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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

For the quarterly period ending June 30, 2004

For the transition period from                      to                     

Commission File Number: 000-29101

SEQUENOM, INC.

(Exact name of registrant as specified in its charter)

Registrant’s telephone number, including area code: (858) 202-9000

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 x No ¨

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes x No ¨

The number of shares of the Registrant’s Common Stock outstanding as of August 2, 2004 was 39,644,205.

SEQUENOM, INC.

INDEX

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PART I - FINANCIAL INFORMATION

CONDENSED CONSOLIDATED BALANCE SHEETS

(Dollars in thousands, except par value and share information)

See accompanying notes.

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CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Dollars in thousands, except per share information)

See accompanying notes.

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CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Dollars in thousands)

See accompanying notes.

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NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(1) Basis of Presentation

The accompanying unaudited consolidated financial statements of SEQUENOM, Inc. have been prepared in accordance with U.S. generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and disclosures required by U.S. generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments, consisting of normal recurring adjustments, considered necessary for a fair presentation have been included. Interim results are not necessarily indicative of results for a full year.

The condensed balance sheet at December 31, 2003 has been derived from the audited financial statements at that date but does not include all of the information and disclosures required by generally accepted accounting principles for complete financial statements. Certain amounts in the December 31, 2003 balance sheet have been reclassified to conform with current year presentation.

These financial statements should be read in conjunction with the audited financial statements and disclosures thereto included in SEQUENOM’s Annual Report on Form 10-K for the year ended December 31, 2003, as filed with the Securities and Exchange Commission (“SEC”).

(2) Subsequent event

In July 2004, we announced the termination of internal drug discovery efforts and closure of our Pharmaceutical business segment, reducing our headcount by approximately 50 by the end of 2004. We will continue with our outlicensing program to capitalize on the value of our disease gene discoveries for diagnostic and therapeutic product development. We expect to incur charges of $2 million to $3 million, primarily in the third quarter of 2004, related to the closure of this business. Of the estimated charge, approximately $0.7 million to $1.7 million relates to future cash outflows, primarily staff severance costs and other contractual obligations, and approximately $1.3 million relates to non-cash charges from the write-off of equipment taken out of service and intangible assets of no value to our ongoing business. From July 1, 2004 we will report our results in one business segment.

(3) Segment information

In July 2004, we announced the termination of internal drug discovery efforts and the closure of the SEQUENOM Pharmaceuticals business segment during the third quarter of 2004, which will reduce our costs and expenses and is expected to provide the cash necessary to support our remaining business through 2006. This will be the last quarter that we report our financial results in two business segments, SEQUENOM Genetic Systems and SEQUENOM Pharmaceuticals.

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Segment information for the three and six months ended June 30, 2004 and 2003 is as follows (dollars in thousands):

We have no intersegment revenues. Corporate expenses are allocated to segments based on each segment’s estimated portion of total operational expenses. We do not currently segregate assets by segment because a significant portion of our total assets are cash, cash equivalents, and marketable securities which we do not assign to our two operating segments.

(4) Comprehensive Income (Loss)

Statement of Financial Accounting Standards (“SFAS”) No. 130, Reporting Comprehensive Income, requires reporting and displaying comprehensive income (loss) and its components, which, for us, includes net loss and unrealized gains and losses on investments and foreign currency translation gains and losses. In accordance with SFAS No. 130, the accumulated balance of other comprehensive income (loss) is disclosed as a separate component of stockholders’ equity. A summary of our comprehensive loss is as follows (dollars in thousands):

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(5) Net Loss Per Share

In accordance with SFAS No. 128, Earnings Per Share, basic net income (loss) per share is computed by dividing the net income (loss) for the period by the weighted average number of common shares outstanding during the period, including shares held in escrow relating to the acquisition of Axiom Biotechnologies, Inc., during the three and six months ended June 30, 2003. Diluted net income (loss) per share is computed by dividing the net income (loss) for the period by the weighted average number of common and common equivalent shares outstanding during the period. Common equivalent shares are comprised of incremental common shares issuable upon the exercise of stock options and warrants, and were excluded from historical diluted loss per share because of their anti-dilutive effect.

(6) Stock-Based Compensation

We account for our stock-based awards to employees in accordance with Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (“APB 25”) and the related Interpretation No. 44, Accounting for Certain Transactions Involving Stock Compensation—An Interpretation of APB Opinion No. 25. We have adopted the disclosure-only alternative of SFAS 123, Accounting for Stock-Based Compensation (“SFAS 123”).

If compensation cost for stock-based awards had been determined consistent with the fair value method prescribed in SFAS No. 123, our net loss would have been the following pro forma amounts:

Options or stock awards issued to non-employees who are not a member of our Board of Directors are recorded at their fair value and periodically remeasured as determined in

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accordance with SFAS No. 123 and EITF 96-18 Accounting for Equity Instruments with Variable Terms that are Issued For Consideration other than Employee Services Under SFAS No. 123, and recognized over the related service period.

(7) Inventories

Inventories are stated at the lower of cost (first-in, first-out) or market value. The components of inventories were (dollars in thousands):

(8) Acquisition and Integration Costs

As of June 30, 2004 we had approximately $1.2 million remaining in accrued acquisition costs, relating to the acquisition of Gemini Genomics, plc in 2001. The remaining acquisition liability relates to lease commitment costs. We do not know how long it will take us to sublease our remaining surplus space. The remaining amount accrued at June 30, 2004 represents approximately 26 months of remaining lease payments, net of sublease income from existing subleased space, and if we do not sublease the remaining space by the end of that term we will incur additional expense of approximately $50,000 per month for 52 more months.

The activity in the six month period ended June 30, 2004 was as follows (dollars in thousands):

In the three months ended June 30, 2004, we reduced the carrying value of our acquired intangibles relating to the acquisition of Gemini Genomics by $1.3 million and reduced the associated long term deferred tax liability by $0.5 million to reflect an income tax purchase accounting adjustment, in accordance with EITF 93-7 Uncertainties Related to Income Taxes in a Purchase Business Combination.

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(9) Warranty reserves

Generally, we do not have any significant post-delivery obligations associated with our product sales. We accrue for warranty expenses and other allowances at the time of shipment based on historical service expense and trends. Such amounts are not generally significant.

(10) New Accounting Pronouncements

In March 2004, the Emerging Issues Task Force (EITF) ratified its consensus related to the application guidance within EITF Issue No. 03-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments. EITF Issue No. 03-1 applies to investments in debt and equity securities within the scope of SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities, and equity securities that are not subject to the scope of SFAS No. 115 and not accounted for under the equity method under APB Opinion 18 and related interpretations. EITF Issue No. 03-1 requires that a three-step model be applied in determining when an investment is considered impaired, whether that impairment is other than temporary and the measurement of an impairment loss. The recognition and measurement guidance within EITF Issue No. 03-1 will be applied by us to other-than-temporary impairment evaluations beginning July 1, 2004. The adoption of EITF Issue No. 03-1 is not expected to have a material impact on our financial position or results of operations.

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All statements in this report that are not historical are forward-looking statements within the meaning of Section 21E of the Securities Exchange Act. These forward-looking statements can generally be identified as such because the context of the statement will include words such as “may,” “will,” “intend,” “plans,” “believes,” “anticipates,” “expects,” “estimates,” “predicts,” “potential,” “continue,” “opportunity,” “goals,” or “should,” the negative of these words or words of similar import. Similarly, statements that describe our future plans, strategies, intentions, expectations, objectives, goals or prospects are also forward-looking statements. These forward-looking statements are or will be, as applicable, based largely on our expectations and projections about future events and future trends affecting our business, and so are or will be, as applicable, subject to risks and uncertainties including but not limited to the risk factors discussed in this report, that could cause actual results to differ materially from those anticipated in the forward-looking statements. We caution investors that there can be no assurance that actual results or business conditions will not differ materially from those projected or suggested in such forward-looking statements as a result of various factors, including, but not limited to, the risk factors discussed below under the caption “Risks and Uncertainties Related to Our Business”. Our expectations and the events, conditions, and circumstances on which these future forward-looking statements are based, will likely change.

SEQUENOM^®, SpectroCHIP^®, and MassARRAY^TM are trademarks of SEQUENOM, Inc.

Overview

We are a genetics company that has been organized into two distinct business units: SEQUENOM Genetic Systems and SEQUENOM Pharmaceuticals. As previously announced, during the third quarter of 2004, our internal drug discovery efforts will be terminated and our Pharmaceuticals business unit will be closed. We will concentrate on revenue-generating opportunities from our Genetic Systems business in the genetic research and diagnostic services markets. We will continue with our efforts to outlicense our disease gene discoveries (drug targets, diagnostic and pharmacogenetic markers, signaling pathways and novel biological mechanisms) generated by our Pharmaceuticals business unit for potential therapeutic or diagnostic product development by others and use our research results to improve the capabilities of our MassARRAY platform.

Following the closure of our Pharmaceuticals business unit, we will be a genetics company dedicated to the sales and support of our MassARRAY platform and to the continued expansion of DNA analysis applications for use with our system. We have created high-performance DNA analysis technology that efficiently and precisely measures genetic variation. We have used MassARRAY technology and our extensive collections of DNA samples from diseased and healthy individuals to identify disease-related genes that affect the health of significant portions of the population. Based on our discoveries, we develop diagnostic content, as well as outlicense disease gene discoveries for diagnostic and therapeutic product development.

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Since our inception, we have incurred significant losses. As of June 30, 2004, we had an accumulated deficit of $401.2 million. We expect to continue to incur losses going forward at least until the end of 2005.

SEQUENOM Genetic Systems. This business unit includes the sales and support of our MassARRAY hardware, consumables and software product offerings, and research and development directed toward new products and applications for the MassARRAY platform. We have sold our products to genetics, pharmacogenetics, diagnostic, and agricultural biotechnology companies, as well as leading research institutions, in North America, Europe, and Asia.

As of June 30, 2004, our product revenues consisted of revenues from the sales of MassARRAY consumables and MassARRAY systems, maintenance agreements for systems, and sales and licensing of proprietary software.

The seven MassARRAY system sales during the second quarter included four MassARRAY Compact system. This is the fourth consecutive quarter for which revenues from consumables have exceeded revenues from hardware. Following the closure of our Pharmaceutical segment, we will continue to use discoveries made by that segment to improve and expand the capabilities of our systems business. The impact of our MassARRAY Compact system and other new products and product applications on future revenues, margins, expenses, and cash flows remains uncertain and depends on many factors as described below under the caption “Risks and Uncertainties Related to Our Business”.

SEQUENOM Pharmaceuticals. Prior to the decision to close, this business unit included operations relating to disease gene discovery, target identification, functional validation, and ultimately potential diagnostic and therapeutic product development. SEQUENOM Pharmaceuticals applied human genetics to systematically identify potential disease-associated genes that affect significant portions of the overall population. This business unit also provided genetic research services. This segment’s revenues consisted primarily of genetic validation services, and grant and contract research.

Prior to June 30, 2004, we completed numerous scans of the human genome and identified over 60 candidate genes indicating association with the following diseases: breast cancer, lung cancer, prostrate cancer, melanoma, schizophrenia, type II diabetes, obesity, dyslipidemia (HDL-cholesterol), hypertension, osteoarthritis and osteoporosis. In most studies we have replicated our initial disease-association findings in additional independent populations followed by appropriate biological confirmation experiments where feasible. Internal development on a small number of our validated disease gene discoveries was initiated. Following the closure of the Pharmaceuticals business unit, our goal is to outlicense our disease gene discoveries to other parties for development and ultimately for the production of therapeutic and diagnostic products. We expect our overall research and development expenses and expenses to be reduced by the closure of the Pharmaceuticals business unit.

We expect revenues from our outlicensing efforts with respect to our disease gene discoveries to be minimal for the foreseeable future. To the extent that revenues are realized, if at all, they may

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fluctuate significantly as revenues will be based upon out-licensing of gene and target-related intellectual property, the occurrence of certain milestones, and successful product development and commercialization, all of which are uncertain and difficult to predict. As a result, our entitlement to, and the timing and amounts of, any licensing and milestone payments and royalty or revenue sharing payments on future diagnostic and therapeutic product sales are uncertain and difficult to predict. To achieve such revenues we will likely be dependent upon the efforts, resources and success of the licensees who will need to invest significant dollar amounts in research and development efforts and regulatory approvals over several years.

Results of Operations for the Three Months and Six Months Ended June 30, 2004 and 2003

Results of Operations-Consolidated

Revenues

Total revenues for the three and six months ended June 30, 2004 declined to $6.0 million and $11.1 million, respectively, from $7.7 million and $15.1 million, respectively, for the same periods in 2003.

Product revenues were derived from the sale of consumables including our SpectroCHIP bioarray chips, MassARRAY systems, maintenance agreements, sales and licensing of our proprietary software and license fees from end-users. For the three and six months ended June 30, 2004 compared to the three and six months ended June, 2003, consumable revenues decreased from $3.0 million to $2.7 million and $6.3 million to $6.1 million, respectively, as our average selling prices for our SpectroCHIP bioarray chips and related consumables have declined, offsetting increased sales volumes due to the increase in the cumulative number of installed systems. MassARRAY system hardware sales declined from $3.5 million to $1.9 million and from $6.0 million to $2.5 million in the three and six months ended June 30, 2004 and 2003, respectively. MassARRAY system placements in the first half of 2004 were below our expectation and although hardware revenues increased 250% in the three months ended June 30, 2004 compared to the three months ended March 31, 2004, we continue to see the number of new account opportunities for our highest throughput systems for genotyping declining as the market reaches saturation. In addition, the sales cycles for our recently introduced MassARRAY Gene Expression application and MassARRAY Compact system are longer than planned. It now appears that the sales cycles for the Gene Expression application and MassARRAY Compact system are similar to those of our other products, rather than being shorter, and that the lower price point for the MassARRAY Compact system has not resulted in a shorter sales cycle as we had originally expected.

We continue to develop our market for clinical genetics and molecular medicine where the testing accuracy and broad DNA analytical capabilities of our MassARRAY system are well suited. We expect that future revenues for our business will be affected by, among other things, MassARRAY product and application demand, the acceptance of our MassARRAY Compact system, customer budgets, new product and application introductions, competitive conditions and government research funding.

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Service revenues from the Pharmaceuticals business unit in the three and six months ended June 30, 2004 were $0.1 million and $0.2 million, respectively, declining from $0.2 million and $0.8 million, respectively, in the same periods in 2003. The reduction in service revenue is because we chose to pursue internal discovery genetics programs and to discontinue pursuit of low-margin collaborative genotyping services. We expect revenue from present and future outlicensing of our disease gene discoveries that were generated in our Pharmaceuticals business unit to be minimal for the foreseeable future.

Cost of product and service revenues and gross margin

Cost of product and service revenues for the three and six months ended June 30, 2004 were $3.5 million and $6.5 million, respectively, compared to $4.6 million and $8.6 million, respectively, for the same periods in 2003. Gross margins for the three and six months ended June 30, 2004 were 41% and 41%, respectively, compared to 40% and 43%, respectively, for the same periods in 2003. Gross margins declined by 3% for the six months ended June 30, 2004 compared the same period in 2003 due to increased inventory reserves for slow-moving components reducing margins by 9% compared to the same period in 2003. This reduction in gross margin was partially offset by higher-margin consumable sales making up a greater proportion of total revenue in 2004.

Research and development expenses

Research and development expenses decreased to $6.1 million and $12.1 million, respectively, from $6.5 million and $12.3 million, respectively, for the three and six months ended June 30, 2004 and 2003. The net decrease in expenses for the three and six month periods ended June 30, 2003 and 2004 primarily relate to lower internal expenses following the substantial completion of our gene scan program in 2003, offset by additional headcount expenses. We expect research and development expenses to start to decrease during the third quarter of 2004 as a result of the termination of internal drug discovery efforts.

Sales, general and administrative expenses

Sales, general and administrative expenses for the three and six months ended June 30, 2004 were $5.8 million and $11.4 million, respectively, compared to $5.8 million and $11.8 million, respectively, for the same periods in 2003. The $0.4 million decrease for the six months ended June 30, 2004 from the same period in 2003 was due to a reduction in legal-related expenses of $0.4 million due to lower legal activity, insurance expenses of $0.3 million due to premium reductions and depreciation of $0.2 million as an increasing proportion of our asset base is fully depreciated, offsetting an increase in headcount expenses and selling expenses of $0.5 million as we strengthen our sales function. The consistent expense of $5.8 million in the three months ended June 30, 2003 and 2004 result from headcount and related expense increases from additional sales and marketing activities offsetting our reduced legal, insurance and depreciation expenses. We expect headcount and related expenses to increase during 2004 as we expand our sales operations.

Amortization of acquired intangibles

In connection with the acquisition of Gemini Genomics, plc in 2001 we acquired approximately $18.7 million of intangible assets, including clinical data collections and patent rights. In connection with the acquisition of Axiom Biotechnologies, Inc. in 2002 we acquired approximately $0.5 million of intangible assets, including patent rights, human cell banks, and

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assay technology. In the three months ended June 30, 2004, we reduced the carrying value of our acquired intangibles relating to the acquisition of Gemini Genomics by $1.3 million to reflect an income tax purchase accounting adjustment. As a result of the closure of the Pharmaceuticals business segment in July 2004, we will write off approximately $0.3 million of intangible assets acquired with Axiom Biotechnologies that have no future alternative use. Our amortization expense will be reduced in future periods as a result of the lower value of our intangibles. The remaining intangible assets are being amortized over three to five years.

Amortization of deferred stock-based compensation

Deferred stock compensation represents the difference between the estimated fair value of our common stock and the exercise price of options at the date of grant. During the three and six months ended June 30, 2003, we recorded amortization of deferred stock compensation of approximately $49,000 and $107,000, respectively. Amortization was completed during 2003, resulting in no charge for the three and six months ending June 30, 2004. These amounts all relate to stock options granted prior to our initial public offering in February 2000 and were amortized over the vesting periods of the individual stock options in accordance with FASB Interpretation No. 28.

Net interest income

Net interest income was $0.1 million and $0.2 million, respectively, for the three and six months ended June 30, 2004, compared to $0.3 million and $0.7 million, respectively, for the same periods of 2003. The decrease from 2003 to 2004 resulted from lower average balances of interest-bearing investments and lower interest rates, offset by lower interest expense due to the decrease in the amount of debt outstanding during the two periods.

Deferred income tax benefit

The deferred tax benefit of $0.6 million and $0.7 million for the six months ended June 30, 2004 and 2003, respectively, is due to the tax effects related to amortization on the intangible assets, including clinical data collections and patent rights, acquired from Gemini Genomics. In the three months ended June 30, 2004, we reduced the long term deferred tax liability by $0.5 million to reflect an income tax purchase accounting adjustment relating to the acquisition of Gemini Genomics. This reduction will slightly lower the deferred tax benefit received in future periods.

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Business segment highlights for the three and six months ended June 30, 2004 and 2003:

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We do not currently segregate assets by segment because a significant portion of our total assets are assets commonly used by both segments and cash and cash equivalents which we do not assign to our two operating segments.

Results of Operations - SEQUENOM Genetic Systems

Revenues

Revenues for the three and six months ended June 30, 2004 decreased to $5.8 million and $10.6 million, respectively, from $7.3 million and $13.9 million, respectively, for the same periods in 2003. These product revenues were derived from the sale of consumables including our SpectroCHIP bioarray chips, MassARRAY systems, licensing of our proprietary software, maintenance agreements, and license fees from end-users. The decline in overall sales was mainly due to lower average selling prices for our chips and other consumables, and a decrease in the number of MassARRAY systems sold as our market for high-throughput genotyping reaches saturation and as we are in the early stages of penetrating the market for our Compact system. Sales of consumables in the three and six months ended June 30, 2004 decreased to $2.7 million and $6.1 million, respectively, from $3.0 million and $6.3 million in the three and six months ended June 30, 2003. This reduction was due primarily to a decline in the average selling price of our SpectroCHIP bioarray chips and related consumables due to increased discounts more than offset the increased volume of SpectroCHIP bioarray chip sales driven by the increased total number of installed systems.

Cost of Product Revenue and Gross Margin

Cost of product revenues for the three and six months ended June 30, 2004 were $3.5 million and $6.3 million, respectively, compared to $4.4 million and $7.8 million, respectively, for the same periods in 2003. Gross margins for the three and six months ended June 30, 2004 were 40% and 41%, respectively, compared to 40% and 44%, respectively, for the same periods of the prior year. Gross margins were reduced by 9% due to our additional slow-moving inventory reserves of $0.8 million for excess inventory on hand, which offset the positive effect of the overall mix of products moving towards higher-margin consumable sales from lower-margin hardware sales in the three and six months ended June 30, 2004.

We believe that gross margin in future periods will be affected by, among other things, the mix of products sold, competitive conditions, sales volumes, discounts offered, inventory reserves required and royalty payment obligations on in-licensed technologies.

Research and Development Expenses

Research and development expenses for the three and six months ended June 30, 2004 increased to $2.9 million and $5.3 million, respectively, from $2.3 million and $4.6 million, respectively, for the same periods in the prior year. These expenses consist primarily of salaries and related personnel expenses, improvements to our existing products and validation of products under development. The increases in the three and six months ended June 30, 2004 were primarily due

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to increased headcount expenses and research supply expenses. We expect an increase in expense in this area in 2004 as we continue research and development related to diagnostic product opportunities and as we seek regulatory approval, directly or through partners, for our diagnostic products.

Selling, General and Administrative Expenses

Selling, general and administrative expenses for the three and six months ended June 30, 2004 increased to $4.3 million and $8.5 million, respectively, from $4.2 million and $8.3 million, respectively, for the same periods in the prior year. The increase of $0.2 million from the six months ended June 30, 2003 to the same period in 2004 resulted from increases in headcount expenses and sales related expenses of $0.7 million as we expand our sales operations, offset by a decrease in legal, insurance, depreciation and other expenses of $0.5 million due to lower premiums and reduced legal activity. These expenses consist primarily of salaries and related expenses for sales and marketing, customer support, business development, legal, finance and human resource personnel, and their related function’s expenses. We expect headcount and related expenses to increase during 2004 as we expand our sales operations.

Results of Operations - SEQUENOM Pharmaceuticals

Revenues

Total revenues for the SEQUENOM Pharmaceuticals segment declined to $0.2 million and $0.5 million, respectively, for the three and six months ended June 30, 2004 from $0.3 million and $1.2 million, respectively, for the three and six months ended June 30, 2003. Service revenues for the three and six months ended June 30, 2004 declined to $0.1 million and $0.2 million, respectively, from $0.2 million and $0.8 million, respectively for the same periods in 2003. We derived these revenues from the completion of significant phases of genetic validation projects. We expect revenue from present and future outlicensing of our disease gene discoveries that were generated in our Pharmaceuticals business unit to be minimal for the foreseeable future.

Cost of Product and Service Revenue and Gross Margin

Cost of product and service revenues for the three and six months ended June 30, 2004 were $35 thousand and $0.2 million, respectively, compared to $0.2 million and $0.8 million, respectively for the same periods in 2003. Gross margin for the three and six months ended June 30, 2004 was 79% and 57%, respectively, compared to 39% and 38%, respectively, for the same periods of the prior year. Gross margins are dependent on the particular contract terms of the work undertaken in each quarter and the ratio of research income to lower margin service contract work.

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Research and Development Expenses

Research and development expenses for the three and six months ended June 30, 2004 decreased to $3.2 million and $6.9 million, respectively, from $4.2 million and $7.7 million, respectively, for the same periods in the prior year. These expenses consist primarily of salaries and related personnel expenses, materials expenses and expenses related to our disease gene discovery and development programs, and expenses relating to work performed under research contracts. The $1.0 million and $0.8 million decrease for the three and six months ended June 30, 2004, respectively, from the same periods in 2003 was a result of the substantial completion of our internal gene scan program in the second quarter of 2003. Research and development expenses with respect to our internal drug discovery efforts will terminate with the closure of the Pharmaceuticals business unit during the third quarter of 2004.

Selling, General and Administrative Expenses

Selling, general and administrative expenses for the three months and six months ended June 30, 2004 decreased to $1.5 million and $3.0 million, respectively, from $1.7 million and $3.5 million, respectively, in the prior year. These expenses consist primarily of salaries and related expenses for business development, legal, finance and human resource personnel, and their related function’s expenses. The $0.5 million decrease from the six months ended June 30, 2003 to 2004 resulted primarily from lower legal, insurance, depreciation and headcount expenses. Although the Pharmaceuticals business unit will be closed during the third quarter of 2004, certain selling, general and administrative expenses will continue to be incurred going forward in connection with maintaining and promoting our gene target discoveries and our outlicensing activities related to those discoveries.

Liquidity and Capital Resources

As of June 30, 2004, cash, cash equivalents, short-term investments and restricted cash totaled $50.7 million compared to $67.5 million as of December 31, 2003. Our cash reserves are held in a variety of interest-bearing instruments including investment-grade corporate bonds, commercial paper and money market accounts.

Short-Term

We consider the material drivers of our cash flow to be sales volumes, inventory management and operating expenses. Our principal sources of liquidity are our cash, cash equivalents and short-term investments. Cash used in operations for the six months ended June 30, 2004 was $13.0 million compared to $17.1 million for the same period in 2003. The use of cash was a result of the net loss of $19.8 million for the six months ended June 30, 2004, adjusted for non-cash depreciation and amortization of $5.2 million, $0.6 million of deferred income tax benefit and reductions in accounts receivable balances of $0.5 million due to lower sales activity and reduced time taken to collect receivables, reductions of $3.9 million in inventory levels from inventory management and valuation reserves, increases in other liabilities of $1.2 million, and

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reductions in accounts payable and deferred income of $3.6 million. At our current and anticipated level of operating loss, we expect to incur an operating cash outflow on a quarterly basis. We anticipate that this will continue in the future as we continue to invest in new product research and development, regulatory approval, and sales, marketing and support activities. As a result, our cash, cash equivalents and marketable security balances will decline. If the current trend of cash use continues, we will need additional capital by the end of 2006 to support our activities, as described in our discussion under the heading “Long-Term” below.

Investing activities, other than the changes in our short-term investments and restricted cash, used $1.6 million in cash during the first six months of 2004 due to leasehold improvements and purchases of additional laboratory equipment.

Net cash used by financing activities was $2.0 million for the six months ended June 30, 2004 compared to $0.7 million used by financing activities for the same period in 2003. Financing activities during the first six months of 2004 included net payments of $2.1 million for long-term debt and capital leases and the receipt of proceeds from the exercise of stock options and employee stock purchase plan purchases of approximately $120,000.

Long-Term

We filed a registration statement on Form S-3 with the Securities and Exchange Commission (“SEC”) on January 30, 2004 to sell common stock and/or warrants to purchase common stock over time in one or more offerings up to a maximum aggregate initial offering price of $50,000,000. We currently intend to use net proceeds from any future sale of securities under this registration statement, if such sale were to occur at all, for general corporate purposes, which may include research and development, capital expenditures, working capital, and general and administrative expenses. We may also use a portion of the net proceeds from any such sale to acquire or invest in businesses, products and technologies that are complementary to our own.

The following table summarizes our contractual obligations as of June 30, 2004:

Future operating lease commitments have not been reduced by future sublease rentals aggregating $0.9 million.

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Based on our current plans, we believe our cash, cash equivalents and short-term investments will be sufficient to fund our operating expenses, debt obligations and capital requirements through 2006. However, the actual amount of funds that we will need will be determined by many factors, some of which are beyond our control, and we may need funds sooner than currently anticipated. These factors include but are not limited to:

We have a $15.1 million bank line of credit provided by the Union Bank of California, of which $7.4 million is outstanding and $7.7 million is available for borrowing and expires on January 31, 2005. We have no commitments for any additional financings. We filed a registration statement on Form S-3 with the Securities and Exchange Commission (“SEC”) on January 30, 2004 to sell common stock and/or warrants to purchase common stock over time in one or more offerings up to a maximum aggregate initial offering price of $50,000,000. We currently intend to use net proceeds from any future sale of securities under this registration statement, if such sale were to occur at all, for general corporate purposes, which may include research and development, capital expenditures, working capital, and general and administrative expenses. We may also use a portion of the net proceeds from any such sale to acquire or invest in businesses,

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products and technologies that are complementary to our own. When we require additional funds, general market conditions or the then-current market price of our common stock may not support capital raising transactions such as an additional public or private offering of our common stock or other securities. If additional funds are required and we are unable to obtain them on a timely basis or on terms favorable to us, we may be required to cease or reduce further commercialization of our products, to cease or reduce certain research and development projects, to sell some or all of our technology or assets or to merge all or a portion of our business with another entity. If we raise additional funds by selling shares of our capital stock, the ownership interest of our stockholders will be diluted.

Risks and Uncertainties Related to Our Business

The following is a summary of the many risks we face in our business. You should carefully read these risks and uncertainties in evaluating our business.

We have a limited operating history.

We are a relatively new company and, for the most part, our technologies, particularly our internally discovered disease gene discoveries are at an early stage of discovery and development. We have experienced limited success in partnering with collaborators to further research, develop, and commercialize our disease gene discoveries. We may not be successful in researching, developing, or commercializing these targets under our present collaborations and we may not be successful in entering into any new collaborations involving our disease gene discoveries. We also have a limited history of product sales and we continue to commercialize new products and create new applications for our products. You should evaluate us in the context of the uncertainties and complexities affecting an early stage company developing products and applications for the life science industries. We need to make significant investments to ensure our products perform properly and are cost-effective and we will likely need to apply for and obtain certain regulatory approvals to sell our products for diagnostic and therapeutic applications and it is uncertain whether such approvals will be granted. Even if we develop products for commercial use and obtain all necessary regulatory approval, we may not be able to develop products that are accepted in the genomic, diagnostic, pharmaceutical or other markets and that can be marketed and sold successfully.

We have a history of operating losses, anticipate future losses and may never become profitable.

We have experienced significant operating losses in each period since our inception. At June 30, 2004, our accumulated deficit was approximately $401.2 million. These losses have resulted principally from expenses incurred in research and development, from selling, general and administrative expenses associated with our operations and the write-down to the carrying value of acquired goodwill and intangibles. We expect to incur operating losses in the future as a result of expenses associated with research and product development, production, marketing and

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selling, and general and administrative expenses as well as expenses associated with consolidating and completing the integration of any business or technology that we may acquire in the future. Our general and administrative expenses are likely to increase as we seek to comply with evolving standards for corporate governance and public disclosure. To achieve profitability, we would need to generate significant additional revenue with positive gross margins. It is uncertain when, if ever, we will become profitable, or cash-flow positive. Even if we were to become profitable, we might not be able to sustain or increase profitability on a quarterly or annual basis.

Our operating results may fluctuate significantly.

Our revenues and results of operations may fluctuate significantly, depending on a variety of factors, including the following:

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Further, our revenues and operating results are difficult to predict because they depend on the number, timing and type of MassARRAY system placements that we make during the year, the number, timing and types of software licensed or sold, and the quantity and timing of consumables sales for the installed base of systems. Changes in the relative mix of our MassARRAY system and consumables sales can have a significant impact on our gross margin, as consumable sales typically have margins significantly higher than MassARRAY system sales. In recent quarters, our sales mix has been comprised of a greater proportion of higher-margin consumable sales. Our revenues and operating results are also difficult to predict because they depend upon, for example as is the case with our collaboration with Procter & Gamble Pharmaceuticals, the completion of milestones and the duration of and progress made under collaborative research and commercialization programs with partners. The absence of or delay in generating revenues could cause significant variations in our operating results from year to year and could result in increased operating losses.

We believe that period-to-period comparisons of our financial results will not necessarily be meaningful. You should not rely on these comparisons as an indication of our future performance. If our operating results in any future period fall below the expectations of securities analysts and investors, our stock price will likely fall.

We have a history of generating a large percentage of our revenue at the end of each quarterly accounting period.

Due to the way that many customers in our target markets allocate and spend their budgeted funds for acquisition of our products, a large percentage of our sales are booked at the end of each quarterly accounting period. Because of this timing of our sales, we may not be able to reliably predict order volumes and our quarterly revenues. A sales delay of only a few days may significantly impact our quarter-to-quarter comparisons. If our quarterly revenues fall below the expectations of securities analysts and investors, our stock price may decline. Similarly, if we are unable to ship our customer orders on time, there could be a material adverse effect on revenues for a given quarter.

We will need additional capital in the future to support our growth, which will result in dilution to our stockholders.

Based on our current plans, we believe our cash, cash equivalents and short-term investments will be sufficient to fund our operating expenses, debt obligations and capital requirements through 2006. However, the actual amount of funds that we will need will be determined by many factors, some of which are beyond our control, and we may need funds sooner than currently anticipated. These factors include but are not limited to:

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When we require additional funds, general market conditions or the then-current market price of our common stock may not support capital raising transactions such as an additional public or private offering of our common stock or other securities. If additional funds are required and we are unable to obtain them on a timely basis or on terms favorable to us, we may be required to cease or reduce further commercialization of our products, to cease or reduce certain research and development projects, to sell some or all of our technology or assets or business units or to merge all or a portion of our business with another entity. If we raise additional funds by selling shares of our capital stock, the ownership interest of our stockholders will be diluted.

A reduction in revenues from sales of MassARRAY products would harm our business.

A decline in the demand for MassARRAY systems and consumables would reduce our total revenues and harm our business. We expect that sales of MassARRAY systems and consumables will account for most of our total revenues for the foreseeable future. We continue to see the number of new account opportunities for our highest throughput MassARRAY system for the high throughput genotyping market, declining. We have experienced reduced demand over the past several quarters for our highest throughput and largest capacity versions of the MassARRAY system. The sales cycles of our new MassARRAY Gene Expression application and MassARRAY Compact system are longer than planned and are consistent with the sales

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cycles for our other products. Also, over the past year, competitors have offered low priced fee-for-service genotyping services and technologies to the DNA analysis marketplace. These factors and the following factors, among others, would reduce the demand for MassARRAY products:

Our revenues are subject to the risks faced by pharmaceutical, diagnostic, and biotechnology companies and governmental and other research institutions.

We expect that our revenues in the foreseeable future will be derived primarily from MassARRAY system products provided to pharmaceutical and biotechnology companies, laboratories, and governmental and other research institutions. Our operating results could fluctuate substantially due to reductions and delays in research and development expenditures by these customers. These reductions and delays could result from factors such as:

None of these factors are within our control.

We depend on sales of our consumable chips and other MassARRAY consumables for a significant portion of our revenues.

Sales of our consumable chips and other consumables for the MassARRAY system are an important source of revenue. Revenues from MassARRAY consumables totaled approximately $15 million or 53% of our total revenues in the year ended December 31, 2003. Factors which may limit the use of our consumable chips and other consumables include:

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If our customers are unable to adequately prepare samples for our MassARRAY system, the overall market demand for our products would decline.

Before using the MassARRAY system, customers must prepare samples by following several steps that are subject to human error, including DNA isolation and DNA amplification. If DNA samples are not prepared appropriately, or the proposed assays are too complex, the MassARRAY system may not generate a reading or a correct reading. If our customers experience these difficulties, they might achieve lower levels of throughput than specified for the system. If our customers are unable to generate expected levels of throughput, they might not continue to purchase our consumables, they could express their discontent with our products to others, or they could collaborate with others to jointly benefit from the use of our products. Any or all of these actions would reduce the overall market demand for our products. From time to time, we have experienced customer complaints regarding data quality and difficulty in processing more complex assays.

The sales cycles for our products and for licensing our SNP and gene target discoveries are lengthy, and we may expend substantial funds and management effort with no assurance of successfully selling our products or services or licensing our SNP and gene target discoveries.

The sales cycles for our MassARRAY system products are typically lengthy, and for our Gene Expression application and MassARRAY Compact system, the sales cycles have been longer than originally planned. It now appears that the sales cycles for the Gene Expression application and MassARRAY Compact system are similar to that of our other products, rather than being shorter, and that the lower price point for the MassARRAY Compact system has not resulted in a shorter sales cycle as we had originally expected. The sales cycle for licensing our SNP and gene target discoveries is also typically lengthy. Our sales efforts and our licensing efforts require the effective demonstration of the benefits, value, and differentiation and validation of our products, services, and discoveries, to, and significant training of, multiple personnel and departments within a potential customer. We may be required to negotiate agreements containing terms unique to each prospective customer or licensee which would lengthen the sales cycle. We may expend substantial funds and management effort with no assurance that we will sell our products or services or license our discoveries.

We may not be able to successfully adapt our products for commercial applications.

A number of potential applications of our MassARRAY technology may require significant enhancements in our core technology. If we are unable to complete the development, introduction or scale-up of any product, or if any of our new products or applications, such as gene expression analysis, do not achieve a significant level of market acceptance, our business, financial condition and results of operations could be seriously harmed. We may fail to sustain the market

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acceptance of our products that have been already established, such as our MassARRAY systems, or of new products and applications. Sustaining or achieving market acceptance will depend on many factors, including demonstrating to customers that our technology is cost competitive or superior to other technologies and products that are available now or that may become available in the future. We believe that our revenue growth and profitability will substantially depend on our ability to overcome significant technological challenges and successfully introduce our newly developed products, applications and services into the marketplace.

We have limited commercial production capability and experience and may encounter production problems or delays, which could result in lower revenue.

We partially assemble the MassARRAY system and partially manufacture our consumable chips and MassARRAY kits. To date, we have only produced these products in moderate quantities. Our customers require that we comply with current good manufacturing practices that we may not be able to meet. We may not be able to maintain acceptable quality standards as we continue or ramp up production. To achieve anticipated customer demand levels, we will need to scale-up our production capability and maintain adequate levels of inventory while manufacturing our products at a reasonable cost. We may not be able to produce sufficient quantities to meet market demand or manufacture our product at a reasonable cost. If we cannot achieve the required level and quality of production, we may need to outsource production or rely on licensing and other arrangements with third parties. This reliance could reduce our gross margins and expose us to the risks inherent in relying on others. We might not be able to successfully outsource our production or enter into licensing or other arrangements with these third parties, which would adversely affect our business.

We depend on third-party products and services and limited sources of supply to develop and manufacture our products.

We rely on outside vendors to supply certain products and the components and materials used in our products. Some of these products, components and materials are obtained from a single supplier or a limited group of suppliers. Our MassARRAY system is comprised of several components, of which the following are currently obtained from a single supplier: Bruker Daltonics, Inc. supplies our mass spectrometers, Samsung Electronics Co., Ltd. supplies our nanodispensers (also known as pintools), and Majer Precision Engineering, Inc. supplies the pins for the pintools. Amersham Biosciences Corp. is the sole supplier of an enzyme called Thermosequenase. Our consumable chips are supplied by Samsung Electronics Co., Ltd. and also by Process Specialties, Inc. Other than our agreement with Bruker Daltonics, Inc. which expires in 2006, we do not have long-term agreements with these vendors. We have experienced quality problems with and delays in receiving wafers used to produce our consumable chips, and also had technical difficulties with our pin-tool nanoliter dispenser device. We have also experienced software and operational difficulties with our MassARRAY Compact system. Our reliance on outside vendors generally and a sole or a limited group of suppliers in particular involves several risks, including:

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We may not derive any revenues from our gene discovery programs.

Our gene target discoveries are very early stage discoveries and we may not be able to license them and even if we do license them, they may not result in revenues for us and may not result in marketable products. Our technologies and approach to gene discovery may not enable any licensee to successfully identify the specific genes that cause or predispose individuals to the complex diseases that were the targets of our efforts. The diseases we targeted are generally believed to be caused by a number of genetic and environmental factors. It may not be possible to address such diseases through gene-based therapeutic or diagnostic products. Even if specific genes are identified, our discoveries may not lead to the development of commercial products, or otherwise generate revenue.

We and our licensees and collaborators may not be successful in developing or commercializing therapeutic, diagnostic or other products using our products, services or discoveries.

Development of therapeutic products by our licensees and development of diagnostic or other products by us or our collaborators are subject to risks of failure inherent in the development and commercial viability of any such product, such as demand for such product. These risks further include the possibility that such product would:

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If a licensee discovers therapeutic products or we or a collaborator discover diagnostic or other products using our technology, products, services or discoveries, we may rely on that licensee or collaborator (hereafter jointly and severally referred to as “partner”) for product development, regulatory approval, manufacturing and marketing of those products before we can realize revenue and some or all of the milestone payments, royalties or other payments we may be entitled to under the terms of the licensing or collaboration agreement. If we are unable to successfully achieve milestones or our partners fail to develop successful products, we will not earn the revenues contemplated. Our agreements may allow our partners significant discretion in electing whether to pursue any of these activities. We cannot control the amount and timing of resources our partners may devote to our programs or potential products. As a result, we cannot be certain that our partners will choose to develop or commercialize any products or will be successful in doing so. In addition, if a partner is involved in a business combination, such as a merger or acquisition, or changes its business focus, its performance under its agreement with us may suffer and, as a result, we may not generate any revenues or only limited revenues from the royalty, milestone and similar payment provisions contained in our agreement with that partner.

We may not successfully obtain regulatory approval of any therapeutic, diagnostic or other product which we or our licensing or collaborative partners develop.

The Food and Drug Administration, or FDA, must approve any drug product before it can be marketed in the United States. A drug product must also be approved by regulatory agencies of foreign governments before the product can be sold outside the United States. Before a new drug application can be filed with the FDA, the potential product must undergo preclinical testing and clinical trials. Commercialization of any therapeutic, diagnostic or other product that our licensees or collaborators or we develop would depend upon successful completion of preclinical testing and clinical trials. Preclinical testing and clinical trials are long, expensive and uncertain processes, and we do not know whether we, our licensees or any of our collaborators, would be permitted or able to undertake clinical trials of any potential products. It may take us or our licensees or collaborators many years to complete any such testing, and failure could occur at any stage. Preliminary results of trials do not necessarily predict final results, and acceptable results in early trials may not be repeated in later trials. A number of companies in the pharmaceutical industry, including biotechnology companies, have suffered significant setbacks in advanced clinical trials, even after promising results in earlier trials. Delays or rejections of potential products may be encountered based on changes in regulatory policy for product approval during the period of product development and regulatory agency review. If our projects reach clinical trials, we or our licensees or collaborators could decide to discontinue development of any or all of these projects at any time for commercial, scientific or other reasons.

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If the validity of the consents from volunteers were to be challenged, we could be forced to stop using some of our resources, which would hinder our gene discovery outlicensing efforts and our diagnostic product development efforts.

We have attempted to ensure that all clinical data and genetic and other biological samples that we receive from our subsidiaries and our clinical collaborators have been collected from volunteers who have provided our collaborators or us with appropriate consents for the data and samples provided for purposes which extend to include our gene discovery outlicensing activities and diagnostic product development activities. We have attempted to ensure that data and samples that have been collected by our clinical collaborators are provided to us on an anonymous basis. We have also attempted to ensure that the volunteers from whom our data and samples are collected do not retain or have conferred on them any proprietary or commercial rights to the data or any discoveries derived from them. Our clinical collaborators are based in a number of different countries, and to a large extent we rely upon our clinical collaborators for appropriate compliance with the voluntary consents provided and with local law and regulation. That our data and samples come from and are collected by entities based in different countries results in complex legal questions regarding the adequacy of consents and the status of genetic material under a large number of different legal systems. The consents obtained in any particular country could be challenged in the future, and those consents could prove invalid, unlawful or otherwise inadequate for our purposes. Any findings against us or our clinical collaborators could deny us access to or force us to stop using some of our clinical or genetic resources which would hinder our gene discovery outlicensing efforts and our diagnostic product development efforts. We could become involved in legal challenges which could consume a substantial proportion of our management and financial resources.

If we cannot obtain licenses to patented SNPs and genes, we could be prevented from obtaining significant revenue or becoming profitable.