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 September 30, 2006
OR
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o |
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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
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94-3161073 |
(State or other jurisdiction of
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(I.R.S. Employer |
incorporation or organization)
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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 þ No o
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):
Large
accelerated filer
o
Accelerated filer
o
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 November 1, 2006 was
36,590,098
Solexa, Inc.
FORM 10-Q
For the Quarter Ended September 30, 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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September 30, |
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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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$ |
47,051 |
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$ |
38,403 |
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Accounts receivable |
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399 |
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539 |
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Inventory |
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3,669 |
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754 |
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Other current assets |
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5,194 |
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2,422 |
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Total current assets |
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56,313 |
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42,118 |
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Property and equipment, net |
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4,955 |
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4,378 |
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Intangible assets, net |
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3,283 |
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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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455 |
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482 |
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Total assets |
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$ |
87,535 |
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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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$ |
3,555 |
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$ |
2,235 |
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Accrued compensation |
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2,261 |
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2,067 |
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Accrued professional fees |
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1,289 |
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705 |
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Equipment financing, current portion |
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32 |
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31 |
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Forward loss contingency |
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1,028 |
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Deferred revenue, current portion |
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260 |
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1,518 |
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Deferred rent and lease obligations |
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997 |
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801 |
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Other accrued liabilities |
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327 |
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529 |
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Total current liabilities |
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8,721 |
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8,914 |
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Deferred revenues, net of current portion |
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2,224 |
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1,905 |
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Equipment financing, net of current portion |
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23 |
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44 |
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Deferred rent and lease obligations, net of current portion |
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1,612 |
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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
September 30, 2006 and December 31, 2005 |
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Common stock: $0.01 par value; 60,000 shares
authorized; 36,585 shares and 30,027 shares issued and
outstanding at September 30, 2006 and December 31,
2005, respectively |
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366 |
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300 |
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Additional paid-in capital |
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152,087 |
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109,575 |
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Deferred compensation |
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(326 |
) |
Accumulated other comprehensive income |
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3,344 |
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2,064 |
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Accumulated deficit |
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(80,842 |
) |
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(51,840 |
) |
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Total stockholders equity |
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74,955 |
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59,773 |
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Total liabilities and stockholders equity |
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$ |
87,535 |
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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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Nine Months Ended |
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September 30, |
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September 30, |
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2006 |
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2005 |
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2006 |
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2005 |
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Revenues: |
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Service revenue |
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$ |
569 |
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$ |
844 |
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$ |
2,300 |
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$ |
2,848 |
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Other revenue |
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134 |
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Total revenues |
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569 |
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844 |
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2,434 |
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2,848 |
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Operating costs and expenses: |
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Cost of service revenue |
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339 |
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3,889 |
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2,167 |
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6,167 |
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Manufacturing startup and excess capacity costs |
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1,386 |
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2,110 |
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Research and development |
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5,803 |
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4,784 |
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17,621 |
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12,430 |
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Sales, general and administrative |
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4,288 |
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2,699 |
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12,902 |
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9,162 |
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Restructuring charge |
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333 |
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Total operating costs and expenses |
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11,816 |
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11,372 |
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34,800 |
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28,092 |
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Loss from operations |
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(11,247 |
) |
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(10,528 |
) |
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(32,366 |
) |
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(25,244 |
) |
Interest income |
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623 |
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231 |
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1,977 |
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|
458 |
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Interest expense |
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(139 |
) |
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(298 |
) |
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(456 |
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(862 |
) |
Other income (expense), net |
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285 |
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(24 |
) |
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285 |
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(31 |
) |
Gain (loss) on foreign exchange |
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149 |
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(183 |
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266 |
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232 |
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Loss from operations |
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(10,329 |
) |
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(10,802 |
) |
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(30,294 |
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(25,447 |
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Income tax benefit related to foreign research and development tax credit |
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(443 |
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(1,292 |
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Net loss |
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(9,886 |
) |
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(10,802 |
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(29,002 |
) |
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(25,447 |
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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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$ |
(9,886 |
) |
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$ |
(10,802 |
) |
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$ |
(29,002 |
) |
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$ |
(25,969 |
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Basic and diluted net loss per common share |
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$ |
(0.27 |
) |
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$ |
(0.43 |
) |
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$ |
(0.80 |
) |
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$ |
(1.53 |
) |
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Shares used in computation of net loss per common share |
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36,541 |
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25,369 |
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36,054 |
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16,938 |
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See accompanying notes.
4
SOLEXA, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
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Nine Months Ended |
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September 30, |
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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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$ |
(29,002 |
) |
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$ |
(25,447 |
) |
Adjustments to reconcile net loss to net cash used in operating activities: |
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Depreciation and amortization |
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2,121 |
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|
3,358 |
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Stock based compensation expense |
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|
3,070 |
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|
81 |
|
Business combination engagement fees |
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|
987 |
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Gain on sale of assets |
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(285 |
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Amortization of warrant value related to note payable |
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|
175 |
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Changes in operating assets and liabilities: |
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Accounts receivable |
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|
140 |
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|
53 |
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Inventory |
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(2,915 |
) |
|
|
271 |
|
Other assets |
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|
(2,745 |
) |
|
|
1,389 |
|
Accounts payable |
|
|
1,320 |
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|
|
(2,907 |
) |
Forward loss contingency |
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(1,028 |
) |
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Accrued
compensation |
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|
194 |
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|
1,537 |
|
Other accrued liabilities |
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|
718 |
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|
3,099 |
|
Deferred revenues |
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|
(939 |
) |
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|
568 |
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Non-current liabilities |
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|
(769 |
) |
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(1,078 |
) |
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Net cash used in operating activities |
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(30,120 |
) |
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(17,914 |
) |
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Investing activities: |
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Purchases of property and equipment |
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(2,211 |
) |
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(812 |
) |
Cost associated with a patent purchase |
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(35 |
) |
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(75 |
) |
Proceeds from sale of assets |
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325 |
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Costs paid in connection with the business combination |
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(642 |
) |
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Net cash used in investing activities |
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(1,921 |
) |
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(1,529 |
) |
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Financing activities: |
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Issuance of common stock, net of issuance costs |
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37,681 |
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31,034 |
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Proceeds from the exercise of stock options |
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|
525 |
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|
336 |
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Proceeds from the exercise of warrants |
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1,488 |
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Repayment of bank loan |
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(3,000 |
) |
Proceeds from equipment sale and leaseback, and note, net |
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|
126 |
|
Repayment of equipment loans |
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(20 |
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Net cash provided by financing activities |
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39,674 |
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|
28,496 |
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Net
increase in cash and cash equivalents |
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7,633 |
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|
9,053 |
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Effect of exchange rate differences on cash and cash equivalents |
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1,015 |
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(405 |
) |
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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$ |
47,051 |
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$ |
19,111 |
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See accompanying notes.
5
SOLEXA, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2006
1. Description of Business
Solexa, Inc. (Solexa, or the Company) is in the business of developing and commercializing
genetic analysis technologies. We are currently developing and commercializing a novel
instrumentation system for genetic analysis, the Solexa Genome Analysis System, based on our
reversible-terminator Sequencing-by-Synthesis, or SBS, chemistry and based on our Clonal Single
Molecule Array 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 commenced commercial shipment of our
first-generation system, including the 1G Genome Analyzer, in the second quarter of 2006. We
currently generate service revenues in our genomics services business from processing biological
samples supplied to us by customers. We have generated revenues in 2006 to date using our MPSS
technology, which we discontinued in the third quarter of 2006, and
we currently intend to provide genomic
services utilizing our next-generation Solexa Genome Analysis System. We believe the Solexa
Genome Analysis 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 resequencing 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 nine months ended September 30,
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 trading 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.
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.
6
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.
In
accordance with its policy, the Company reviews its estimation of
accrued compensation on an ongoing basis. This review as of September
30, 2006, indicated that the current estimate of payments that would
be made and used for recording compensation expense for the three and
nine months ended September 30, 2006 is less than the previous
estimate that was used for recording compensation expense in the
Companys financial statements as of and for the three and six
months ended June 30, 2006. The effect of this change in estimate was
to reduce our accrued compensation liability and related compensation
expense and net loss for the three months and nine months ended
September 30, 2006, by $955,000.
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 three months and nine months ended September 30, 2006, as more fully described
in Note 4 to the Companys condensed consolidated financial statements.
Valuation and amortization methodThe Company estimates the fair value of stock options
granted using the Black-Scholes option-pricing formula and a single option award approach. This
fair value is then amortized on a straight-line basis over the requisite service periods of the
awards, which is generally the vesting period.
Concentrations and Geographic Information
Revenue from two customers represented 35% and 34%, respectively, of the Companys revenue for
the three months ended September 30, 2006 and revenue from three customers represented 45%, 17% and
12%, respectively, for the nine months ended September 30, 2006. Revenue from two customers
represented 66% and 10% of the Companys revenue, respectively, for the three months ended
September 30, 2005 and 62% and 11%, respectively, for the nine months ended September 30, 2005.
In the three months and nine months ended September 30, 2006 and the corresponding periods of
2005, 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 |
|
|
Nine Months Ended |
|
|
|
September 30, |
|
|
September 30, |
|
|
|
2006 |
|
|
2005 |
|
|
2006 |
|
|
2005 |
|
United States |
|
$ |
522 |
|
|
$ |
783 |
|
|
$ |
2,176 |
|
|
$ |
2,624 |
|
United Kingdom |
|
|
47 |
|
|
|
22 |
|
|
|
228 |
|
|
|
115 |
|
Other |
|
|
|
|
|
|
39 |
|
|
|
30 |
|
|
|
109 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
569 |
|
|
$ |
844 |
|
|
$ |
2,434 |
|
|
$ |
2,848 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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 and nine months ended September 30, 2006 and of common stock and
ordinary shares outstanding for the three months and nine months ended September 30, 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 11,405,447 and 7,897,255 common shares as of September 30, 2006 and 2005,
respectively, were not considered in the computation of basic and diluted net loss per share.
7
Recent Accounting Pronouncements
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 December 31, 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.
In June 2006, the FASB issued FASB Interpretation No. 48, or FIN 48, Accounting for
Uncertainty in Income Taxes . FIN 48 provides interpretive guidance for recognition and
measurement of tax positions taken or expected to be taken in a tax return. This interpretation is
effective for fiscal years beginning after December 15, 2006.
The Company is reviewing the impact of FIN
48, but does not expect the adoption of FIN 48 to have a material impact on its financial statements.
In
September 2006, the FASB issued Statement of Financial Accounting Standards No. 157, Fair
Value Measurements (SFAS No. 157). SFAS No. 157 defines fair value, establishes a framework for
measuring fair value in generally accepted accounting principles (GAAP), and expands disclosures
about fair value measurements. SFAS No. 157 is effective for financial statements issued for fiscal
years beginning after November 15, 2007, and interim periods within those fiscal years. The Company
is currently evaluating the impact of adopting SFAS No. 157 on its financial statements.
In September 2006, the Securities and Exchange Commission (SEC) issued Staff Accounting
Bulletin No. 108 (SAB). Due to diversity in practice among registrants, SAB 108 expresses SEC
staff views regarding the process by which misstatements in financial statements are evaluated for
purposes of determining whether financial statement restatement is necessary. SAB 108 is effective
for fiscal years ending after November 15, 2006, and early
application is encouraged. The Company does not
believe SAB 108 will have a material impact on its results from operations or financial position.
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. The expenses were included in the consolidated statements of operations as follows
(in thousands):
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Nine Months Ended |
|
|
|
September 30, 2006 |
|
|
September 30, 2006 |
|
Manufacturing start up and excess capacity costs |
|
$ |
33,000 |
|
|
$ |
58,000 |
|
Cost of service revenue |
|
|
26,000 |
|
|
|
39,000 |
|
Research and development |
|
|
399,000 |
|
|
|
1,073,000 |
|
Sales, general and administrative |
|
|
507,000 |
|
|
|
1,593,000 |
|
|
|
|
|
|
|
|
Non-cash stock-based employee compensation expense |
|
$ |
965,000 |
|
|
$ |
2,763,000 |
|
|
|
|
|
|
|
|
For the three months and nine months ended September 30, 2006, in accordance with SFAS 123R,
the Company recognized non-cash stock-based employee compensation expenses of $965,000 and $2.8
million, respectively. Both basic and diluted loss per share for the three months and nine months
ended September 30, 2006 were $0.03 and $0.08 higher, respectively, than if the Company had not
adopted SFAS 123R and continued to account for stock-based compensation under APB 25. Stock-based
employee compensation costs capitalized into inventory and charged against the forward loss
contingency were $6,000 and $1,000, respectively for the three months ended September 30, 2006 and
$18,000 and $14,000, respectively for the nine months ended September 30, 2006.
As of September 30, 2006, total unrecognized compensation costs related to non-vested awards
of $10.8 million are expected to be recognized over a weighted average period of approximately 2.53
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:
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
Nine Months Ended |
|
|
September 30, 2006 |
|
September 30, 2006 |
Risk-free interest rate |
|
|
4.51 |
% |
|
|
4.91 |
% |
Expected volatility |
|
|
0.77 |
|
|
|
0.85 |
|
Expected life (in years) |
|
|
6.08 |
|
|
|
6.06 |
|
Expected dividend yield |
|
|
0 |
% |
|
|
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 periods 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 illustrates 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 months and nine months ended September 30, 2005 (in thousands, except per share amounts):
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Nine Months Ended |
|
|
|
September 30, 2005 |
|
|
September 30, 2005 |
|
Net loss, as reported |
|
$ |
(10,802 |
) |
|
$ |
(25,969 |
) |
Add: Stock-based employee compensation, as reported |
|
|
34 |
|
|
|
81 |
|
Deduct: Stock-based employee compensation as if fair value
method applied to all awards |
|
|
(1,071 |
) |
|
|
(2,839 |
) |
|
|
|
|
|
|
|
Net loss, pro forma as if fair value method applied to all awards |
|
$ |
(11,839 |
) |
|
$ |
(28,727 |
) |
|
|
|
|
|
|
|
Basic and diluted net loss per share, as reported |
|
$ |
(0.43 |
) |
|
$ |
(1.53 |
) |
|
|
|
|
|
|
|
Basic and diluted net loss per share, pro forma as if fair value
method applied to all awards |
|
$ |
(0.47 |
) |
|
$ |
(1.70 |
) |
|
|
|
|
|
|
|
9
For the three months and nine months ended September 30, 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 September 30, 2006, the Company has 33,827 shares available
for grant under the 2005 Equity Incentive Plan. Option transactions under all the Company plans
during the three quarters ended September 30, 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 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Granted |
|
|
248,000 |
|
|
|
9.01 |
|
|
|
|
|
|
|
|
|
Exercised |
|
|
(21,299 |
) |
|
|
5.50 |
|
|
|
|
|
|
|
|
|
Forfeited |
|
|
(41,931 |
) |
|
|
6.05 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding at June 30, 2006 |
|
|
3,706,994 |
|
|
$ |
6.75 |
|
|
|
8.67 |
|
|
$ |
9,765 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Granted |
|
|
22,500 |
|
|
|
8.88 |
|
|
|
|
|
|
|
|
|
Exercised |
|
|
(52,488 |
) |
|
|
5.92 |
|
|
|
|
|
|
|
|
|
Forfeited |
|
|
(77,448 |
) |
|
|
7.11 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding at September 30, 2006 |
|
|
3,599,558 |
|
|
$ |
6.75 |
|
|
|
8.41 |
|
|
$ |
10,533 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercisable at September 30, 2006 |
|
|
1,441,447 |
|
|
$ |
6.98 |
|
|
|
7.68 |
|
|
$ |
5,247 |
|
The weighted average fair value of options granted during the three months and nine months
ended September 30, 2006 was $8.88 and $9.11, respectively.
Cash received from options exercised during the three months and nine months ended September
30, 2006 was approximately $311,000 and $525,000, respectively. In connection with these exercises,
there was no tax benefit realized by the Company due to the Companys current loss position.
We have not recorded any deferred tax assets related to the compensation costs that result
from the adoption of SFAS 123R because the utilization of such assets or liabilities is dependent
upon future earnings, if any. We are uncertain about the timing and amount of any future earnings.
We have concluded that it was more likely than not that such deferred tax assets would not be
realized. Accordingly, all of our deferred tax assets have been fully offset by a valuation
allowance as of September 30, 2006.
10
5. Balance Sheet Accounts
Inventory consisted of the following (in thousands):
|
|
|
|
|
|
|
|
|
|
|
September 30, |
|
|
December 31, |
|
|
|
2006 |
|
|
2005 |
|
Raw materials |
|
$ |
2,320 |
|
|
$ |
213 |
|
Work in process |
|
|
1,349 |
|
|
|
541 |
|
|
|
|
|
|
|
|
|
|
$ |
3,669 |
|
|
$ |
754 |
|
|
|
|
|
|
|
|
Other current assets consisted of the following (in thousands):
|
|
|
|
|
|
|
|
|
|
|
September 30, |
|
|
December 31, |
|
|
|
2006 |
|
|
2005 |
|
Prepaid expenses |
|
$ |
984 |
|
|
$ |
544 |
|
Research and development tax credit receivable |
|
|
3,554 |
|
|
|
1,789 |
|
Other |
|
|
656 |
|
|
|
89 |
|
|
|
|
|
|
|
|
|
|
$ |
5,194 |
|
|
$ |
2,422 |
|
|
|
|
|
|
|
|
Property and equipment consisted of the following (in thousands):
|
|
|
|
|
|
|
|
|
|
|
September 30, |
|
|
December 31, |
|
|
|
2006 |
|
|
2005 |
|
Leasehold improvements |
|
$ |
3,888 |
|
|
$ |
3,500 |
|
Laboratory and other equipment |
|
|
8,097 |
|
|
|
6,288 |
|
|
|
|
|
|
|
|
|
|
|
11,985 |
|
|
|
9,788 |
|
Less accumulated depreciation and amortization |
|
|
(7,030 |
) |
|
|
(5,410 |
) |
|
|
|
|
|
|
|
|
|
$ |
4,955 |
|
|
$ |
4,378 |
|
|
|
|
|
|
|
|
6. Forward Loss Contingency
In our genomics services business, we enter into service contracts to provide genetic analysis
of samples provided to us by customers. If management considered it probable that performance on
the contract would result in a loss and this loss could be reasonably estimated, a loss reserve was
recorded.
Changes in the forward loss reserves during the three months and nine months ended September
30, 2006 and 2005 were as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Nine Months Ended |
|
|
|
September 30, |
|
|
September 30, |
|
|
|
2006 |
|
|
2005 |
|
|
2006 |
|
|
2005 |
|
Balance at beginning of period |
|
$ |
28 |
|
|
$ |
|
|
|
$ |
1,028 |
|
|
$ |
|
|
Loss experienced on completed samples |
|
|
(28 |
) |
|
|
|
|
|
|
(1,033 |
) |
|
|
|
|
Reversal of forward loss accrual for completed contracts |
|
|
|
|
|
|
|
|
|
|
(72 |
) |
|
|
|
|
Change in forward loss estimate |
|
|
|
|
|
|
2,167 |
|
|
|
77 |
|
|
|
2,167 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at September 30 |
|
$ |
|
|
|
$ |
2,167 |
|
|
$ |
|
|
|
$ |
2,167 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
In addition, we recorded zero and $207,000 in cost of service revenue during the three and
nine months ended September 30, 2006, respectively, for the cost of samples in excess of our
estimates at the beginning of the year.
11
7. Comprehensive Loss
The following are the components of comprehensive loss (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Nine Months Ended |
|
|
|
September 30, |
|
|
September 30, |
|
|
|
2006 |
|
|
2005 |
|
|
2006 |
|
|
2005 |
|
Net loss |
|
$ |
(9,886 |
) |
|
$ |
(10,802 |
) |
|
$ |
(29,002 |
) |
|
$ |
(25,969 |
) |
Currency translation |
|
|
330 |
|
|
|
(656 |
) |
|
|
1,280 |
|
|
|
(465 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive loss |
|
$ |
(9,556 |
) |
|
$ |
(11,458 |
) |
|
$ |
(27,722 |
) |
|
$ |
(26,434 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
8. Stockholders Equity
On November 18, 2005, Solexa entered into an agreement to issue up 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 approximately $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, related to this purchase agreement.
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 consideration for the payment of accrued
board fees. The related expense of $140,000 was recognized in 2005 in the periods when the related
services were rendered.
On September 19, 2006, Solexa entered into an equity line of credit agreement with a private
investor. During the two-year term of the agreement, the Company may sell at its discretion up to $75
million in registered shares of Solexa common stock to the private investor at a small discount to
the market price. The Company will determine, at its sole discretion, the timing and amount of any
sales, subject to certain conditions. In addition, the agreement also provides that from time to
time and at the Companys sole discretion we may grant the private investor the right to exercise
one or more options to purchase additional shares of the Companys common stock for an amount of
shares determined by the Company. We would sell these shares of common stock to the private
investor based upon a weighted average price of our common stock, less a small discount.
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 nine months ended September 30, 2006, the Company issued 283,641 shares of common
stock for total cash consideration of $1,488,000 from the exercise of warrants.
During the nine months ended September 30, 2006, the Company issued 87,998 shares of common
stock for total cash consideration of $525,000 from the exercise of employee stock options.
At the Companys annual meeting of stockholders held on October 4, 2006, the stockholders of
Solexa approved the 2005 Equity Incentive Plan, as amended by the Board of Directors on July 28,
2006, to increase the aggregate number of shares of common stock authorized for issuance under the
incentive plan by 3,000,000 shares. This incentive plan provides for the grant of incentive stock
options, nonstatutory stock options, stock purchase awards, stock bonus awards, stock appreciation
rights, stock unit awards and other forms of equity compensation.
9. 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):
|
|
|
|
|
|
|
|
|
|
|
September 30 |
|
|
December 31, |
|
|
|
2006 |
|
|
2005 |
|
Purchased technology |
|
$ |
4,348 |
|
|
$ |
4,143 |
|
Accumulated amortization |
|
|
(1,065 |
) |
|
|
(633 |
) |
|
|
|
|
|
|
|
Intangible assets, net |
|
$ |
3,283 |
|
|
$ |
3,510 |
|
|
|
|
|
|
|
|
12
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 6.9 years). Amortization expense related
to identifiable intangible assets for the nine months ended September 30, 2006 and 2005 was
approximately $403,000 and $340,000, respectively.
Estimated future amortization expense of intangible assets is as follows (in thousands):
|
|
|
|
|
2006 (Remaining 3 months) |
|
$ |
129 |
|
2007 |
|
|
516 |
|
2008 |
|
|
516 |
|
2009 |
|
|
516 |
|
2010 |
|
|
516 |
|
Thereafter |
|
|
1,090 |
|
|
|
|
|
|
|
$ |
3,283 |
|
|
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10. Income Tax Benefit
The Company maintained a full valuation allowance on our deferred tax assets as of September 30, 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 the Company in
recent years represented sufficient negative evidence under SFAS No. 109, and, accordingly, a full
valuation allowance was recorded against deferred tax assets. Solexa intend to maintain a full
valuation allowance on the deferred tax assets until sufficient positive evidence exists to support
reversal of the valuation allowance.
The Companys tax benefit was $443,000 and $1.3 million for the three months and nine months ended
September 30, 2006, compared to zero for the three months and nine months ended September 30, 2005.
This tax benefit results from our estimate of those portions of the annual refundable research
credits for 2006 allowed by the United Kingdom Inland Revenue which are attributable to the three
months and nine months ended September 30, 2006, respectively.
11. 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 United States. Pursuant to the 401(k) Plan, employees in the United States may elect to reduce
their current compensation by up to 50% (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 $116,000 and $361,000
for the three months and nine months ended September 30, 2006 and $101,000 and $317,000 for the
three months and nine months ended September 30, 2005, respectively.
12. Subsequent Event
On November 12, 2006, we entered into a definitive merger agreement under which Illumina, Inc.
(Illumina) will acquire the Company in a stock-for-stock merger. Under the merger agreement, our
stockholders will receive, subject to certain collar provisions, shares of Illumina common stock
valued at $14.00 per Solexa share, which represents a total equity consideration of approximately
$600 million. In addition, we entered into a definitive securities purchase agreement in which
Illumina purchased 5,154,639 shares of our common stock for an aggregate cash consideration of
approximately $50 million on November 13, 2006.
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 and nine months ended September 30, 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 similar 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 discontinued providing MPSS
services in the third quarter of 2006. We are currently developing and commercializing 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
commenced commercial shipment of our firstgeneration system, including the 1G Genome Analyzer, in
the second quarter of 2006 under our Early Access program. We have not
yet determined the performance specifications for our Early Access systems nor have we invoiced
customers for the systems that we have shipped and installed. 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 trading 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.
As
of September 30, 2006, we had an accumulated deficit of approximately $80.8 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 $47.1 million as of September 30, 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. While we anticipate that sales of the Solexa Genome Analysis System will become our
primary revenue source, our genomics services business based on MPSS technology, which had
previously been conducted by Lynx Therapeutics, has to date constituted our primary revenue source.
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 discontinued
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. We also
expect to receive a significant portion of our product revenue from a small number of customers in
the early stages of commercialization of our Solexa Genome Analysis System.
14
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 our discontinuation of MPSS-based services could adversely impact
our genomics services revenues.
We have not yet begun to recognize revenue on the sale of our genetic analysis system. 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; the existence of competing genetic analysis systems; and
revenue recognition policies.
Our operating costs and expenses include cost of service revenue, manufacturing start up and
excess capacity costs, research and development expenses, sales, general and administrative
expenses and restructuring expense. 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 for the three months and nine months ended
September 30, 2006 excludes amounts charged to a forward loss contingency reserve that we
established in the third quarter of 2005. Cost of service revenue for the three months and nine
months ended September 30, 2005 include a charge of $2.2 million for the forward contingency
reserve established in the third quarter of 2005. The loss contingency reserve was fully utilized
as of September 30, 2006, and therefore the balance has been reduced to zero. The remaining
outstanding balance of the loss contingency reserve at December 31, 2005 was $1.0 million. We did
not incur cost of service revenue until completion of the business combination transaction between
Lynx and Solexa Limited.
Manufacturing start-up costs primarily include excess direct labor, excess supplies, outside
expenses and excess overhead associated with production of the 1G Genome Analyzer and related
consumables.
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 significant product improvements
related to our genomics services business, and stock based compensation. Research and development
expenses are expected to increase due to spending for ongoing technology development and
implementation, including hiring additional personnel and consumption of flow cells and reagents
for internal use in research and development.
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, and stock based compensation. Sales,
general and administrative expenses are expected to increase in support of our research and
development and commercial efforts, notably personnel, personnel-related and other expenses related
to additional hiring and operation of field operations staff including personnel focused on sales,
field service and field application support.
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 fair value of goodwill
and intangibles for impairment considerations, assumptions for
valuing options and warrants and assumptions for accrued compensation. Actual results could differ
materially from these estimates.
An accounting policy is deemed to be critical if it requires an accounting estimate to be made
based on assumptions about matters that are highly uncertain at the time the estimate is made, if
different estimates reasonably could have been used, or if changes in the estimate that are
reasonably likely to occur could materially impact the financial statements. Management believes
that other than the adoption of Statement of Financial Accounting Standards (SFAS) No. 123
(revised 2004), Share-Based Payment (SFAS 123R), there have been no significant changes during
the nine months ended September 30, 2006 to the items that we disclosed as our critical accounting
policies and estimates in Managements Discussion and Analysis of Financial Condition and Results
of Operations in our Annual Report on Form 10-K for the fiscal year ended December 31, 2005.
15
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 that these
criteria have not yet been met, then any amounts billed to the customer are recorded as deferred
revenue.
Inventory
Inventory is stated at the lower of cost (which approximates first-in, first-out cost) or
market. The balance at September 30, 2006 was classified as raw materials and work in process. Raw
material inventories consist of reagents and other chemicals utilized while performing genomics
services and components used to produce our 1G Genome Analyzer and related consumables.
Work-in-process inventories consist of the accumulated cost of experiments not completed and
subassemblies for our 1G Genome Analyzer and related consumables. Amounts in excess of the genomics
services 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.
Inventory used in producing instruments and consumables is charged to deferred cost of goods sold
when the products are sold and to cost of goods when the related revenue is recognized. Instrument
components, 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.
The determination of net carrying value of goodwill and intangible assets and the extent to
which, if any, there is impairment are dependent upon material estimates and judgements on our
part, including the useful life over which the intangible assets are to be amortized, and the
estimates of the value of future net cash flows, which are based upon further estimates of future
revenues, expenses and operating margins.
Accrued
Compensation
In
accordance with its policy, the Company reviews its estimation of
accrued compensation payments on an ongoing basis. The amount of the
liability is based in part on performance by the Company against
certain operating metrics. On a quarterly basis the Company evaluates its expected achievement against such metrics and adjusts its
liability accordingly.
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. 123R.
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.
16
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.
For the three months and nine months ended September 30, 2006, in accordance with SFAS 123R,
the Company recognized non-cash stock-based employee compensation expenses of $965,000 and $2.8
million, respectively. Both basic and diluted loss per share for the three months and nine months
ended September 30, 2006 were $0.03 and $0.08 higher, respectively, than if we had not adopted SFAS
123R and continued to account for stock-based compensation under APB 25. Stock-based employee
compensation costs capitalized into inventory and charged against the forward loss contingency were
$6,000 and $1,000, respectively for the three months ended September 30, 2006 and $18,000 and
$14,000, respectively, for the nine months ended September 30, 2006. The operating expenses
discussed above include the following allocations of share-based compensation expense for the three
months and nine months ended September 30, 2006 (in thousands):
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Nine Months Ended |
|
|
|
September 30, 2006 |
|
|
September 30, 2006 |
|
Manufacturing start up and excess capacity costs |
|
$ |
33 |
|
|
$ |
58 |
|
Cost of service revenue |
|
|
26 |
|
|
|
39 |
|
Research and development |
|
|
399 |
|
|
|
1,073 |
|
Sales, general and administrative |
|
|
507 |
|
|
|
1,593 |
|
|
|
|
|
|
|
|
Non-cash stock-based employee compensation expense |
|
$ |
965 |
|
|
$ |
2,763 |
|
|
|
|
|
|
|
|
Recent Accounting Pronouncements
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 December 31, 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.
In June 2006, the FASB issued FASB Interpretation No. 48, (FIN 48), Accounting for
Uncertainty in Income Taxes . FIN 48 provides interpretive guidance for recognition and
measurement of tax positions taken or expected to be taken in a tax return. This interpretation is
effective for fiscal years beginning after December 15, 2006. We are reviewing the impact of FIN
48, but do not expect the adoption of FIN 48 to have a material impact on our consolidated
financial statements.
In September 2006, the FASB issued Statement of financial Accounting Standards No. 157, Fair
Value Measurements (SFAS No. 157). The Statement defines fair value, establishes a framework for
measuring fair value in generally accepted accounting principles (GAAP), and expands disclosures
about fair value measurements. SFAS No. 157 is effective for financial statements issued for fiscal
years beginning after November 15, 2007, and interim periods within those fiscal years. The Company
is currently evaluating the impact of adopting SFAS No. 157 on its financial statements.
In September 2006, the Securities and Exchange Commission (SEC) issued Staff Accounting
Bulletin No. 108 (SAB 108). Due to diversity in practice among registrants, SAB 108 expresses SEC
staff views regarding the process by which misstatements in financial statements are evaluated for
purposes of determining whether financial statement restatement is necessary. SAB 108 is effective
for fiscal years ending after November 15, 2006, and early application is encouraged. We do not
believe SAB 108 will have a material impact on our results from operations or financial position.
Results of Operations
Revenues
Service Revenue. Service revenues for the three months and nine months ended September 30,
2006 were approximately $569,000 and $2.3 million, respectively. Service revenues for the three
months and nine months ended September 30, 2005 were approximately
17
$844,000 and $2.8 million, respectively. The decreases in revenue for the three months and
nine months ended September 30, 2006 compared to the three months and nine months ended September
30, 2005 were primarily due to a windup of our contracts based on
MPSS technology. The three months and nine months ended September 30,
2006 included only service revenue associated with the MPSS business. The nine months
ended September 30, 2005 included only service revenue associated with the MPSS business that we
obtained in the business combination and therefore only for the period from March 5, 2005 through
September 30, 2005. 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 as well as additional variability
attributable to product mix and pricing, to continue through 2006 and beyond, including after we
complete the transition to our next-generation technology in our genomics services business.
We
ceased performing MPSS experiments for customers in the third quarter of 2006. We anticipate beginning to perform genomics services using our SBS reversible
terminator chemistry and Clonal Single Molecule Array technology. 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.
Other Revenue. Other revenue for the nine months ended September 30, 2006 was approximately
$134,000 resulting from initial performance on a government grant contract. There was no
corresponding revenue for the three months ended September 30, 2006 or the three months and nine
months ended September 30, 2005.
Operating Costs and Expenses
Total
operating costs and expenses were approximately $11.8 million
and $34.8 million for the
three months and nine months ended September 30, 2006, respectively, compared to $11.4 million and
$28.1 million for the three months and nine months ended September 30, 2005, respectively. The
increase in operating costs and expenses for the nine months ended September 30, 2006 over the same
period for 2005 is due primarily to increased operating costs following the business combination
between Lynx and Solexa Limited, product manufacturing start up and excess capacity costs, the
expensing of stock-based compensation under SFAS 123R, increased material costs for research and
development, including the construction of a number of instruments for internal use, and increased
professional fees for SEC reporting and compliance partially offset by a decrease in the costs of
service revenue, including the absence of a $2.2 million provision for future loss contingencies
recorded in 2005 and costs incurred in 2005 related to execution of the business combination and
the restructuring. The nine months ended September 30, 2005 included operating costs and expenses
associated with the operations of Lynx that we acquired in the business combination only from March
5, 2005 through September 30, 2005. The increase in operating costs and expenses for the three
months ended September 30, 2006 over the same period in 2005 is due primarily to product
manufacturing start up and excess capacity costs, the expensing of stock-based compensation under
SFAS 123R and increased research and development spending partially offset by a decrease in the
costs of service revenue including the absence of a $2.2 million provision for future loss
contingencies recorded in the third quarter of 2005. In accordance
with its policy, the Company reviews its estimation of accrued
compensation on an ongoing basis. This review as of September, 30,
2006, indicated that the current estimate of payments that would be
made and used for recording compensation expense for the three and
nine months ended September 30, 2006 is less than the previous
estimate that was used for recording compensation expense in the
Companys financial statements as of and for the three and six
months ended June 30, 2006. The effect of this change in estimate was
to reduce our accrued compensation liability and related compensation
expense and net loss for the three months and nine months ended
September 30, 2006, by $950,000.
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 and nine months ended September 30, 2006,
cost of service revenue were $339,000 and $2.2 million, respectively, compared to $3.9 million and
$6.2 million for the three months and nine months ended September 30, 2005, respectively. The
decreases in cost of service revenue for the three months and nine months ended September 30, 2006
compared to the same periods for 2005 were primarily due to a decrease in our genomics service
business and costs charged against the forward loss contingency previously provided. The nine
months ended September 30, 2005 included only cost of service revenue associated with the MPSS
business that we obtained in our business combination and therefore only for the period from March
5, 2005 through September 30, 2005.
Cost of service revenue is net of amounts charged against the $2.2 million future loss
contingency reserve that we recorded in the third quarter of 2005 for future loss contingencies
with respect to existing genomics service contracts. The loss contingency reserve was fully
utilized as of September 30, 2006.
18
Manufacturing Startup and Excess Capacity Costs. For the three months and nine months ended
September 30, 2006, manufacturing start up and excess capacity
costs were approximately $1.4
million and $2.1 million, respectively. The impact of the change
in estimate for accrued compensation was a decrease in expenses of
$102,000 for the three months and nine months ended September 30,
2006. There were no similar costs for the three months and nine
months ended September 30, 2005. Manufacturing start up and excess capacity costs for the three
months and nine months ended September 30, 2006 included excess direct labor, excess supplies and
outside expenses and excess overhead, and inventory scrap and write-downs. We began commercial
shipments of the Solexa Genome Analysis System in the second quarter of 2006. Product costs
associated with shipments in the second and third quarters have been deferred until the related
revenue is recognized. We expect manufacturing costs and product revenue to increase in the future
as we ramp up the manufacturing of our next-generation instrument and associated consumables. These
costs will include personnel, materials and overhead. This ramp up of production activities both in
the US and the UK will continue in the fourth quarter of 2006.
Research
and Development Expenses. Research and development expenses were
approximately $5.8
million and $17.6 million for the three months and nine months ended September 30, 2006,
respectively, compared to $4.8 million and $12.4 million for the three months and nine months ended
September 30, 2005, respectively. The $1.0 million increase in research and development expenses
for the three months ended September 30, 2006 compared to the three months ended September 30, 2005
was primarily due to increases in personnel and related expenses due to the hiring of additional
permanent and temporary employees, charges for stock-based compensation, and increases in material
expenses. The $5.2 million increase in research and development expenses for the nine months ended
September 30, 2006 versus the nine months ended September 30, 2005 was primarily due to increased
operating costs following the business combination on March 4, 2005, increases in material expenses
related to instrument prototypes, increases in personnel and related expenses, and charges for
stock-based compensation. The impact of the change in estimate for
accrued compensation was a decrease in expense of $628,000 for the
three months and nine months ended September 30, 2006.
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
additional instruments for internal R&D projects, including our plan to sequence a human genome to
draft level of completion in 2006.
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 recognize revenue on the sale of the Solexa Genome
Analysis 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 $4.3 million and $12.9 million for the three months and nine months ended September
30, 2006, respectively, compared to $2.7 million and $9.2 million for the three months and nine
months ended September 30, 2005, respectively. The increase of
$1.6 million in sales, general and
administrative spending for the three months ended September 30, 2006 compared to the same period
for 2005 was primarily due to increased personnel and related expenses; increased professional
fees, initial costs associated with building our field sales organization and charges for
stock-based compensation. The increase of $3.7 million in sales, general and administrative
spending for the nine months ended September 30, 2006 compared to the same period for 2005 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, initial costs associated with building our field service
organization and charges for stock-based compensation, partially offset by the absence of costs
related to consummation of the business combination transaction. The
impact of the change in estimate for accrued compensation was a
decrease in expense of $225,000 for the three months and nine months
ended September 30, 2006.
We expect sales, general and administrative expenses to increase as we hire additional
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
additional sales and marketing personnel, including salespeople, application scientists and field
service and customer service/technical support personnel.
Restructuring Charge. There was no restructuring charge for the three months and nine months
ended September 30, 2006 compared to $333,000 for the three months and nine months ended September
30, 2005. The 2005 restructuring charge included severance and benefit costs from a workforce
reduction.
Interest Income
Interest income for the three months and nine months ended September 30, 2006 was $623,000 and
$2.0 million, respectively, compared to $231,000 and $458,000 for the three months and nine months
ended September 30, 2005, respectively. The increase in interest income for the three months and
nine months ended September 30, 2006 compared to the same periods for 2005 was primarily
19
due to increased amounts of cash and cash equivalents as a result of sales of our common stock
in private placement transactions, as well as the increase in interest rates period over period.
Interest Expense
Interest expense was approximately $139,000 and $456,000 for the three months and nine months
ended September 30, 2006, respectively, compared to $298,000 and $862,000 for the three months and
nine months ended September 30, 2005, respectively. 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, in 2005, the assumption of $3.0 million of Lynxs note obligations.
Other Income
Other income was approximately $285,000 for the three months and nine months ended September
30, 2006. This other income resulted from our sale of certain fixed assets in the quarter ended
September 30, 2006 at a selling price that exceeded the Companys net book value.
Income Tax Benefit
We maintained a full valuation allowance on our deferred tax assets as of September 30, 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 benefit was approximately $443,000 and $1.3 million for the three months and nine
months ended September 30, 2006, respectively, compared to zero for the three months and nine
months ended September 30, 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 and nine months ended September 30, 2006.
Liquidity and Capital Resources
Cash and cash equivalents increased from approximately $38.4 million as of December 31, 2005
to approximately $47.1 million as of September 30, 2006.
Operating Activities. Net cash used in operating activities was approximately $30.1 million
for the nine months ended September 30, 2006 as compared to $17.9 million for the nine months ended
September 30, 2005. The increase in cash used in operating activities resulted primarily from an
increase in our net loss, an increase in our inventory in preparation for shipping our
next-generation genetic analysis instrument systems and an increase in our UK tax receivable which
are partially offset by increases in stock-based compensation expense.
Investing Activities. Net cash used in investing activities was approximately $1.9 million for
the nine months ended September 30, 2006, compared to $1.5 million for the nine months ended
September 30, 2005. Increased net cash used in investing activities was primarily due to an
increase in purchases of property and equipment, partially offset by the absence of cash expenses
incurred in the business combination.
Financing Activities. Net cash provided by financing activities was approximately $39.7
million for the nine months ended September 30, 2006, compared to net cash provided by financing
activities of $28.5 million for the nine months ended September 30, 2005. Net cash provided by
financing activities in the nine months ended September 30, 2006 consisted of $37.7 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. Net cash
from financing activities of $28.5 million for the nine months ended September 30, 2005 consisted
of funds received pursuant to a private placement of common stock, net of financing cost; the
proceeds of stock options and the proceeds from the sale and
leaseback of equipment, partially offset by the repayment of a bank
loan.
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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 sales, general and
administrative activities, working capital, capital expenditures and other general corporate
purposes. We expect our capital investments during 2006 to be approximately $3.0 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.
On September 19, 2006, we entered into an equity line of credit agreement with a private
investor. During the two-year term of the agreement, we may sell at our discretion up to $75
million in registered shares of common stock to the private investor at a small discount to the
market price. We will determine, at our sole discretion, the timing and amount of any sales,
subject to certain conditions. In addition, the agreement also provides that from time to time and
at our sole discretion we may grant the private investor the right to exercise one or more options
to purchase additional shares of common stock for an amount of shares determined by us. We would
sell these shares of common stock to the private investor based upon a weighted average price of
our common stock, less a small discount. We intend to use the net proceeds as needed to fund the
development and commercialization of the Solexa Genome Analysis System, working capital and other
general corporate purposes.
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 September 30, 2006, we had an accumulated
deficit of $80.8 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 September 30, 2006, together with the funds available
under our equity line of credit agreement, 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.
Off-Balance Sheet Arrangements. At September 30, 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.
Subsequent Event
On November 12, 2006, we entered into a definitive merger agreement under which Illumina, Inc.
(Illumina) will acquire the Company in a stock-for-stock merger. Under the merger agreement, our
stockholders will receive, subject to certain collar provisions, shares of Illumina common stock
valued at $14.00 per Solexa share, which represents a total equity consideration of approximately
$600 million. In addition, we entered into a definitive securities purchase agreement in which
Illumina purchased 5,154,639 shares of our common stock for an aggregate cash consideration of
approximately $50 million on November 13, 2006.
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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 11% of our revenue for the nine months
ended September 30, 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.
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Item 4. Controls and Procedures
Disclosure Controls and Procedures
Based on their evaluation as of September 30, 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 September 30, 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
September 30, 2006.
Changes in Internal Controls over Financial Reporting
We have hired a Senior Director of Finance in June 2006 and a US Controller in July 2006
and are recruiting additional finance and accounting personnel to fill multiple open positions in
our finance organization. During the first quarter of 2006, we implemented a new companywide
automated accounting system. During the third quarter of 2006 we have contracted for additional
temporary and consulting personnel resources.
Except as discussed above, there were no changes in our internal control over financial
reporting during the quarter ended September 30, 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 nine
months ended September 30, 2006. As of September 30, 2006, we had an accumulated deficit of
approximately $80.8 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, and we have begun commercial
shipments to a limited number of customers. 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 in sufficient quantities or on terms that will generate
profits or positive cash flow. Although we have begun to accept orders for the Solexa Genome
Analysis System, and to ship this system to customers under our Early Access program, we have not
yet determined the performance specifications for our Early Access systems nor have we invoiced
customers for the systems that we have shipped and installed. Furthermore, although we have
developed DNA sequencing instruments that we used previously in providing gene expression services
to customers, these instruments were 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 the fourth quarter of
2006, including launching a number of applications to be run on the Solexa Genome Analysis System
in 2006; making the Solexa Genome Analysis System broadly commercially available in the fourth
quarter of 2006; deploying the Solexa Genome Analysis System in our genomics services business; and
generating a draft sequence of a 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;
continuing to increase our field based customer support operations and producing and operating
additional 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.
Our technology platform is at the development stage and is unproven for market acceptance.
We are developing the Solexa Genome Analysis System for certain kinds of genetic analysis,
including sequencing the DNA of genomes and of individual genes and genomic regions, gene
expression and small RNA analysis. We have discontinued our MPSS technology, which had been used
for certain of these kinds of genetic analysis, including gene expression and small RNA analysis.
While we have commenced commercial shipments of our Solexa Genome Analysis System, these
technologies are still in development, and we may not be able to move beyond the Early Access phase
of our commercialization or to successfully complete development of these technologies or
commercialize them. Our success depends on many factors, including:
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acceptance of our technology in the marketplace; |
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our ability to establish an instrument manufacturing capability, or obtain instruments from another manufacturer; and |
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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.
We expect that a substantial portion of our sales will be to customers at universities or research
laboratories the amount and timing of whose funding is dependent on third-party sources.
Many of our potential customers must 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 and services, we intend to develop a sales
and marketing group with the appropriate technical expertise. While we have hired an executive to
run our field organization and have both made initial hires and transferred existing employees to
roles in 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.
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 increased internal manufacturing capacity for instruments, flow cells
and reagents, or to contract with one or more manufacturing partners. While we have begun to hire
dedicated manufacturing personnel, including our Chief Operating Officer, who is in charge of
manufacturing, we are currently using additional personnel from our research and development and
genomics services groups and consultants to address our anticipated manufacturing and outsourcing
needs. There is no assurance that we will be able to build
25
manufacturing capacity internally, or to contract with one or more manufacturing partners, 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 continued following 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 have discontinued 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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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.
We currently depend on a small number of 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 internally 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
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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. While we have commenced commercial shipments of our new genetic analysis instrument
system, we have shipped only to a limited number of customers under an Early Access program, and we
have not yet recognized any revenue for the systems. Thus, unless and until we are able to more
broadly commercialize our new genetic analysis instrument system, we will be dependent on a small
number of customers, 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.
We
intend to deploy our novel instrument system in our genomics services business. Any
delays or other difficulties in implementing the new technology could reduce the number of samples
we are able to process and the revenues we recognize and could increase our loss.
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. It is too early to determine the sales cycle for our systems
business, which may also be lengthy. 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.
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 Eagle Research and Development, LLC,
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
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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.
Our employees are based in Hayward, California and Cambridge, United Kingdom. We have
increased staff substantially since the end of 2005 and we plan to hire additional personnel at
both sites. In addition, we have begun to deploy customer support staff at remote locations. 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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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 UK pound relative to the United 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 genetic 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
28
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.
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.
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.
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.
29
We use hazardous chemicals, lasers, 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.
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. 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 September 30, 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
30
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 September 30, 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 2006, we
hired a Senior Director of Finance, and during the third quarter we replaced a US Controller, who
departed Solexa in April 2006.
Our companys officers, directors and their affiliated entities have substantial control over the
company.
Our companys executive officers, directors and entities affiliated with them, in the
aggregate, as of October 13, 2006 beneficially owned approximately 20% of the outstanding common
stock of the company, including warrants and options currently
exercisable or exercisable 60 days from
October 13, 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.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
On July 14, 2006 and July 18, 2006, we issued 13,960 shares and 17,820 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. The Warrant
Shares were sold for $228,000 in cash to these accredited investors,
who were issued the Exercised
Warrants in connection with a private placement transaction. 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.
31
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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Incorporated by Reference |
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Filed |
Number |
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Description |
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Form |
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File No |
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Exhibit |
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Filing Date |
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Herewith |
10.47
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Letter Agreement, dated as of May
19, 2006, by and between Solexa,
Inc. and Richard H. Lussier.
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8-K
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000-22570
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10.47 |
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7/6/2006 |
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10.48
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Letter Agreement, dated as of July
5, 2006, by and between Solexa,
Inc. and Omead Ostadan.
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8-K
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000-22570
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10.48 |
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7/6/2006 |
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10.49
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Letter Agreement regarding New
Alternative One-Time Bonus
Arrangement, dated July 5, 2006,
by and between Solexa, Inc. and
Omead Ostadan.
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8-K
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000-22570
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10.49 |
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7/6/2006 |
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10.50
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Indemnity Agreement, dated as of
July 5, 2006, by and between
Solexa, Inc. and Richard H.
Lussier.
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8-K
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000-22570
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10.50 |
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7/6/2006 |
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10.51
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Indemnity Agreement, dated as of
July 5, 2006, by and between
Solexa, Inc. and Omead Ostadan
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8-K
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000-22570
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10.51 |
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7/6/2006 |
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10.52
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Letter Agreement dated as of June
12, 2006, by and between Solexa,
Inc. and Brock Siegel
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8-K
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000-22570
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10.52 |
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7/19/2006 |
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10.53
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Indemnity Agreement, dated as of
July 17, 2006, by and between
Solexa, Inc. and Brock Siegel
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8-K
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000-22570
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10.53 |
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7/19/2006 |
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10.54
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Independent Contract Services
Agreement, dated as of July 28,
2006, between Solexa, Inc. and
Joseph Whitters.
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8-K
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000-22570
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10.54 |
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8/3/2006 |
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10.55
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Indemnity Agreement, dated as of
July 28, 2006, between Solexa,
Inc. and Joseph Whitters.
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8-K
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000-22570
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10.55 |
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8/3/2006 |
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10.1
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Form of Indemnity Agreement
entered into between the Company
and its directors and officers.
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8-K
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000-22570
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10.1 |
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8/31/06 |
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10.56
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Common Stock Purchase Agreement
between the Company and Azimuth
Opportunity Ltd. dated September
19, 2006.
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8-K
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000-22570
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10.56 |
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9/20/06 |
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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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X |
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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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X |
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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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X |
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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. |
32
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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By: |
/s/ John West
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John West |
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Chief Executive Officer
(Principal Executive Officer) |
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Date: November 14, 2006
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By: |
/s/ Linda Rubinstein
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Linda Rubinstein |
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Vice President and Chief Financial Officer
(Principal Financial and Accounting Officer) |
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Date: November 14, 2006
33
Exhibit Index
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Exhibit |
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Incorporated by Reference |
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Filed |
Number |
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Description |
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Form |
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File No |
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Exhibit |
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Filing Date |
|
Herewith |
10.47
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Letter Agreement, dated as of May
19, 2006, by and between Solexa,
Inc. and Richard H. Lussier.
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8-K
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000-22570
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10.47 |
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7/6/2006 |
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10.48
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Letter Agreement, dated as of July
5, 2006, by and between Solexa,
Inc. and Omead Ostadan.
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8-K
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000-22570
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10.48 |
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7/6/2006 |
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10.49
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Letter Agreement regarding New
Alternative One-Time Bonus
Arrangement, dated July 5, 2006,
by and between Solexa, Inc. and
Omead Ostadan.
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8-K
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000-22570
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10.49 |
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7/6/2006 |
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10.50
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Indemnity Agreement, dated as of
July 5, 2006, by and between
Solexa, Inc. and Richard H.
Lussier.
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8-K
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000-22570
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10-50 |
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7/6/2006 |
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10.51
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Indemnity Agreement, dated as of
July 5, 2006, by and between
Solexa, Inc. and Omead Ostadan.
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8-K
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000-22570
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10-51 |
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7/6/2006 |
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10.52
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Letter Agreement dated as of June
12, 2006, by and between Solexa,
Inc. and Brock Siegel.
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8-K
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000-22570
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10-52 |
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7/19/2006 |
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10.53
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Indemnity Agreement, dated as of
July 17, 2006, by and between
Solexa, Inc. and Brock Siegel
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8-K
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000-22570
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10-53 |
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7/19/2006 |
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10.54
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Independent Contract Services
Agreement, dated as of July 28,
2006, between Solexa, Inc. and
Joseph Whitters.
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8-K
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000-22570
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10.54 |
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8/3/2006 |
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10.55
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Indemnity Agreement, dated as of
July 28, 2006, between Solexa,
Inc. and Joseph Whitters.
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8-K
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000-22570
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10.55 |
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8/3/2006 |
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10.1
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Form of Indemnity Agreement
entered into between the Company
and its directors and officers.
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8-K
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000-22570
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10.1 |
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8/31/2006 |
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10.56
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Common Stock Purchase Agreement
between the Company and Azimuth
Opportunity Ltd. dated September
19, 2006.
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8-K
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000-22570
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10.56 |
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9/20/2006 |
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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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X |
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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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X |
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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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X |
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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. |