not affect operating loss or net loss.
4. Stock-based Employee Compensation
Effective January 1, 2006, the Company adopted Statement of Financial Accounting Standard No.
123R, Share Based Payment (SFAS 123R), using the modified prospective application method. Under
this method, all employee stock-based payments, including grants of stock options, are recognized
in the income statement as an operating expense, based on their fair values over the requisite
service period. Awards that are granted after January 1, 2006 were measured and non-cash employee
compensation expenses were recognized in the consolidated statements of operations in accordance
with SFAS 123R. In addition, the non-vested portion of awards as of January 1, 2006 also resulted
in recognition of non-cash employee compensation expense. The Company recognizes share-based
employee compensation expense ratably over the vesting period of options, adjusted for the expected
forfeiture rate.
For the three months ended March 31, 2006, in accordance with SFAS 123R, the Company
recognized non-cash stock-based employee compensation expenses of $846,000. The expenses were
included in the consolidated statements of operations as follows (in thousands):
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Three Months Ended |
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March 31, 2006 |
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Cost of service revenue |
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$ |
6 |
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Research and development |
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|
315 |
|
Sales, general and administrative |
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|
525 |
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Non-cash stock-based employee compensation expense |
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$ |
846 |
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|
There
was no tax benefit from recording this non-cash expense. As a result
of adopting Statement 123(R) on January 1, 2006, the
companys net loss for the period ended March 31, 2006, is $846,000 higher than if it had continued to account for
share-based compensation under Opinion 25. Both basic and diluted
loss per share for the period ended March 31, 2006 would have
been $0.24 if the company had not adopted Statement 123(R), compared
to reported basic and diluted loss per share of $0.27. Stock-based employee
compensation costs capitalized into inventory and charged against the forward loss contingency were
$7,000 and $7,000, respectively.
As of March 31, 2006, total unrecognized compensation costs related to non-vested awards of
$10.9 million is expected to be recognized over a weighted average period of approximately 2.81
years.
8
Under SFAS 123R, we estimate the fair value of stock options at the date of grant using the
Black-Scholes option valuation model. Expected volatility is based on trading activity of the
Company since the business combination between Solexa Limited and Lynx Therapeutics, Inc. and that
of certain comparable companies in our industry. The Company uses an estimate of the expected life
based on the weighted-average difference between the vesting term and the contract term. The
risk-free rate for periods within the contractual life of the option is based on the U.S. Treasury
yield curve in effect at the time of grant. The fair value of options at date of grant and the
assumptions utilized to determine such values are indicated in the following table:
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Three Months Ended |
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March
31, 2006 |
Risk-free interest rate |
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4.83 |
% |
Expected volatility |
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88 |
% |
Expected life (in years) |
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6.04 |
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Expected dividend yield |
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|
0 |
% |
Prior to the adoption of SFAS 123R, we applied SFAS 123, amended by
SFAS 148, Accounting for Stock-Based Compensation
Transition and Disclosure (SFAS 148), which allowed companies
to apply the existing accounting rules under APB 25,
Accounting for Stock Issued to Employees, and related
Interpretations. Periods prior to the adoption of 123R have not been
restated. In general, as the exercise price of options granted under
these plans was equal to the market price of the underlying common
stock on the grant date, no stock-based employee compensation cost
was recognized in our net income (loss) for period prior to the
adoption of SFAS 123R. AS required by SFAS 148 prior to the adoption
of SFAS 123R, we provided pro forma net loss and pro forma net loss
per share disclosures for stock-based awards, as if fair-value-based
method defined in SFAS 123 had been applied.
The following table illustrate the effect on net loss after tax and
net loss per share as if we had applied the fair value recognition
provisions of SFAS 123 to stock-based compensation during the three
month period-ended March 31, 2005 (in thousands, except per
share amounts):
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
March 31, 2005 |
|
Net loss, as reported |
|
$ |
(5,782 |
) |
Add: Stock-based employee compensation as reported |
|
|
13 |
|
Deduct: Stock-based employee compensation as if fair value
method applied to all awards |
|
|
(14 |
) |
|
|
|
|
Net loss, pro forma as if fair value method applied to all awards |
|
$ |
(5,783 |
) |
|
|
|
|
Basic and diluted net loss per share, as reported |
|
$ |
(0.96 |
) |
|
|
|
|
Basic and diluted net loss per share, pro forma as if
fair value method applied to all awards |
|
$ |
(0.96 |
) |
|
|
|
|
For the three months ended March 31, 2006, the only stock option plan under which the Company
awarded new grants to employees was the 2005 Equity Incentive Plan. The 2005 Equity Incentive Plan
awards generally vest either ratably over four years of service or one quarter at the end of the
first year and then ratably over the following three years of service and have a contractual life
of 10 years. At March 31, 2006, the Company has 366,534 shares available for grant under the 2005
Equity Incentive Plan. Option transactions under all the Company plans during the quarter ended
March 31, 2006 are summarized as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted- |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average |
|
|
|
|
|
|
|
|
|
|
Weighted |
|
|
Remaining |
|
|
|
|
|
|
Number of |
|
|
Average |
|
|
Contractual |
|
|
Aggregate Intrinsic |
|
|
|
Shares |
|
|
Exercise |
|
|
Term |
|
|
Value |
|
|
|
(In thousands) |
|
|
Price_ |
|
|
(In years) |
|
|
(In thousands) |
|
Outstanding at December 31, 2005 |
|
|
3,090,308 |
|
|
$ |
6.15 |
|
|
|
|
|
|
|
|
|
Granted |
|
|
497,500 |
|
|
|
9.17 |
|
|
|
|
|
|
|
|
|
Exercised |
|
|
(14,211 |
) |
|
|
6.84 |
|
|
|
|
|
|
|
|
|
Forfeited |
|
|
(51,373 |
) |
|
|
6.28 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding at March 31, 2006 |
|
|
3,522,224 |
|
|
$ |
6.57 |
|
|
|
8.82 |
|
|
$ |
14,782 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercisable at March 31, 2006 |
|
|
1,104,937 |
|
|
$ |
7.39 |
|
|
|
7.80 |
|
|
$ |
5,596 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
9
The weighted average fair value of options granted during the three months ended March 31,
2006 was $6.87. The total intrinsic value, the difference between the exercise price and the market
price on the date of exercise, of options exercised during the three months ended March 31, 2006,
was $44,500.
Cash received from options exercised during the three months ended March 31, 2006 was
approximately $97,000. In connection with these exercises, there was no tax benefit realized by the
Company due to the Companys current loss position.
The following table summarizes additional information about options outstanding at March 31,
2006:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted |
|
|
|
|
|
Options Exercisable |
|
|
Number |
|
Average |
|
|
|
|
|
Number |
|
|
|
|
Outstanding |
|
Remaining |
|
Weighted |
|
Exercisable |
|
Weighted |
|
|
As of |
|
Contractual |
|
Average |
|
As of |
|
Average |
Range of Exercise Prices |
|
3/31/06__ |
|
Term |
|
Exercise Price |
|
3/31/06 |
|
Exercise Price |
$1.28 $2.31
|
|
|
487,110 |
|
|
|
8.18 |
|
|
$ |
1.41 |
|
|
|
218,500 |
|
|
$ |
1.48 |
|
$2.32 $4.38
|
|
|
324,545 |
|
|
|
5.83 |
|
|
$ |
4.18 |
|
|
|
308,351 |
|
|
$ |
4.18 |
|
$4.39 $6.39
|
|
|
2,098,900 |
|
|
|
9.29 |
|
|
$ |
6.10 |
|
|
|
487,367 |
|
|
$ |
6.19 |
|
$6.40 $10.78
|
|
|
601,989 |
|
|
|
9.39 |
|
|
$ |
9.07 |
|
|
|
81,623 |
|
|
$ |
8.73 |
|
$10.79 $21.56
|
|
|
3,286 |
|
|
|
5.97 |
|
|
$ |
20.05 |
|
|
|
2,702 |
|
|
$ |
20.06 |
|
$21.57 $70.00
|
|
|
714 |
|
|
|
1.02 |
|
|
$ |
70.00 |
|
|
|
714 |
|
|
$ |
70.00 |
|
$70.01 $220.50
|
|
|
3,895 |
|
|
|
3.34 |
|
|
$ |
204.95 |
|
|
|
3,895 |
|
|
$ |
204.95 |
|
$220.51 $1,074.50
|
|
|
1,785 |
|
|
|
3.90 |
|
|
$ |
1,074.50 |
|
|
|
1,785 |
|
|
$ |
1,074.50 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$1.28 $1,074.50
|
|
|
3,522,224 |
|
|
|
8.82 |
|
|
$ |
6.57 |
|
|
|
1,104,937 |
|
|
$ |
7.39 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
5. Balance Sheet Accounts
Inventory consisted of the following (in thousands):
|
|
|
|
|
|
|
|
|
|
|
March 31, |
|
|
December 31, |
|
|
|
2006 |
|
|
2005 |
|
Raw materials |
|
$ |
176 |
|
|
$ |
213 |
|
Work in process |
|
|
691 |
|
|
|
541 |
|
|
|
|
|
|
|
|
|
|
$ |
867 |
|
|
$ |
754 |
|
|
|
|
|
|
|
|
Other current assets consisted of the following (in thousands):
|
|
|
|
|
|
|
|
|
|
|
March 31, |
|
|
December 31, |
|
|
|
2006 |
|
|
2005 |
|
Prepaid expenses |
|
$ |
924 |
|
|
$ |
544 |
|
Research and development tax credit receivable |
|
|
2,218 |
|
|
|
1,789 |
|
Other receivables |
|
|
350 |
|
|
|
89 |
|
|
|
|
|
|
|
|
|
|
$ |
3,492 |
|
|
$ |
2,422 |
|
|
|
|
|
|
|
|
Property and equipment consisted of the following (in thousands):
|
|
|
|
|
|
|
|
|
|
|
March 31, |
|
|
December 31, |
|
|
|
2006 |
|
|
2005 |
|
Leasehold improvements |
|
$ |
3,536 |
|
|
$ |
3,500 |
|
Laboratory and other equipment |
|
|
6,392 |
|
|
|
6,288 |
|
|
|
|
|
|
|
|
|
|
$ |
9,928 |
|
|
$ |
9,788 |
|
Less accumulated depreciation and amortization |
|
|
(5,947 |
) |
|
|
(5,410 |
) |
|
|
|
|
|
|
|
|
|
$ |
3,981 |
|
|
$ |
4,378 |
|
|
|
|
|
|
|
|
10
6. Forward Loss Contingency
In our genomics services business, we enter into service contracts to provide genetic analysis
on samples provided to us by customers. If management considers it probable that performance on the
contract will result in a loss and this loss can be reasonably estimated, a loss reserve is
recorded.
Changes in the forward loss reserves during the three months ended March 31, 2006 and 2005
were as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
March 31, |
|
|
|
2006 |
|
|
2005 |
|
Balance at beginning of year |
|
$ |
1,028 |
|
|
$ |
|
|
Loss experienced on completed samples |
|
|
(669 |
) |
|
|
|
|
Reversal of forward loss accrual for completed contracts |
|
|
(72 |
) |
|
|
|
|
Change in forward loss estimate |
|
|
77 |
|
|
|
|
|
|
|
|
|
|
|
|
Balance at March 31 |
|
$ |
364 |
|
|
$ |
|
|
|
|
|
|
|
|
|
In
addition, we recorded $207,000 in cost of service revenue during the
three months ended March 31, 2006 for the cost of samples in
excess of our estimates at the beginning of the quarter.
7. Comprehensive Loss
The following are the components of comprehensive loss (in thousands):
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
March 31, |
|
|
|
2006 |
|
|
2005 |
|
Net loss |
|
$ |
(9,333 |
) |
|
$ |
(5,260 |
) |
Currency translation |
|
|
116 |
|
|
|
(9 |
) |
|
|
|
|
|
|
|
Comprehensive loss |
|
$ |
(9,217 |
) |
|
$ |
(5,269 |
) |
|
|
|
|
|
|
|
8. Commitments and Contingencies
We lease facilities and certain equipment under non-cancelable operating leases with various
expiration dates through 2008. Future minimum lease payments under non-cancelable operating leases
as of March 31, 2006 are as follows (in thousands):
|
|
|
|
|
|
|
Operating |
|
|
|
Leases |
|
Remainder of 2006 |
|
$ |
2,394 |
|
2007 |
|
|
3,286 |
|
2008 and thereafter |
|
|
3,250 |
|
|
|
|
|
Total minimum payments |
|
$ |
8,930 |
|
|
|
|
|
9.
Stockholders Equity
On November 18, 2005, Solexa entered into an agreement to issue to 10.0 million shares of
common stock at $6.50 per share and five-year warrants to purchase approximately 3.5 million shares
of common stock at an exercise price of $7.50 per share. On November 23, 2005, pursuant to the
agreement, Solexa issued approximately 3.9 million shares of common stock and warrants to purchase
approximately 1.3 million shares of common stock, receiving net proceeds of $23.3 million.
Following receipt of stockholder approval, Solexa issued on January 19, 2006 approximately 6.1
million shares of common stock and warrants to purchase approximately 2.2 million shares of common stock, receiving net proceeds
of approximately $37.8 million. In aggregate, Solexa raised a total of approximately $61.1 million,
net of issuance costs.
11
In January 2006, the Company issued 13,042 shares of common stock from the 2005 Equity
Incentive Plan to members of the Board of Directors in lieu of board fees accrued. The related
expense had been recognized in 2005 in the approximate amount of $140,000.
In January 2006, the Company issued 24,580 shares of common stock to Silicon Valley Bank in a
net exercise of warrants to purchase 59,999 shares of common stock. No proceeds were received by
the Company as a result of this net exercise.
During the three months ended March 31, 2006, the Company issued 251,861 shares of common
stock for total cash consideration of $1,260,000 from the exercise of warrants.
During the three months ended March 31, 2006, the Company issued 14,211 shares of common stock
for total cash consideration of $97,000 from the exercise of employee stock options.
10. Goodwill and Intangible Assets
Goodwill is not being amortized but is tested for impairment annually, as well as when an
event or circumstance occurs indicating a possible impairment in value.
Intangible assets consist of the following (in thousands):
|
|
|
|
|
|
|
|
|
|
|
March 31, |
|
|
December 31, |
|
|
|
2006 |
|
|
2005 |
|
Purchased technology |
|
$ |
4,164 |
|
|
$ |
4,143 |
|
Accumulated amortization |
|
|
(763 |
) |
|
|
(633 |
) |
|
|
|
|
|
|
|
Intangible assets, net |
|
$ |
3,401 |
|
|
$ |
3,510 |
|
|
|
|
|
|
|
|
All intangible assets are being amortized using a straight-line method over their estimated
useful lives. Purchased technologies have been assigned useful lives of between 7 and 10 years
(with a weighted average remaining life of approximately 8.6 years). Amortization expense related
to identifiable intangible assets for the three months ended March 31, 2006 and 2005 was
approximately $130,000 and $89,000, respectively.
Estimated future amortization expense of intangible assets is as follows (in thousands):
|
|
|
|
|
2006 (Remaining 9 months) |
|
$ |
397 |
|
2007 |
|
|
531 |
|
2008 |
|
|
531 |
|
2009 |
|
|
530 |
|
2010 |
|
|
481 |
|
Thereafter |
|
|
931 |
|
|
|
|
|
|
|
$ |
3,401 |
|
|
|
|
|
11. Income Tax Benefit
We maintained a full valuation allowance on our deferred tax assets as of March 31, 2006.
The valuation allowance was determined in accordance with the provisions of Statement of Financial
Accounting Standards No. 109, Accounting for Income Taxes ( SFAS No. 109), which requires an
assessment of both positive and negative evidence of possible sources of taxable income and then a
determination of whether it is more likely than not that deferred tax assets are recoverable. This
assessment is required on a jurisdiction by jurisdiction basis. Cumulative losses incurred by us in
recent years represented sufficient negative evidence under SFAS No. 109, and, accordingly, a full
valuation allowance was recorded against deferred tax assets. We intend to maintain a full valuation allowance on
the deferred tax assets until sufficient positive evidence exists to support reversal of the
valuation allowance.
12
Our
tax provision benefit was $411,000 for the three months ended March 31, 2006, compared to
zero for the three months ended March 31, 2005. This tax benefit results from our estimate of that
portion of the annual refundable research credits for 2006 allowed by the United Kingdom Inland
Revenue which is attributable to the three months ended March 31, 2006.
12. Pension Plans
We operate a defined contribution group personal pension plan for substantially all of our
United Kingdom employees and a 401(k) Plan, also a defined contribution plan for the employees in
the Unites States. Pursuant to the 401(k) Plan, employees in the United States may elect to reduce
their current compensation by up to 25% (subject to an annual limit prescribed by the Internal
Revenue Code) and have the amount of such reduction contributed to the 401(k) Plan. The 401(k) Plan
permits, but does not require, additional contributions to the 401(k) Plan by us on behalf of all
participants in the 401(k) Plan. Company contributions to the plans totaled $133,000 and $100,000
for the three months ended March 31, 2006 and 2005, respectively.
13. Subsequent Event
In April 2006, Solexa, Ltd. entered into an additional facilities lease for our United Kingdom
operations. The lease is for approximately 7,000 square feet which we expect to use for both office
and research and development use. The lease term is through July 12, 2008 with total rent and
common area charges of approximately $560,000.
13
Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
This discussion and analysis should be read in conjunction with our financial statements and
accompanying notes included in this report and our 2005 audited financial statements and notes
thereto included in our Form 10-K filed on March 31, 2006.
Operating results for the three months ended March 31, 2006 are not necessarily indicative of
results that may occur in future periods.
Except for the historical information contained herein, the following discussion contains
forward-looking statements that involve risks and uncertainties. When used herein, the words
believe, anticipate, expect, estimate and imilar expressions are intended to identify such
forward-looking statements. There can be no assurance that these statements will prove to be
correct. Our actual results could differ materially from those anticipated in these forward-looking
statements as a result of certain factors which are difficult to forecast and can materially affect
our quarterly or annual operating results. Please see Part II. Item 1A Risk factors. We undertake
no obligation to update any of the forward-looking statements contained herein to reflect any
future events or developments.
Overview
We are in the business of developing and commercializing genetic analysis technologies. We
currently generate service revenues in our genomics services business from processing biological
samples supplied to us by customers using our MPSS technology. We intend to discontinue providing
MPSS services in 2006. We are currently developing and preparing to commercialize the Solexa Genome
Analysis System, which performs DNA sequencing based on our proprietary reversible-terminator
Sequencing-by-Synthesis, or SBS, chemistry and our Clonal Single Molecule Array technology. This
instrument platform is expected to perform a range of analyses, including whole genome
resequencing, gene expression analysis and small RNA analysis. We believe that this technology,
which can potentially generate over a billion bases of DNA sequence from a single experiment with a
single sample preparation, will dramatically reduce the cost, and improve the practicality, of
human resequencing relative to conventional technologies. We expect our first-generation
instrument, the 1G Genome Analyzer, to enable human genome resequencing below $100,000 per sample,
which would make it the first platform to reach this important milestone. We introduced the 1G
Genome Analyzer to customers in 2005 and expect to begin shipping and recognizing revenues on
instruments in 2006. Our longer-term goal is to further reduce the cost of resequencing a human
genome to a few thousand dollars for use in a wide range of applications from basic research
through clinical diagnostics.
On March 4, 2005, Solexa Limited, a privately held United Kingdom company, and Lynx
Therapeutics, Inc., a Delaware corporation, completed a business combination. Solexa Limited became
a wholly-owned subsidiary of Lynx as a result of the transaction, and Lynx changed its name to
Solexa, Inc. However, because immediately following the business combination transaction the former
Solexa Limited shareholders owned approximately 80% of the shares of the common stock of Lynx,
Solexa Limiteds designees to the combined companys board of directors represented a majority of
the combined companys directors and Solexa Limiteds senior management represented a majority of
the senior management of the combined company, Solexa Limited was deemed to be the acquiring
company for accounting purposes. Accordingly, the assets and liabilities of Lynx were recorded, as
of the date of the business combination, at their respective fair values and added to those of
Solexa Limited. The results of operations of the combined company for 2005 reflect those of Solexa
Limited, to which the results of operations of Lynx were added from the date of the consummation of
the business combination. The results of operations of the combined company reflect purchase
accounting adjustments, including increased amortization and depreciation expense for acquired
assets.
In connection with this business combination transaction, Lynx changed its name to Solexa,
Inc. and its symbol to SLXA. Unless specifically noted otherwise, as used throughout these
Consolidated Financial Statements, Lynx Therapeutics or Lynx refers to the business, operations
and financial results of Lynx Therapeutics, Inc. prior to the business combination consummated on
March 4, 2005, Solexa Limited refers to the business of Solexa Limited, a privately held United Kingdom company prior to the
business combination, Solexa refers to the business of the combined company after the business
combination, and we refers to either the business
operations and financial results of Solexa Limited prior
to the business combination or the business of the combined company after the business combination,
as the context requires.
14
As of March 31, 2006, we had an accumulated deficit of approximately $61.2 million. We expect
to continue to incur net losses as we proceed with the commercialization and development of our
technologies. The size of these losses will depend on the rate of growth, if any, in our revenues
and on the level of our expenses. Our cash and cash equivalents have increased from $38.4 million
as of December 31, 2005 to $68.8 million as of March 31, 2006, due to financing activities
involving a private placement of shares of our common stock and warrants to purchase our common
stock and warrant exercises, partially offset by cash used in operations.
On November 18, 2005, we entered into a definitive agreement for a private placement of common
stock and warrants to purchase common stock that raised approximately $23.3 million, net of
expenses, in the fourth quarter of 2005. On January 19, 2006, we received the balance of net
proceeds of approximately $37.8 million pursuant to this agreement. In aggregate, we raised a total
of approximately $61.1 million net of issuance costs in connection with the two closings of the
private placement.
Prior to the business combination with Lynx, Solexa Limited was a development stage company
with minimal revenue. As a result of the business combination, Solexa is no longer a development
stage company. Until our instrument system is available for commercial use, our primary revenue
source will be from our genomics services business based on MPSS technology, which had previously
been conducted by Lynx Therapeutics. Lynx historically received, and we expect to continue to
receive in the future, a significant portion of our genomics services revenues from a small number
of customers. We intend to discontinue services based on MPSS in 2006 and are in the process of
renegotiating our current MPSS customer contracts in order to provide these customers with services
based on our SBS chemistry.
Revenues from the genomics services business in each quarterly period have in the past, and
could in the future, fluctuate due to: the level of service fees, which is tied to the price,
number and timing of biological samples received from our customers, as well as our performance of
the related genomics services on the samples; the timing and amount of any technology access fees
and the period over which the revenue is recognized; the number, type and timing of new, and the
termination of existing, agreements with customers; and the sale of instruments, reagents and other
consumables, if any. In addition, our plans to introduce genomics services based on our
next-generation technology and to discontinue MPSS-based services could adversely impact our
genomics services revenues.
We expect revenues from the sale of our genetic analysis systems to commence in 2006. We
anticipate that systems revenues will fluctuate due to a number of factors, including: the level
and timing of sales of instruments, reagents and other consumables and service contracts; the
timing and ability of Solexa to manufacture or procure these items; the pricing and technical
performance levels of our products; and the existence of competing genetic analysis systems.
Our operating costs and expenses include cost of service revenue, research and development
expenses, and sales, general and administrative expenses. Cost of service revenue includes
primarily, the cost of direct labor, materials and supplies, outside expenses, equipment and
overhead including instrument depreciation, as well as period spending on work-in-process samples
that exceeds the expected revenue for those samples. Cost of service revenue in the first quarter
of 2006 excludes amounts charged to a forward loss contingency that we established in the third
quarter of 2005, of which $364,000 and $1.0 million remained outstanding at March 31, 2006 and
December 31, 2005, respectively. We did not incur cost of service revenue until completion of the
business combination transaction between Lynx and Solexa Limited.
Research and development expenses include the cost of personnel, materials and supplies,
outside expenses, equipment and overhead incurred by us in research and development related to our
genetic analysis instrument systems and process development and improvements related to our
genomics services business. Research and development expenses are expected to increase due to spending for
ongoing technology development and implementation, including building additional instruments for
internal use in research and development.
15
Sales, general and administrative expenses include the cost of personnel, materials and
supplies, outside expenses, equipment and overhead incurred by us primarily in our administrative,
sales and marketing, legal and investor relations activities. Sales, general and administrative
expenses are expected to increase in support of our research and development and commercial
efforts.
Critical Accounting Policies and Estimates
The preparation of our consolidated financial statements in conformity with US generally
accepted accounting principles requires management to make estimates and assumptions that affect
the amounts reported in our financial statements and accompanying notes. The items in our financial
statements requiring significant estimates and judgments include determining the useful lives of
fixed assets for depreciation and amortization calculations, determining the fair value of goodwill
and intangibles for impairment considerations, assumptions for valuing options and warrants,
estimates of future losses for contracts in our genomics services business and assumptions for tax
credits that we can claim for research and development activities. Actual results could differ
materially from these estimates.
Revenue
Revenues are related principally to services that we perform on biological samples we receive
from our customers. We recognize revenue when persuasive evidence of an arrangement exists,
services have been rendered and materials are delivered, the fee is fixed or determinable, and
collectibility is reasonably assured. Should conditions cause management to determine these
criteria have not yet been met, then any amounts billed to the customer are recorded as deferred
revenue.
Forward Loss Contingency
In our genomics services business, we enter into service contracts to provide genetic analyses
on samples provided to us by customers. If management considers it probable that performance on the
contract will result in a loss and this loss can be reasonably estimated, a loss reserve is
recorded. Management makes estimates of the costs to complete the applicable genetic analyses based
on historical experience; expectations of the nature and volume of future samples; the proportion
of fixed and variable costs; expectations with respect to production capacity, yields and
efficiency in our genomics services business; expectations with respect to the timing and expense
of implementing our next-generation technology in our genomics services business; the expected rate
of adoption by current customers of our next-generation technology in lieu of MPSS to perform
genetic analyses on their biological samples; and expectations of genomic services business sample
volume as a whole, including both MPSS and our next-generation technology. If our assumptions or
conditions change, the forward loss contingency will be adjusted accordingly.
16
Inventory
Inventory is stated at the lower of cost (which approximates first-in, first-out cost) or
market. The balance at March 31, 2006 was classified as raw materials and work in process. Raw
material inventories consist primarily of reagents and other chemicals utilized while performing genomics services.
Work-in-process inventories consist of the accumulated cost of experiments not completed. Amounts
in excess of the inventorys net realizable value are charged to cost of service revenue or to the
forward loss contingency reserve, as appropriate. Inventory used in providing genomics services and
for reagent sales is charged to cost of service revenue when the related revenue is recognized.
Reagents, chemicals and flow cells purchased for internal development purposes are charged to
research and development expenses upon receipt or as consumed.
Goodwill and Other Intangible Assets
Goodwill represents the excess of the purchase price over the fair value of net tangible and
identifiable intangible assets acquired in the business combination. Other intangibles including
patents, acquired technology rights and developed technology are being amortized using the
straight-line method over estimated useful lives of seven to ten years.
Goodwill is not amortized. We review goodwill for impairment annually (or more frequently if
impairment indicators exist). We review other intangible assets for impairment when indicators of
impairment exist.
Stock-based Employee Compensation
Commencing January 1, 2006, we adopted the provisions of SFAS No. 123R, Share-Based
Payment, which required us to expense the fair value of grants made under our equity incentive
plans over the requisite service period. We adopted the Modified Prospective Application
transition method, which does not result in the restatement of previously issued financial
statements. Awards that were granted after January 1, 2006 were measured and non-cash employee
compensation expenses were recognized in the condensed consolidated statements of operations in
accordance with SFAS No. 123(R). In addition, the non-vested portion of awards as of January 1,
2006 also resulted in recognition of non-cash employee compensation expense. We recognize
share-based employee compensation expense ratably over the vesting period of options, adjusted for
the expected forfeiture rate.
We estimate the fair value of stock options using a Black-Scholes valuation model, consistent
with the provisions of SFAS 123R. SFAS 123R requires the use of subjective assumptions, including
the options expected life and the price volatility of the underlying stock. The expected
volatility is based on the Companys trading activity since the business combination and that of
comparable companies in our industry.
In accordance with SFAS No. 123R, we recognized non-cash employee compensation expenses of
approximately $846,000 or 7.65% of total operating costs and expenses for the three months ended
March 31, 2006. The share-based employee compensation expenses for the three months March 31, 2006
were based on the fair values of 467,500 shares of options granted during the period, in addition
to the fair value of approximately 1.8 million shares of options granted before January 1,
2006 which were unvested as of that date, net of the capitalized portion. The operating expenses
discussed above include the following allocations of share-based compensation expense for the three
months ended March 31, 2006 (in thousands):
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
March 31, 2006 |
|
Cost of service revenue |
|
$ |
6 |
|
Research and development |
|
|
315 |
|
Sales, general and administrative |
|
|
525 |
|
|
|
|
|
Non-cash stock-based employee compensation expense |
|
$ |
846 |
|
|
|
|
|
Stock-based employee compensation costs capitalized into inventory and charged against the
forward loss contingency during the three months ended March 31, 2006 were approximately $7,000 and
$7,000, respectively.
17
Recent Accounting Pronouncements
FASB Staff Position No. 123(R)-3 In November 2005, the FASB issued FASB Staff Position No.
123(R)-3 (FSP FAS 123(R)-3), Transition Election to Accounting for Tax Effects of Share-Based
Payment Awards. This pronouncement provides an alternative method of calculating the excess tax
benefits available to absorb any tax deficiencies recognized subsequent to the adoption of SFAS
123R. We have until November 2006 to make a one-time election to adopt the transition method. We
are currently evaluating FSP FAS 123(R)-3 and whether to make this election. This one-time election
will not affect operating loss or net loss.
Results of Operations
Revenues
Revenues for the three months ended March 31, 2006 were approximately $768,000, compared to
revenues of $605,000 for the three months ended March 31, 2005. The increase in revenue of $163,000
was primarily due to revenue generated by the genomics service business subsequent to the business
combination of Lynx and Solexa Limited. The three months ended March 31, 2005 only included the
genomics service business revenue of Lynx from March 5 through March 31, 2005. We had been a
development stage company prior to that time. We have experienced variability from period to period
in revenues attributable to our genomics services business based in part on the timing of receipt
of biological samples, variability in outstanding contracts and the presence of non-service fee
revenues, including sales of reagents and other consumables. We expect this variability to continue
through 2006 and beyond.
During the remainder of 2006, we anticipate beginning to perform genomics services using our
SBS reversible terminator chemistry and Clonal Single Molecule Array technology and ceasing to
perform MPSS experiments for customers. Our contract with E.I. du Pont de Nemours and Company has
been amended to reduce the remaining maximum amount payable to Solexa to $1.5 million, of which a
portion is related to the delivery of an instrument and related consumables and the balance to
genomics services to be performed under the agreement. Our revenues could vary in 2006 and beyond
due to interruptions in genomics services production until the new instrumentation is ready to be
deployed in our genomics services business and as the new instrumentation is brought on line as
well as due to variable customer demand until the new technology has demonstrated equivalence or
superiority to the MPSS technology. During the remainder of 2006, we also anticipate the first
deliveries to customers of our first-generation Solexa Genome Analysis Systems.
Operating Costs and Expenses
Total operating costs and expenses were approximately $11.1 million for the three months ended
March 31, 2006, compared to $5.9 million for the three months ended March 31, 2005. The increase in
operating costs for 2006 over 2005 is due primarily to increased operating costs following the
business combination between Lynx and Solexa Limited, the expensing of stock-based compensation
under SFAS 123R, increased material costs for research and development and increased professional
fees for SEC reporting and compliance partially offset by the absence of costs related to execution
of the business combination. The three months ended March 31, 2005 only included operating costs
and expenses of Lynx from March 5 through March 31, 2005.
Cost of Service Revenue. Cost of service revenue primarily reflects the cost of providing our
genomics services, including a reserve for
future loss contingencies, direct labor, materials and supplies, outside expenses, equipment and
overhead, including instrument depreciation. In addition, we include in cost of service revenue
period spending on work-in-process samples that exceeds the expected revenue for those
samples. For the three months ended March 31, 2006, cost of service fees were $912,000,
compared to $540,000 for the three months ended March 31, 2005. Cost of service revenue
increased $372,000 as a result of the addition of revenue from the genomics services business of Lynx after completion of the business combination, charges for work-in
process samples that exceed the expected revenue and charges for stock-based compensation.
18
Cost of service revenue is net of amounts charged to a future loss contingency that we
recorded in the third quarter of 2005 for future loss contingencies with respect to existing
service fee contracts. At March 31, 2006, the forward loss contingency which remained on the
balance sheet was $364,000. We update this reserve based on an evaluation of contracts with samples
performed at a loss; an assessment of our future obligations under these contracts; and a range of
forecast assumptions for our future performance of these obligations, including but not limited to
the timing of sample receipt, genomics services business sample volume as a whole, our plans to
cease operation of our MPSS technology and to deploy our next-generation technology, and operating
efficiencies. This reserve may vary in future periods due to additional data on our costs to
process these samples; expectations of the nature and volume of future samples; the proportion of
fixed and variable costs; expectations with respect to production capacity, yields and efficiency
in our genomics services business; expectations with respect to the timing and expense of
implementing our next-generation technology in our genomics services business; the expected rate of
adoption by current customers of our next-generation technology in lieu of MPSS to perform genetic
analysis on their biological samples; and expectations of the genomic service business sample
volume as a whole, for both MPSS and our next-generation technology.
At the time that we begin to perform genomics services using our next-generation technology,
we anticipate that our material and labor costs per sample may decline; however, we could
experience periods of higher spending in the event we process samples using both the older MPSS and
the new technology in parallel and we experience efficiency levels below expectations as we work
with the new technology.
We expect cost of goods sold to increase in the future from zero at present as we initiate the
manufacturing of our next-generation instrument and associated consumables. These costs will
include personnel, materials and overhead. We anticipate that production activities will take place
both in the US and the UK in the remaining months of 2006.
Research and Development Expenses. Research and development expenses were approximately $6.3
million for the three months ended March 31, 2006, compared to $3.0 million for the three months
ended March 31, 2005. The $3.3 million increase in research and development expenses was primarily
due to increases in personnel and related expenses resulting from the business combination,
increases in material expenses, particularly our spending on components for the production of
instrument prototypes based on the new technology and charges for stock-based compensation.
We expect research and development expenses to increase in the future as we continue product
development efforts for our next-generation genetic analysis instrument system, build and operate a
fleet of instruments for internal R&D projects, including our plan to sequence a human genome in
2006, and build out additional leasehold improvements.
We cannot reasonably estimate the timing and costs of our research and development programs
due to the risks and uncertainties associated with developing a novel genetic analysis instrument
system and subsequent improvements. We expect that there will be significant additional work
required to optimize the instrument and consumable portions of the system to achieve target
performance levels even after we begin to ship and recognize revenue on the sale of our
next-generation instrument system. Furthermore, we anticipate continued spending on research and
development related to future-generation systems and to additional applications of our genetic
analysis instrument systems.
Sales, General and Administrative Expenses. Sales, general and administrative expenses were
approximately $3.8 million for the three months ended March 31, 2006, compared to $2.3 million for
the three months ended March 31, 2005. The increase of $1.5 million in sales, general and
administrative spending was primarily due to increased operating costs following the business
combination due both to the business combination and to subsequent recruiting, including increased
personnel and related expenses; increased professional fees related to SEC compliance; and charges
for stock-based compensation.
19
We expect sales, general and administrative expense to increase in the near future as we hire
increased personnel to support the commercialization of our next-generation genetic analysis
instrument system and to increase non-personnel sales and marketing spending, including but not
limited to promotional materials and activities, market research, travel and training. We expect to
hire sales and marketing personnel, including salespeople, application specialists and field
service and customer service/technical support personnel. We may need to establish additional
places of business in conjunction with this hiring.
Interest Income
Interest income for the three months ended March 31, 2006 was $655,000, compared to $136,000
for the three months ended March 31, 2005. The increase in interest income of $519,000 was
primarily due to increased amounts of cash and cash equivalents as a result of sales of our common
stock in private placement transactions.
Interest Expense
Interest expense was approximately $156,000 for the three months ended March 31, 2006,
compared to $132,000 for the three months ended March 31, 2005. Interest expense is related
principally to the business combination, including the assumption of an idle facility that had been
written off prior to the business combination and for which a portion of the rental payments are
treated as interest expense and the assumption of $3.0 million of Lynxs note obligations.
Income Tax Provision (Benefit)
We maintained a full valuation allowance on our deferred tax assets as of March 31, 2006.
The valuation allowance was determined in accordance with the provisions of Statement of Financial
Accounting Standards No. 109, Accounting for Income Taxes (SFAS No. 109), which requires an
assessment of both positive and negative evidence of possible sources of taxable income and then a
determination of whether it is more likely than not that deferred tax assets are recoverable. This
assessment is required on a jurisdiction by jurisdiction basis. Cumulative losses incurred by us in
recent years represented sufficient negative evidence under SFAS No. 109, and, accordingly, a full
valuation allowance was recorded against deferred tax assets. We intend to maintain a full
valuation allowance on the deferred tax assets until sufficient positive evidence exists to support
reversal of the valuation allowance.
Our
tax provision benefit was approximately $411,000 for the three months ended March 31,
2006, compared to zero for the three months ended March 31,
2005. This tax benefit results from our
estimate of that portion of the annual refundable research credits for 2006 allowed by the United
Kingdom Inland Revenue which is attributable to the three months ended March 31, 2006.
Liquidity and Capital Resources
Cash and cash equivalents increased from approximately $38.4 million as of December 31, 2005
to approximately $68.8 million as of March 31, 2006.
Operating Activities. Net cash used in operating activities was approximately $8.5 for the
three months ended March 31, 2006 as compared to $5.1 million for the three months ended March 31,
2005. Increase in cash used in operating activities resulted primarily from increases in our net
loss, partially offset by increases in stock-based compensation expense and depreciation and
amortization expense.
Investing Activities. Net cash used in investing activities was approximately $341,000 for
the three months ended March 31, 2006, compared to $818,000 for the three months ended March 31,
2005. Decreased net cash used in investing activities was primarily due to the absence of cash
expenses incurred in the business combination and to the reduction in capital expenditures.
20
Financing Activities. Net cash provided by financing activities was approximately $39.1
million for the three months ended March 31, 2006, compared to net cash used by financing
activities of $2,000 for the three months ended March 31, 2005. Net cash provided by financing
activities in the three months ended March 31, 2006 consisted of $37.8 million received pursuant to
a private placement of common stock and warrants to purchase common stock, net of related financing
costs, and proceeds from the exercise of stock options and warrants.
On November 18, 2005, we entered into an agreement to issue to private investors 10.0 million
shares of common stock at $6.50 per share and five-year warrants to purchase approximately 3.5
million shares of common stock at an exercise price of $7.50 per share. On November 23, 2005,
pursuant to the agreement, we issued approximately 3.9 million shares of common stock and warrants
to purchase approximately 1.3 million shares of common stock, receiving net proceeds of $23.3
million. Upon receipt of stockholder approval, we issued on January 19, 2006 approximately 6.1
million shares of common stock and warrants to purchase approximately 2.2 million shares of common
stock, receiving net proceeds of approximately $37.8 million. In aggregate, we received a total of
approximately $61.1 million, net of issuance costs.
Operating Capital Requirements. We plan to use available funds for ongoing commercial,
research and development and related general sales and administrative activities, working capital,
capital expenditures and other general corporate purposes. We expect our capital investments during
2006 to be approximately $3.1 million and to consist primarily of expenditures for capital
equipment required in the normal course of business, for the introduction of our Solexa Genome
Analysis System and for leasehold improvements.
We have obtained funding for our operations primarily through sales of common stock, ordinary
shares and preferred shares, payments received under contractual arrangements with customers,
proceeds from the exercise of stock options and warrants and interest income. Consequently,
investors in our equity securities and our customers are significant sources of liquidity for us.
Therefore, our ability to maintain liquidity is dependent upon a number of uncertain factors,
including but not limited to the following: our ability to advance and commercialize further our
new technologies; our ability to generate revenues through expanding and converting existing
customer arrangements to our new technologies and obtaining significant new customers either in our
genomics services business or through the sale of our instruments and consumables related to the
Solexa Genome Analysis System, and the receptivity of capital markets toward our equity or debt
securities. The cost, timing and amount of funds required by us for specific uses cannot be
precisely determined at this time and will be based upon the progress and the scope of our
commercial and research and development activities; payments received under customer agreements;
our ability to establish and maintain customer agreements; costs of protecting intellectual
property rights; legal and administrative costs; additional facilities capacity needs; and the
availability of various methods of financing.
Solexa Limited incurred net losses each year since its inception in 1998 through March 4,
2005, the date on which the business combination transaction with Lynx was consummated, and we have
continued to incur net losses since that time. As of March 31, 2006, we had an accumulated deficit
of $61.2 million. Net losses may continue for the next several years as we proceed with the
development and commercialization of our technologies. The presence and size of these potential net
losses will depend, in part, on the rate of growth, if any, in our revenues and on the level of our
expenses.
We believe that our cash balances at March 31, 2006 will be sufficient to meet our projected
working capital and other cash requirements through at least the next twelve months. However, there
can be no assurance that future events will not require us to seek additional borrowings or capital
and, if so required, that such borrowing or capital will be available on acceptable terms.
Contractual Obligations and Commitments. We have long-term, non-cancelable building and
equipment lease commitments. Future payments due under building leases and other contractual
obligations as of March 31, 2006 (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Less than |
|
|
|
|
|
|
Total |
|
|
1 year |
|
|
1-3 years |
|
Equipment loan |
|
$ |
72 |
|
|
$ |
33 |
|
|
$ |
39 |
|
Operating leases |
|
|
8,858 |
|
|
|
3,182 |
|
|
|
5,676 |
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
8,930 |
|
|
$ |
3,215 |
|
|
$ |
5,715 |
|
|
|
|
|
|
|
|
|
|
|
Off-Balance Sheet Arrangements. At March 31, 2006 and December 31, 2005, we did not have any
off-balance sheet arrangements or relationships with unconsolidated entities or financial
partnerships, such as entities often referred to as structured finance or special purposes
entities, which are typically established for the purpose of facilitating off-balance sheet
arrangements or other contractually narrow or limited purposes.
21
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
Financial Risk Management
We are exposed to various market risks, including changes in foreign currency exchange rates.
Our United Kingdom subsidiarys assets are held in the U.K. pound, its functional currency. Its
accounts are translated from the U.K. pound to the U.S. dollar using the current exchange rate in
effect at the balance sheet date, for most balance sheet accounts excluding principally certain
intercompany and equity accounts, and using the average exchange rate during the period, for
revenues and expense accounts. Additionally, approximately 7% of our revenue for the three months
ended March 31, 2006 was from foreign countries. All of our sales are denominated in U.S. dollars
or U.K. pounds. As a result, we are exposed to risks associated with foreign exchange rate
fluctuations. To date, we have not taken any action to reduce our exposure to changes in foreign
currency exchange rates, such as options or futures contracts, with respect to transactions between
our subsidiary and us.
The primary objective of our investment activities is to preserve principal while, at the same
time, maximizing yields without significantly increasing risk. To achieve this objective, we invest
in highly liquid and high-quality debt securities. Our investments in debt securities are subject
to interest rate risk. To minimize the exposure due to adverse shifts in interest rates, we invest
in short-term securities and maintain an average maturity of less than one year. As a result, we do
not believe we are subject to significant interest rate risk.
Item 4. Controls and Procedures
Disclosure Controls and Procedures
Based on their evaluation as of March 31, 2006, our Chief Executive Officer and Vice President
and Chief Financial Officer have concluded that, as a result of the material weakness discussed
below, our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under
the Securities Exchange Act of 1934, as amended) were not effective in providing reasonable
assurance that the information required to be disclosed by us in this report on Form 10-Q was
recorded, processed, summarized and reported within the time periods specified in the Securities
and Exchange Commissions rules and Form 10-Q.
A material weakness is a control deficiency, or combination of control deficiencies, that
results in more than a remote likelihood that a material misstatement of the annual or interim
financial statements will not be prevented or detected. As of March 31, 2006, management has
determined a material weakness exists in our ability to maintain effective controls over the
application of generally accepted accounting principles (GAAP) related to the financial reporting
process. We currently have limited financial personnel and they do not possess sufficient depth,
skills and experience to ensure that all transactions are accounted for in accordance with GAAP.
Additionally, we have insufficient formalized procedures to assure that transactions receive
adequate review by accounting personnel with sufficient technical accounting expertise.
The ineffective control over the application of GAAP related to the financial reporting
process could result in a material misstatement to our annual or interim financial statements that
may not be prevented or detected. As a result, management has determined that this control deficiency constituted a
material weakness in internal controls over financial reporting as of March 31, 2006.
22
Changes in Internal Controls over Financial Reporting
We are recruiting additional finance and accounting personnel to fill multiple open positions
in our finance organization. During the second quarter of 2005 we hired a controller, who departed
in April 2006. Her duties are currently being performed by a consultant, who is serving as an
interim finance director. During the first quarter of 2006, we implemented a new companywide
automated accounting system and contracted for additional temporary and consulting personnel
resources. In addition, we are in the process of reviewing our control procedures surrounding
monthly account reconciliations, support for manual journal vouchers and the review of the monthly
close to determine any additional steps necessary to remediate the material weaknesses.
Except as discussed above, there were no changes in our internal control over financial
reporting during the quarter ended March 31, 2006 that have materially affected, or are reasonably
likely to materially affect, our internal control over financial reporting.
Limitations on the Effectiveness of Controls
Our management, including our Chief Executive Officer and Vice President and Chief Financial
Officer, does not expect that our disclosure controls and procedures or our internal controls will
prevent all errors and all fraud. A control system, no matter how well conceived and operated, can
provide only reasonable, not absolute, assurance that the objectives of the control system are met.
Further, the design of a control system must reflect the fact that there are resource constraints,
and the benefits of controls must be considered relative to their costs. Because of the inherent
limitations in all control systems, no evaluation of controls can provide absolute assurance that
all control issues and instances of fraud, if any, within the company have been detected. These
inherent limitations include the realities that judgments in decision-making can be faulty, and
that breakdowns can occur because of simple error or mistake.
Additionally, controls can be circumvented by the individual acts of some persons, by
collusion of two or more people, or by management override of the control. The design of any system
of controls also is based in part upon certain assumptions about the likelihood of future events,
and there can be no assurance that any design will succeed in achieving its stated goals under all
potential future conditions; over time, control may become inadequate because of changes in
conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of
the inherent limitations in a cost-effective control system, misstatements due to error or fraud
may occur and not be detected.
23
Part II. OTHER INFORMATION
Item 1. Legal Proceedings.
We are not a party to any material legal proceedings.
Item 1A.
Risk Factors.
Our business faces significant risks. These risks include those described below and may
include additional risks of which we are not currently aware or which we currently do not believe
are material. If any of the events or circumstances described in the following risks actually
occurs, our business, financial condition or results of operations could be harmed. These risks
should be read in conjunction with the other information set forth in this report.
We have a history of net losses, expect to continue to incur net losses and may not achieve or
maintain profitability.
We have incurred net losses each year since our inception, including a net loss for the three
months ended March 31, 2006. As of March 31, 2006, we had an accumulated deficit of approximately
$61.2 million. Net losses may continue for the next several years as we proceed with the
development and commercialization of our technologies, including the Solexa Genome Analysis System.
The presence and size of these potential net losses will depend, in part, on the rate of growth, if
any, or decline in revenues and on the level of expenses. Research and development expenditures and
sales, general and administrative costs have exceeded revenues to date, and we expect these
expenses to increase in the future. We will need to generate significant revenues to achieve
profitability, and even if we are successful in achieving profitability, there is no assurance we
will be able to sustain profitability.
If we are unable to successfully develop and commercialize our new products, we will not be able to
increase our revenues or become profitable.
We set out to develop new DNA sequencing technologies, and we are now using those technologies
to develop new genetic analysis instruments, consumables and services. If our strategy does not
result in the development of products, including our 1G Genome Analyzer, that we can commercialize
in a timely manner, we will be unable to generate significant revenues. Furthermore, there is no
guarantee that we will be able to sell our instruments and consumables on terms that will generate
profits or positive cash flow. Although we have developed DNA sequencing instruments that we
currently use in providing gene expression services to customers, these instruments are based on
the MPSS technology developed by Lynx rather than the new technologies currently under development.
We cannot be certain that we will successfully develop any new products, including our 1G Genome
Analyzer, in a timely manner, or that the new products will receive commercial acceptance, in which
case we may not be able to increase or maintain our revenues or become profitable.
We have articulated aggressive business and technical objectives for 2006, including our
expectation of recognizing revenue on sales of our 1G Genome Analyzer beginning in the second
quarter of 2006; launching a number of applications to be run on the Solexa Genome Analysis System
in 2006; and sequencing the human genome in 2006. We will need to overcome significant challenges
to achieve these milestones in the designated timeframes, including continuing to improve the
technical performance of our system; obtaining customer acceptance of our products; and producing
and implementing a number of 1G Genome Analyzers at both our U.K. and California sites. Failure to
accomplish these objectives, or to accomplish them within the articulated timeframes, could cause
our stock price to decline or to be come more volatile.
24
Our technology platform is at the development stage and is unproven for market acceptance.
While our MPSS technology has been commercialized and is currently in use for certain kinds of
genetic analysis, including gene expression and small RNA analysis, we are developing our SBS
reversible-terminator chemistry and our Clonal Single Molecule Array technology to perform similar
genetic analyses as well as to sequence the DNA of genomes and of individual genes and genomic
regions. These technologies are still in development, and we may not be able to successfully
complete development of these technologies or commercialize them. Our success depends on many
factors, including:
|
|
|
technical and economic performance of our technologies in relation to competing technologies; |
|
|
|
|
acceptance of our technology in the marketplace; |
|
|
|
|
our ability to establish an instrument manufacturing capability, or obtain instruments
from another manufacturer; and |
|
|
|
|
our ability to manufacture reagents and other consumables, or obtain licenses to resell
reagents and other consumables. |
You must evaluate us in light of the uncertainties and complexities affecting an early stage
genetic analysis systems company. The application of our technologies is at too early a stage to
determine whether they can be successfully implemented within our targeted timeframe, for our
targeted applications or at our targeted technical and economic performance levels. Our
technologies also depend on the successful integration of independent technologies, each of which
has its own development risks. We anticipate that, if our technology is able to successfully reduce
the cost of genetic analysis relative to existing providers, our technology may be able to displace
current technology as well as to expand the market for genetic analysis to include new applications
that are not practical with current technology. The current focus of many of our potential
customers performing DNA sequencing is on candidate region, candidate gene and de novo sequencing,
rather than on whole genome resequencing. Furthermore, although we believe our system should be
suitable for resequencing large and complex genomes, there is no single technique that can be used
to resequence the entire genome of a human. Instead, scientists need to combine several techniques
to address complex structures such as long repeat sequences. One example of such a technique is
paired-end reads. We anticipate developing over time additional techniques, such as paired-end
reads, for use with our system.
Our inability to sequence an entire human genome may limit our market. Many of our potential
customers must, in turn, demonstrate to governmental and other funding sources that our technology
has been successfully developed before they can make substantial purchases of our products. There
is no guarantee, even if our technology can reduce the cost of genetic analysis relative to
existing approaches, that we will be able to induce customers with installed bases of conventional
genetic analysis instruments to purchase our system or that we will be able to expand the market
for genetic analysis to include new applications. Furthermore, if we are only able to successfully
commercialize our genetic analysis systems as a replacement for existing technology, we may face a
much smaller market than we currently anticipate.
We have limited experience in sales, marketing and field support and thus may be unable to
commercialize our genetic analysis instrument systems and services.
Our ability to achieve profitability depends on attracting customers for our genetic analysis
instrument systems and services. There are a limited number of research institutes and
pharmaceutical, biotechnology and agricultural companies that are potential customers for our
products and services. To market and sell our products, we intend to develop a sales and marketing
group with the appropriate technical expertise. We are currently conducting a search for an
executive to run our field organization, including sales, field application support and field
service. We may not successfully build such a field organization. In addition, we may seek to
enlist a third party to assist with sales and distribution globally, in certain regions of the
world or for certain applications. In addition, if we are successful in achieving market acceptance
for our new genetic analysis instruments, we will need either to build internal capabilities to
install and maintain instruments at customer sites, to assist customers with the experiments that
they intend to conduct using our instruments and to train customers on the use of our instruments,
or to contract with one or more partners to do so on our behalf. There is no guarantee, if we do
seek to enter into such arrangements, that we will be successful in attracting one or more
desirable sales and distribution partners, or that we will be able to enter into such arrangements
on favorable terms. If our sales, marketing, field application support and field service efforts, or those of any third-party sales and distribution partner, are not
successful, our technologies and products may not gain market acceptance, which could materially
impact our business operations. Any delay in establishing or inability to expand our sales,
marketing and field support capacity could hurt our business.
25
We will need to develop manufacturing capacity either by ourselves or with a partner.
If we are successful in achieving market acceptance for our new genetic analysis instruments,
we will need either to build internal manufacturing capacity for instruments, flow cells and
reagents, or to contract with one or more manufacturing partners. We are currently using personnel
from our research and development and genomics services groups and consultants to address
manufacturing and outsourcing, and we are conducting a search for an executive to manage these
operations. There is no assurance that we will be able to build manufacturing capacity internally,
or to contract with a manufacturing partner, in order to meet both the volume and quality
requirements necessary to be successful in the market. Any delay in establishing or inability to
expand our manufacturing capacity could hurt our business.
Our current business model is unproven and different from our former business model.
Our current business model is based primarily on the planned sales of genetic analysis
instruments and of reagents and other consumables and services to support customers in their use of
that equipment. Alternative commercial arrangements may take the form of equipment leases,
equipment placements and collaborations with customers at academic, government and commercial labs,
among others.
Lynxs historical business model, which we have continued since the business combination, was
based on providing genomics services using our MPSS technology and supplying customers with DNA
sequences and other information that resulted from experiments. A change in emphasis from our
former business model has caused some current and prospective customers of our genomics services
business to delay, defer or cancel purchasing decisions with respect to new or existing agreements.
There is no assurance that we will be successful in changing the emphasis of our business model
from providing genomics services to selling instruments, consumables and support services to new or
existing customers. We intend to discontinue providing MPSS based services in 2006 and are in the
process of renegotiating our current MPSS customer contracts in order to provide those customers
with services based on our new SBS technology. We have entered into new or amended agreements with
some of our existing customers providing for the transition from MPSS-based services to SBS-based
services. There is no guarantee, however, that all of our customers will migrate to the new
technology platform once it is commercialized or that our genomics services business will generate
positive cash flow or become profitable.
We may need to raise additional funding, which may not be available on favorable terms, if at all.
We may need to raise additional capital through public or private equity or debt financings in
order to satisfy our projected future capital needs.
The amount of additional capital we may need to raise depends on many factors, including:
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the progress of efforts to develop and commercialize new products and services; and |
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the costs of preparing, filing, prosecuting, maintaining, defending and enforcing
patent claims and other intellectual property rights. |
We cannot be certain that additional capital will be available when and as needed or that our
actual cash requirements will not be greater than anticipated. If we require additional capital at
a time when investment in biotechnology companies or in the marketplace in general is limited due
to the then prevailing market or other conditions, we may not be able to raise such funds at the
time that we desire or any time thereafter. If we are unable to obtain financing on terms favorable
to us, our stockholders may experience significant dilution, we may be unable to execute our
business plan, and we may be required to cease or reduce development or commercialization of our products, sell some or all of our technology or assets
or merge with another entity.
26
We currently depend on a small number of genomics services customers for substantially all our
revenues.
Our strategy for the commercialization of our technologies includes entering into customer
agreements in which we provide genomics services to research institutes and pharmaceutical,
biotechnology and agricultural companies. Our genomics services business currently generates
substantially all of our revenues. After we have developed the Solexa Genome Analysis System, it is
our intention to deploy these systems over time to replace the MPSS-based instruments currently
used in our genomics services business. If we are successful in commercializing our genetic
analysis instrument systems, we anticipate continuing to provide genomics services after the
commercial launch in order to meet particular customer requirements and to support the marketing of
our instruments by, for example, allowing potential systems customers to understand how our
instrumentation performs on their samples of interest. We have entered into new or amended
agreements with some of our existing customers providing for the transition from MPSS-based
services to SBS-based services. There is no guarantee, however, that all of our customers will
migrate to the new technology platform once it is commercialized or that our genomics services
business will generate positive cash flow or become profitable.
Prior to the business combination with Solexa Limited, Lynx derived substantially all of its
revenues from customer agreements, collaborations and licenses related to our genomics services
business. Since the business combination we have continued to derive substantially all of our
revenues from customer agreements. A significant portion of our revenues comes from a small number
of customers. Thus, unless and until we are able to commercialize our new genetic analysis
instrument systems under development, we will be dependent on a small number of customers to
continue our current genomics services business, and the loss of one or more of those customers
could harm our results of operations.
Capacity reduction in our genomics services business could increase our losses.
Our genomics services business utilizes proprietary MPSS instruments and information systems.
In addition, the MPSS process is lengthy and complex. These instruments, systems and work processes
are subject to intermittent failures. Any production stoppages or yield reductions due to these
factors or otherwise could reduce the number of samples we are able to process and the revenues we
recognize, could delay our intended termination of MPSS activities in 2006 and could increase our
losses.
The sales cycle for our genomics services business is lengthy, and we may spend considerable
resources on unsuccessful sales efforts or may not be able to enter into agreements on the schedule
we anticipate.
Our ability to obtain customers for our technologies and products depends in significant part
upon the perception that our technologies and products can help reduce the costs or accelerate the
timing of drug discovery and development, diagnostics and genomics efforts. The sales cycle for our
genomics services business is typically lengthy, in many cases nine months or more, because we need
to educate our potential customers and to sell the benefits of our services to a variety of
constituencies within such entities. In addition, we may be required to negotiate agreements
containing terms unique to each customer. We may expend substantial funds and management effort
without any assurance that we will successfully sell our technologies and products. Actual and
proposed consolidations of pharmaceutical companies have negatively affected, and may negatively
affect, the timing and progress of our sales efforts.
We operate in an intensely competitive industry with rapidly evolving technologies, and our
competitors may develop products and technologies that make ours obsolete.
The biotechnology industry is highly fragmented and is characterized by rapid technological
change. In particular, the areas of genetic analysis platforms and genomics research are rapidly
evolving fields. Competition among entities developing genetic analysis systems is intense. Many of
our competitors have substantially greater research and product development capabilities and financial, scientific
and marketing resources than we do.
27
In our genomics services business, we face, and will continue to face, competition primarily
from biotechnology companies, such as Affymetrix, Inc., the Agencourt Biosciences business of
Beckman Coulter, Inc., Celera Genomics Group, Gene Logic, Inc., academic and research institutions
and government agencies, both in the United States and abroad. Our competitors are using a variety
of gene expression analysis methodologies, including chip-based systems, to attempt to identify
disease-related genes and to perform clinical diagnostic tests. In addition, a number of companies
offer DNA sequencing equipment or consumables, including Applera Corporation, Beckman Coulter,
Inc., the Amersham Biosciences business of General Electric and Roche Diagnostics in partnership
with 454 Corporation. Furthermore, a number of other companies and academic groups are in the
process of developing novel techniques for DNA sequencing. These companies include, among others,
Agencourt Personal Genomics, Genizon, Genovoxx, Helicos Biosciences, LI-COR, Lucigen, Microchip
Biotechnologies, Pacific Biosciences, Perlegen, Shimadzu Biotech and Visigen. A number of companies
offer gene expression equipment including Affymetrix, Inc., Agilent Technologies, Applera
Corporation, and Illumina, Inc. In order to successfully compete against existing and future
technologies, we will need to demonstrate to potential customers that our technologies and
capabilities are superior to those of our competitors.
Our future success will depend on our ability to maintain a competitive position with respect
to technological advances. Rapid technological development by others may make our technologies and
future products obsolete.
Any products that are developed based on our technologies will compete in highly competitive
markets. Competitors may be more effective at using their technologies to develop commercial
products than us. Moreover, some of our competitors have, and others may, introduce novel genetic
analysis platforms before we do which, if adopted by customers, could eliminate the market for our
new genetic analysis systems. Furthermore, our competitors may obtain intellectual property rights
that would limit the use of our technologies or the commercialization of diagnostic or therapeutic
products using our technologies. As a result, our competitors products or technologies may render
our technologies and products obsolete or noncompetitive.
Furthermore, our competitors may combine operations through merger, acquisition, licensing,
distribution arrangements, partnerships and other activities. Such arrangements may give our
competitors advantages they did not previously have and lead to even more intense competition.
If management is unable to effectively manage the increasing size and complexity of our
organization, our operating results will suffer.
As of May 1, 2006, our 61 U.S. employees are based in Hayward, California and the 62 employees
of Solexa Limited, a subsidiary, are based near Cambridge, United Kingdom. We plan to hire
additional personnel at both sites. As a result we face challenges inherent in efficiently managing
and coordinating the activities of our increasing number of employees located in different
countries, including the need to implement appropriate systems, financial controls, policies,
standards, benefits and compliance programs. The inability to successfully manage a growing and
internationally diverse organization could hurt our business, and, as a result, the market price of
our common stock could decline.
We are subject to risks associated with our international operations which may harm our business.
A significant portion of our research and development and other operations are located in the
United Kingdom which subjects us to a number of risks associated with conducting business outside
of the United States, including, but not limited to:
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fluctuations in currency exchange rates; |
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imposition of additional taxes and penalties; and |
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28
Currently, most of our employment arrangements with our employees and consultants in the
United Kingdom and lease agreements for our facilities in Cambridge, United Kingdom provide for
payment in British pounds. Increases in the value of the British pound relative to the Unites
States dollar will increase our expenses related to our operations in the United Kingdom, which
could harm our business in the future and reduce the market for our common stock. To date, we have
not engaged in any currency hedging activities, although we may do so in the future.
We could lose key personnel, which could materially affect our business and require us to incur
substantial costs to recruit replacements for such lost personnel.
Any of our key personnel could terminate their employment with us, sometimes without notice,
at any time. John West, our Chief Executive Officer, in particular, is a key member of our
management team. We are also highly dependent on the principal members of our scientific and
commercial staff. The loss of any of these persons services might adversely impact the achievement
of our commercial objectives. In addition, recruiting and retaining qualified scientific personnel
to perform future research and development work will be critical to our success. There is currently
a shortage of skilled executives and employees with technical expertise in our industry, and this
shortage may continue. As a result, competition for skilled personnel is intense, and turnover
rates are high. Competition for experienced scientists from numerous companies, academic and other
research institutions may limit our ability to attract and retain new or current personnel.
If we fail to adequately protect our proprietary technologies, third parties may be able to use our
technologies, which could prevent us from competing in the genomic analysis instrument and genomics
services market.
Our success depends in part on our ability to obtain patents and maintain adequate protection
of the intellectual property related to our technologies and products. The patent positions of
genetic analysis instrument, reagents and other consumables sales and services companies and other
biotechnology companies, including us, are generally uncertain and involve complex legal and
factual questions. We will be able to protect our proprietary rights from unauthorized use by third
parties only to the extent that our proprietary technologies are covered by valid and enforceable
patents or are effectively maintained as trade secrets. The laws of some foreign countries do not
protect proprietary rights to the same extent as the laws of the U.S., and many companies have
encountered significant problems in protecting and defending their proprietary rights in foreign
jurisdictions. We have applied and will continue to apply for patents covering our technologies,
processes and products, as and when we deem appropriate. However, third parties may challenge these
applications, or these applications may fail to result in issued patents. Our existing patents and
any future patents we obtain may not be sufficiently broad to prevent others from practicing our
technologies or from developing competing products. Furthermore, others may independently develop
similar or alternative technologies or design around our patents. In addition, our patents may be
challenged or invalidated or fail to provide us with any competitive advantage.
We also rely on trade secret protection for our confidential and proprietary information.
However, trade secrets are difficult to protect. We protect our proprietary information and
processes, in part, with confidentiality agreements with employees and consultants. However, third
parties may breach these agreements, we may not have adequate remedies for any such breach or our
trade secrets may still otherwise become known by our competitors. In addition, our competitors may
independently develop substantially equivalent proprietary information.
Litigation or third-party claims of intellectual property infringement could require us to spend
substantial time and money and adversely affect our ability to develop and commercialize our
technologies and products.
Our commercial success depends in part on our ability to avoid infringing patents and
proprietary rights of third parties and not breaching any licenses that we have entered into with
regard to our technologies. Other parties have filed, and in the future are likely to continue to
file, patent applications covering imaging, image analysis, fluid delivery, DNA arrays on solid surfaces, chemical and biological
reagents for DNA sequencing, genes, gene fragments, the analysis of gene sequences, gene
expression, DNA amplification and the manufacture and use of DNA chips or microarrays, which are
tiny glass or silicon wafers on which tens or hundreds of thousands of DNA molecules can be arrayed
on the surface for subsequent analysis. If patents covering technologies required by our operations
are issued to others, we may have to rely on licenses from third parties, which may not be
available on commercially reasonable terms, or at all.
29
Third parties may accuse us of employing their proprietary technology without authorization.
In addition, third parties may obtain patents that relate to our technologies and claim that use of
such technologies infringes these patents. Regardless of their merit, such claims could require us
to incur substantial costs, including the diversion of management and technical personnel, in
defending ourselves against any such claims or enforcing our patents. In the event that a
successful claim of infringement is brought against us, we may need to pay damages and obtain one
or more licenses from third parties. We may not be able to obtain these licenses at a reasonable
cost, or at all. Defense of any lawsuit or failure to obtain any of these licenses could adversely
affect our ability to develop and commercialize our technologies and products and thus prevent us
from achieving profitability.
We currently utilize sole-source suppliers for certain components of our Solexa Genome Analysis
System and in our MPSS service business.
We anticipate purchasing, on a sole-source basis, certain components for our 1G Genome
Analyzer and certain consumables used to operate and prepare samples to be run on the 1G Genome
Analyzer. We are in the process of negotiating supply agreements for certain of these sole-source
items. In addition, we currently purchase, on a sole-source basis, the flow cells and certain
enzymes that are used in our MPSS services business.
When we rely on sole vendors, we subject our business to several risks, including:
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the inability to obtain an adequate supply due to manufacturing capacity constraints, a
discontinuation of a product by a third-party manufacturer or other supply constraints; |
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the potential lack of leverage in contract negotiations with the sole vendor; |
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reduced control over quality and pricing of components; and |
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delays and long lead times in receiving materials from vendors. |
We believe that we would be able to purchase alternative instrument components and consumables from
other providers should the need arise, although we would likely incur additional expense and delay.
Such additional expense and delay could be material and could harm our business in the short term.
We use hazardous chemicals and radioactive and biological materials in our business. Any claims
relating to improper handling, storage or disposal of these materials could be time consuming and
costly.
Our research and development processes involve the controlled use of hazardous materials,
including chemicals and radioactive and biological materials. Our operations produce hazardous
waste products. We cannot eliminate the risk of accidental contamination or discharge and any
resultant injury from these materials. We may be sued for any injury or contamination that results
from our use or the use by third parties of these materials, and our liability may exceed our
insurance coverage and our total assets. Federal, state and local laws and regulations govern the
use, manufacture, storage, handling and disposal of hazardous materials. Compliance with
environmental laws and regulations may be expensive, and current or future environmental
regulations may impair our research, development and production efforts.
30
Our facilities in Hayward, California are located near known earthquake fault zones, and the
occurrence of an earthquake or other catastrophic disaster could cause damage to our facilities and
equipment, which could require us to cease or curtail operations.
Our facilities in Hayward, California are located near known earthquake fault zones and are
vulnerable to damage from earthquakes. We are also vulnerable to damage from other types of
disasters, including fire, floods, power loss, communications failures and similar events. If any
disaster were to occur, our ability to operate our business at our facilities would be seriously,
or potentially completely, impaired. In addition, the unique nature of our activities could cause
significant delays in our research programs commercial activities and make it difficult for us to
recover from a disaster. The insurance we maintain may not be adequate to cover our losses
resulting from disasters or other business interruptions. Accordingly, an earthquake or other
disaster could materially and adversely harm our ability to conduct business.
Our stock price may be extremely volatile.
We believe that the market price of our common stock will remain highly volatile and may
fluctuate significantly due to a number of factors. The market prices for securities of many
publicly held, early-stage biotechnology companies have in the past been, and can in the future be
expected to be, especially volatile. For example, during the period from March 7, 2005 to March 31,
2006, the closing sales price of our common stock as quoted on the Nasdaq Capital Market (formerly
the Nasdaq SmallCap Market) and the Nasdaq National Market fluctuated from a low of $4.79 to a high
of $17.00 per share. In addition, the securities markets have from time to time experienced
significant price and volume fluctuations that may be unrelated to the operating performance of
particular companies. The following factors and events may have a significant and adverse impact on
the market price of our common stock:
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fluctuations in our operating results; |
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announcements of technological innovations or new commercial products by us or our
competitors; |
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release of reports by securities analysts; |
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developments or disputes concerning patent or proprietary rights; |
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developments in our relationships with current or future customers; |
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sales of our common stock by large holders, and distributions and/or sales of shares
held by stockholders affiliated with certain of our directors; and |
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general market conditions. |
Many of these factors are beyond our control. These factors may cause a decrease in the market
price of our common stock, regardless of our operating performance.
We have determined that we have a material weakness in our internal controls over financial
reporting. As a result, current and potential stockholders could lose confidence in our financial
reporting, which would harm our business and the trading of our stock.
Under Section 302 of the Sarbanes-Oxley Act of 2002, we are required to evaluate and determine
the effectiveness of our internal controls over financial reporting. As of March 31, 2006, we did
not maintain effective control over the application of GAAP related to the financial reporting
process. This control deficiency could result in material misstatement of the annual or interim
consolidated financial statements that would not be prevented or detected. Accordingly, management
has determined that this control deficiency constitutes a material weakness. Because of this
material weakness, our management concluded that, as of March 31, 2006, we did not maintain
effective internal control over financial reporting based on those criteria. Should we, or our
independent registered public accounting firm, determine in future fiscal periods that we have
additional material weaknesses in our internal controls over financial reporting, the reliability
of our financial reports may be impacted, and our results of operations or financial condition may
be harmed and the price of our common stock may decline. During the second quarter of 2005, we
hired a US controller, who departed Solexa in April 2006. These duties are currently being
performed by a consultant who is serving as an interim finance director.
31
We are required to recognize expense for stock based compensation related to employee stock options
and employee stock purchases, there is no assurance that the expense we are required to recognize
accurately measures the value of our share-based payment awards, and the recognition of this
expense could cause the trading price of our common stock to decline.
On January 1, 2006, we adopted Statement of Financial Accounting Standards No. 123R,
Accounting for Share Based Payments, or SFAS 123R, which requires the measurement and recognition
of compensation expense for all stock-based compensation based on estimated fair values. As a
result, our operating results for the first quarter of 2006 contain, and for future periods will
continue to contain, a charge for stock-based compensation related to employee stock options and
employee stock purchases. The application of SFAS 123R requires the use of an option-pricing model
to determine the fair value of share-based payment awards. This determination of fair value is
affected by our stock price as well as assumptions regarding a number of highly complex and
subjective variables. These variables include our expected stock price volatility over the expected
term of the awards and actual and projected employee stock option exercise behaviors.
Option-pricing models were developed for use in estimating the value of traded options that have no
vesting or hedging restrictions and are fully transferable. Our employee stock options have certain
characteristics that are significantly different from traded options, and changes in the subjective
assumptions can materially affect the estimated value. Although the fair value of employee stock
options is determined in accordance with SFAS 123R and Staff Accounting Bulletin No. 107 using an
option-pricing model, that value may not be indicative of the fair value observed in a willing
buyer/willing seller market transaction.
Our adoption of SFAS 123R has had a material impact on our financial statements and results of
operations, and we expect that this will continue to be the case for future periods. We cannot
predict the effect that this adverse impact on our reported operating results will have on the
trading price of our common stock.
Our companys officers, directors and their affiliated entities have substantial control over the
company.
As of May 1, 2006, our companys executive officers, directors and entities affiliated with
them, in the aggregate, beneficially own approximately 37% of the outstanding common stock of the
company, including warrants and options exercisable within 60 days of May 1, 2006. These
stockholders, if acting together, may be able to influence significantly all matters requiring
approval by our stockholders, including the election of directors and the approval of mergers or
other changes in corporate control.
Anti-takeover provisions in our charter documents and under Delaware law may make it more difficult
to acquire us or to effect a change in our management, even though an acquisition or management
change may be beneficial to our stockholders.
Under our certificate of incorporation, our board of directors has the authority, without
further action by the holders of our common stock, to issue 2,000,000 shares of preferred stock
from time to time in series and with preferences and rights as it may designate. These preferences
and rights may be superior to those of the holders of our common stock. For example, the holders of
preferred stock may be given a preference in payment upon our liquidation or for the payment or
accumulation of dividends before any distributions are made to the holders of common stock.
Any authorization or issuance of preferred stock, while providing desirable flexibility in
connection with financings, possible acquisitions and other corporate purposes, could also have the
effect of making it more difficult for a third party to acquire a majority of our outstanding
voting stock, to remove directors and to effect a change in management. The preferred stock may
have other rights, including economic rights senior to those of our common stock, and, as a result,
an issuance of additional preferred stock could lower the market value of our common stock.
Provisions of Delaware law may also discourage, delay or prevent someone from acquiring or merging
with us.
32
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
On January 16, 2006, January 19, 2006, January 30, 2006 and March 8, 2006, we issued 71,043
shares, 50,000 shares, 24,580 shares and 130,818 shares of our common stock, respectively
(collectively, the Warrant Shares), pursuant to the exercise of warrants to purchase our common
stock (the Exercised Warrants) held by certain of our investors and Silicon Valley Bank. The
Warrant Shares were sold to accredited investors who, except for Silicon Valley Bank, were issued the Exercise Warrants in
connection with a private placement transaction. 251,861 of the Warrant Shares were purchased for
$1.3 million in cash, and 24,580 of the Warrant Shares were acquired by Silicon Valley Bank in a
net exercise of the Exercised Warrants. The Warrant Shares were sold in reliance upon Regulation D,
Rule 506 promulgated under the Securities Act of 1933, as amended. In connection with the purchase
and issuance of the Exercised Warrants, each of the purchasers represented and warranted to us that
it (a) is an accredited investor, (b) is financially sophisticated and able to protect its own
interests, and (c) acquired the warrant for its own account for investment purposes only and not
with a view to, or for sale in connection with, any distribution thereof, except as otherwise may
be permitted under applicable securities laws.
Item 4. Submission of Matters to a Vote of Security Holders.
At a Special Meeting of Stockholders held on January 17, 2006, our stockholders voted on the
following matter:
Proposal I Approval of the issuance of common stock and warrants to purchase common stock in
connection with a financing transaction:
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FOR |
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AGAINST |
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ABSTAIN |
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NO VOTE |
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21,507,517 |
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24,433 |
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841,957 |
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7,587,158 |
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Item 5. Other Information
Under
an amendment effective as of January 1, 2006, we modified the
terms of our Services Agreement, dated December 31, 2003, with E.I. du
Pont de Nemours and Company, to reduce the remaining maximum amount payable to us to $1.5 million,
of which a portion is related to the delivery of an instrument and related consumables and the
balance to genomics services to be performed under the agreement.
Item 6. Exhibits.
We incorporate by reference all exhibits filed in connection with our Annual Report on Form
10-K for the year ended December 31, 2005.
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Exhibit |
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Number |
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Description |
10.20.1+
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Amended and Restated Services and Supply Agreement, by and between E.
I. du Pont de Nemours and Company and Solexa, Inc. |
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31.1
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Certification required by Rule 13a-14(a) or Rule 15d-14(a) of the
Securities Exchange Act of 1934, as amended. |
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31.2
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Certification required by Rule 13a-14(a) or Rule 15d-14(a) of the
Securities Exchange Act of 1934, as amended. |
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32.1*
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Certification required by Rule 13a-14(a) or Rule 15d-14(a) and
Section 1350 of Chapter 63 of Title 18 of the United States Code (18
U.S.C. 1350). |
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+ |
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Portions of this agreement have been deleted pursuant to our request for confidential treatment. |
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* |
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This certification accompanies the Quarterly Report on Form 10-Q to which it relates,
pursuant to Section 906 of the Sarbanes Oxley Act of 2002, and is not deemed filed with the
Securities and Exchange Commission and is not to be incorporated by reference into any filing
of Solexa, Inc. under the Securities Act or the Exchange Act (whether made before or after the
date of the Quarterly Report on Form 10-Q), irrespective of any general incorporation language
contained in such filing. |
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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.
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SOLEXA, INC. |
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/s/ John West |
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By:
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John West |
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Chief Executive Officer |
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(Principal Executive Officer) |
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Date: May 15, 2006 |
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/s/ Linda Rubinstein |
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By:
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Linda Rubinstein |
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Vice President and Chief Financial Officer |
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(Principal Financial and Accounting Officer) |
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Date: May 15, 2006 |
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34
Exhibit Index
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Exhibit |
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Number |
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Description |
10.20.1+
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Amended and Restated Services and Supply Agreement, by and between E.
I. du Pont de Nemours and Company and Solexa, Inc. |
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31.1
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Certification required by Rule 13a-14(a) or Rule 15d-14(a) of the
Securities Exchange Act of 1934, as amended. |
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31.2
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Certification required by Rule 13a-14(a) or Rule 15d-14(a) of the
Securities Exchange Act of 1934, as amended. |
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32.1*
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Certification required by Rule 13a-14(a) or Rule 15d-14(a) and
Section 1350 of Chapter 63 of Title 18 of the United States Code (18
U.S.C. 1350). |
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+ |
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Portions of this agreement have been deleted pursuant to our request for confidential treatment. |
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* |
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This certification accompanies the Quarterly Report on Form 10-Q to which it relates,
pursuant to Section 906 of the Sarbanes Oxley Act of 2002, and is not deemed filed with the
Securities and Exchange Commission and is not to be incorporated by reference into any filing
of Solexa, Inc. under the Securities Act or the Exchange Act (whether made before or after the
date of the Quarterly Report on Form 10-Q), irrespective of any general incorporation language
contained in such filing. |
35