S-1 1 ds1.htm FORM S-1 Form S-1
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As filed with the Securities and Exchange Commission on July 30, 2010

Registration No. 333-            

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM S-1

REGISTRATION STATEMENT

UNDER

THE SECURITIES ACT OF 1933

 

 

COMPLETE GENOMICS, INC.

(Exact name of registrant as specified in its charter)

 

Delaware   8731   20-3226545

(State or other jurisdiction of

incorporation or organization)

 

(Primary Standard Industrial

Classification Code Number)

 

(I.R.S. Employer

Identification Number)

2071 Stierlin Court, Mountain View, CA 94043

(650) 943-2800

(Address, including zip code, and telephone number, including area code, of registrant’s principal executive offices)

 

 

Clifford A. Reid, Ph.D.

President and Chief Executive Officer

Complete Genomics, Inc.

2071 Stierlin Court

Mountain View, CA 94043

(650) 943-2800

(Name, address, including zip code, and telephone number, including area code, of agent for service)

 

 

Copies to:

 

Alan C. Mendelson

Gregory Chin

Latham & Watkins LLP

140 Scott Drive

Menlo Park, California 94025-1008

Telephone: (650) 328-4600

Facsimile: (650) 463-2600

 

Donald J. Murray

Dewey & LeBoeuf LLP

1301 Avenue of the Americas

New York, New York 10019-6092

Telephone: (212) 259-8000

Facsimile: (212) 259-6333

 

 

Approximate date of commencement of proposed sale to the public: As soon as practicable after the effective date of this Registration Statement.

If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box.    ¨

If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.    ¨

If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.    ¨

If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.    ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer    ¨   Accelerated filer    ¨
Non-accelerated filer    x (Do not check if a smaller reporting company)   Smaller reporting company    ¨

 

 

CALCULATION OF REGISTRATION FEE

 

 

Title of Each Class of

Securities to be Registered

 

Proposed Maximum
Aggregate Offering

Price(1)

 

Amount of

Registration Fee(2)

Common Stock, $0.001 par value

 

$86,250,000

 

$6,149.63

 
 
(1)   Includes shares which may be purchased by the underwriters to cover over-allotments, if any.
(2)   Estimated solely for the purpose of computing the amount of the registration fee pursuant to Rule 457(o) under the Securities Act of 1933, as amended.

The Registrant hereby amends this registration statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this registration statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until the registration statement shall become effective on such date as the Commission, acting pursuant to said Section 8(a), may determine.

 

 

 


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The information in this preliminary prospectus is not complete and may be changed. We may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This preliminary prospectus is not an offer to sell these securities and we are not soliciting offers to buy these securities in any jurisdiction where the offer or sale is not permitted.

 

Subject to Completion, July 30, 2010

Preliminary Prospectus

Shares

LOGO

Common Stock

This is the initial public offering of our common stock. No public market currently exists for our common stock. We are offering all of the              shares of our common stock offered by this prospectus. We expect the public offering price to be between $              and $              per share.

We intend to apply to list our common stock on The NASDAQ Global Market under the symbol “GNOM.”

 

 

Investing in our common stock involves a high degree of risk. Before buying any shares, you should carefully read the discussion of material risks of investing in our common stock in “Risk Factors” beginning on page 12 of this prospectus.

Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense.

 

    

Per Share

   Total

Public offering price

   $                     $             

Underwriting discounts and commissions

   $                 $             

Proceeds, before expenses, to us

   $                     $             

The underwriters have the option, exercisable on or before the thirtieth day after the date of this prospectus, to purchase up to an additional              shares of our common stock at the public offering price, less the underwriting discounts and commissions payable by us, to cover over-allotments, if any. If the underwriters exercise this option in full, the total underwriting discounts and commissions will be $            , and our total proceeds, before expenses, will be $            .

The underwriters are offering the common stock as set forth under “Underwriting.” Delivery of the shares will be made on or about                     , 2010.

 

UBS Investment Bank    Jefferies & Company
Baird    Cowen and Company

The date of this prospectus is                     , 2010.


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LOGO

Complete Human Genome Sequencing Service

Simple, Complete Solution

1 Researcher sends DNA samples to complete Genomics.

2 Complete Genomics performs library prep, sequencing, data assembly and analysis.

3 Large-scale data center supports advanced informatics and data management software.

4 Complete Genomics uploads finished, research-ready data to Amazon Web Services for delivery to customers.

5 Customers have access to a suite of analytical tools to enable them to rapidly analyze the genomic data that is generated from their samples.


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You should rely only on the information contained in this prospectus. We have not, and the underwriters have not, authorized anyone to provide you with additional information or information different from that contained in this prospectus. We are offering to sell, and seeking offers to buy, shares of our common stock only in jurisdictions where offers and sales are permitted. The information contained in this prospectus is accurate only as of the date of this prospectus, regardless of the time of delivery of this prospectus or of any sale of shares of our common stock.

 

 

Table of Contents

 

Prospectus Summary

   1

Risk Factors

   12

Special Note Regarding Forward-Looking Statements

   33

Use of Proceeds

   34

Dividend Policy

   35

Capitalization

   36

Dilution

   39

Selected Financial Data

   43

Management’s Discussion and Analysis of Financial Condition and Results of Operations

   45

Business

   66

Management

   84

Executive Compensation

   95

Certain Relationships and Related Party Transactions

   112

Principal Stockholders

   119

Description of Capital Stock

   122

Shares Eligible for Future Sale

   128

Material U.S. Federal Income Tax Consequences to Non-U.S. Holders

   131

Underwriting

   135

Notice to Investors

   138

Legal Matters

   141

Experts

   141

Where You Can Find Additional Information

   141

Financial Statements Index

   F-1

 

 

Through and including                     , 2010 (25 days after the date of this prospectus), federal securities laws may require all dealers that effect transactions in our common stock, whether or not participating in this offering, to deliver a prospectus. This is in addition to the dealers’ obligation to deliver a prospectus when acting as underwriters and with respect to their unsold allotments or subscriptions.

Our logo, “Complete Genomics,” “Complete Genomics Analysis Platform,” “CGA Platform,” “cPAL” and “DNB” and other trademarks or service marks of Complete Genomics, Inc. appearing in this prospectus are the property of Complete Genomics, Inc. This prospectus contains additional trade names, trademarks and service marks of other companies. We do not intend our use or display of other companies’ trade names, trademarks or service marks to imply relationships with, or endorsement or sponsorship of us by, these other companies.

 

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Prospectus Summary

This summary highlights information contained elsewhere in this prospectus and does not contain all of the information you should consider in making your investment decision. You should read this summary together with the more detailed information, including our financial statements and the related notes, elsewhere in this prospectus. You should carefully consider, among other things, the matters discussed in “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” before making an investment decision. Unless otherwise indicated, “Complete Genomics, Inc.,” “Complete Genomics,” “the Company,” “we,” “us” and “our” refer to Complete Genomics, Inc.

Our Company

We are a life sciences company that has developed and commercialized an innovative DNA sequencing platform that we believe will become the preferred solution for complete human genome sequencing and analysis. Our Complete Genomics Analysis Platform, or CGA Platform, combines our proprietary human genome sequencing technology with our advanced informatics and data management software and our innovative, end-to-end, outsourced service model to provide our customers with data that is immediately ready to be used for genome-based research. We believe that our solution will provide academic and biopharmaceutical researchers with complete human genomic data and analysis at an unprecedented quality, cost and scale without requiring them to invest in in-house sequencing instruments, high-performance computing resources and specialized personnel. By removing these constraints and broadly enabling researchers to conduct large-scale complete human genome studies, we believe that our solution has the potential to revolutionize medical research and expand understanding of the basis, treatment and prevention of complex diseases.

We believe that our human genome sequencing technology, which is based on our proprietary DNA arrays and ligation-based read technology, is superior to existing commercially available complete human genome sequencing methods in terms of quality, cost and scale. In the DNA sequencing industry, complete human genome sequencing is generally deemed to be coverage of at least 90% of the nucleotides in the genome. Because we have optimized our technology platform and our operations for the unique requirements of high-throughput complete human genome sequencing, we are able to achieve accuracy levels of 99.999% at a total cost that is significantly less than the total cost of purchasing and using commercially available DNA sequencing instruments. We believe that we will be able to further improve our accuracy levels and reduce the total cost of sequencing and analysis, enabling us to maintain significant competitive advantages over the next several years. Because our technology resides only in our centralized facilities, we can quickly and easily implement enhancements and provide their benefits to our entire customer base. We believe that we will be the first company to sequence and analyze high-quality complete human genomes, at scale, for a total cost of under $1,000 per genome.

While our competitors primarily sell DNA sequencing instruments and reagents that produce raw sequenced data, requiring their customers to invest significant additional resources to process that raw data into a form usable for research, we offer our customers an end-to-end, outsourced solution that delivers research-ready genomic data. As the cost of complete human genome sequencing declines, we believe the basis of competition in our industry will shift from the cost of sequencing to the value of the entire sequencing solution. We believe that our integrated, advanced informatics and data management services will emerge as a key competitive advantage as this shift occurs.

Our genome sequencing center, which began commercial operations in May 2010, combines a high-throughput sample preparation facility, a collection of our proprietary high-throughput sequencing instruments and a large- scale data center. Our customers ship us their samples via common carrier services such as Federal Express and

 

 

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United Parcel Service. We then sequence and analyze these samples and provide our customers with finished, research-ready data, enabling them to focus exclusively on their single highest priority, discovery.

As of March 31, 2010, there had been approximately 24 published and 200 unpublished complete human genomes sequenced worldwide, as reported in the April 2010 edition of Nature. As of July 20, 2010, we have sequenced over 200 complete human genomes year-to-date, including more than 100 in the first three weeks of July 2010, and have an order backlog of over 500 genomes. Our customers include some of the leading global academic and government research centers and biopharmaceutical companies. By the end of 2010, we expect our facility to have the capacity to sequence and analyze over 400 complete human genomes per month. We expect this capacity to increase over threefold in 2011. In future years, we plan to construct additional genome centers in the United States and other strategic markets to accommodate an expected growing global demand for high-quality, low-cost complete human genome sequencing on a large scale.

Our Industry

Studying how genes differ between species and among individuals within a species, or genetic variations, helps scientists to determine their functions and roles in health and disease. Improving our understanding of the genome and its functions has driven and, we expect, will continue to drive advancements in medical research and diagnostics. Genetic analysis products comprise instruments and consumables, as well as associated hardware, software and services directly involved in the study of DNA and RNA. Scientia Advisors, a third-party research firm, estimated genomic revenue in 2009 to be approximately $5.8 billion and projects the market to grow to approximately $9.0 billion by 2014.

The primary genetic analysis methods traditionally used by genetic researchers fall into three categories: DNA sequencing, genotyping and gene expression analysis. DNA sequencing is the process of determining the exact order, or sequence, of the individual nucleotides in a DNA strand so that this information can be correlated to the genetic activity influenced by that segment of DNA. Genotyping is the process of examining certain known mutations or variations in the DNA sequence of genes to determine whether the particular variant can be associated with a specific disease susceptibility or drug response. Gene expression analysis is the process of examining the molecules that are produced when a gene is activated, or expressed, to determine whether a particular gene is expressed in a specific biological tissue.

The Importance of Complete Human Genome Sequencing and the Limitations of Existing Technologies

One of the most difficult challenges facing the genetic research and analysis industry is improving our understanding of how genes contribute to diseases that have a complex pattern of inheritance. For many diseases, multiple genes each make a subtle contribution to a person’s predisposition or susceptibility to a disease or response to a drug treatment protocol. Accordingly, we believe that unraveling this complex network will be critical to understanding human health and disease. We believe that sequencing complete human genomes is the most comprehensive and accurate method by which to achieve these objectives and improve our understanding of human disease.

Innovations in DNA sequencing have led to the development of high-throughput sequencing technologies, commonly referred to as next-generation or second-generation sequencing, which produce thousands to millions of sequences at once. Although second-generation sequencing technologies have led to dramatic reductions in cost and improvements in quality and throughput for complete human genome sequencing, they were designed as general-purpose instruments for sequencing the DNA or RNA of plants, animals, bacteria and viruses. We believe the key limitations of using second-generation technologies for sequencing large numbers of complete human genomes include the following:

 

  §  

High Cost.    Commercially available DNA sequencing instruments cannot sequence complete human genomes at a price low enough to make large-scale projects affordable to researchers.

 

 

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  §  

Insufficient Scale and Speed.    Commercially available DNA sequencing instruments typically require weeks to sequence a complete human genome, which translates into months or years for large projects.

 

  §  

Difficulty of Data Management.    Many users of commercially available DNA sequencing instruments lack the costly computing resources, storage capacity, network bandwidth and specialized personnel to process and analyze the massive data sets generated by sequencing complete human genomes.

Our Solution

We have developed a novel approach to complete human genome sequencing. Our solution combines our proprietary sequencing technology, which achieves accuracy levels of 99.999%, with our advanced informatics and data management software and our innovative, end-to-end service model to deliver research-ready genomic data at a total cost that is significantly less than the total cost of purchasing and operating commercially available DNA sequencing instruments.

Proprietary Sequencing Technology

Our patterned DNA nanoball, or DNB, arrays, due to their small size and biochemical characteristics, enable us to pack DNA very efficiently on a silicon chip. In addition, we have developed a highly accurate combinatorial probe-anchor ligation, or cPAL, read technology, which enables us to read DNA fragments efficiently using small concentrations of low-cost reagents, while retaining extremely high single-read accuracy. We believe this unique combination of our proprietary DNB and cPAL technologies is superior in both quality and cost when compared to other commercially available approaches and provides us with significant competitive advantages. As reported in the January 2010 edition of Science, we sequenced a complete human genome at a consumables cost of approximately $1,800 and with a consensus error rate of approximately 1 error in 100,000 nucleotides. Our read accuracy was further independently validated by one of our customers, the Institute for Systems Biology, or ISB, as published in Science Express in March 2010.

Advanced Informatics and Data Management

Sequencing complete human genomes generates substantial amounts of data that must be managed, stored and analyzed. To address this potential need by our customers, we have built a genomics data processing facility with computing infrastructure for managing both small- and large-scale genomic sequencing projects. Our proprietary assembly software uses advanced data analysis algorithms and statistical modeling techniques to accurately reconstruct over 90% of the complete human genome from approximately two billion 70-base reads. After assembling the genomic data, we use our analysis software to identify and annotate key differences, or variants, in each genome.

By using our analytical tools and data management software, our customers can significantly reduce their investments in computing infrastructure. Our customers are provided with reliable access to assembled and annotated sequence data in multiple formats to ease data sharing and comparative analyses. In addition, our data storage options provide flexibility and allow customers to customize their data management strategy based on their particular business and scientific requirements. We are also developing a suite of web-based analytical tools designed to enable our customers to rapidly analyze the genomic data that is generated from their samples. As the reagent cost of sequencing declines, we believe that the cost and complexity of data analysis and management will emerge as the primary limiting factor for conducting complete human genome analysis.

Innovative, End-to-End Outsourced Solution

While our competitors primarily sell DNA sequencing instruments and reagents that produce raw sequenced data, our end-to-end, outsourced solution enables our customers to offload to us the complex processes of sample preparation, sequencing, computing and data storage and management. We believe our services will expand the

 

 

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potential addressable market by enabling a broad base of researchers who may lack sufficient capital and the specialized personnel necessary to build and operate a sequencing laboratory, or who have historically been constrained by the high total cost of sequencing, to conduct large-scale complete human genome studies.

Our end-to-end solution provides the following advantages to our customers:

 

  §  

High-Quality Data.    Our technology delivers what we believe is the industry’s highest quality complete human genome data.

 

  §  

Cost-Savings.    Our customers are not required to purchase expensive sequencing instruments and high-performance computing resources or hire the necessary specialized personnel to sequence and analyze large sets of complete human genome data.

 

  §  

Speed at Scale.    Our customers can complete their large-scale projects more quickly by using our services than by using commercially available sequencing instruments.

 

  §  

Ease of Use.    Our customers can avoid the difficulty and time-consuming process of purchasing and operating their own sequencing instruments and can outsource the entire process to us, from sample preparation to delivery of research-ready data.

 

  §  

Operational Flexibility.    By outsourcing their large-scale complete human genome sequencing projects to us, our customers can free up the capacity of in-house instruments to run smaller or more targeted sequencing projects and applications.

 

  §  

Technological Flexibility.    As DNA sequencing technology improves, our customers avoid the risk of their expensive instruments becoming technologically obsolete.

 

  §  

Enables Customers to Focus on Discovery.     Outsourcing offloads the operational burdens of managing large-scale genome sequencing projects and enables our customers to focus their resources on research, which can reduce the time to discovery.

We have more than 30 past and current customers, which include some of the leading global academic and government research centers and biopharmaceutical companies. In May 2010, we received an order from SAIC-Frederick, Inc., a prime contractor for the National Cancer Institute’s research and development facility in Frederick, Maryland, to sequence 50 tumor-normal pairs, or 100 complete human genomes, over a six-month period. This contract contains an option for SAIC-Frederick to engage us to sequence 564 additional cancer cases, or 1,128 complete human genomes, over an additional 18-month period. In addition, we sequenced complete genomes that enabled ISB to pinpoint the causal gene, and subsequently confirm that gene’s role, in Miller Syndrome. This work has led to a follow-on project with the ISB to sequence an additional 122 genomes. We also worked with Genentech, Inc. (a member of the Roche Group) on a non-small cell lung cancer study that was the first complete human genome sequence of a primary non-small cell lung tumor and matched normal tissue. The data we delivered allowed Genentech to measure the rate of smoking-induced mutations accumulated over time.

Applications for Our Sequencing Service

Potential applications for our complete human genome sequencing service include:

 

  §  

Cancer Research.    We believe understanding genetic mutations in cancer patients will guide development of new cancer therapeutics and diagnostics and ultimately enable doctors to select the best course of therapy based on the specific mutations found in a tumor.

 

  §  

Mendelian Disease Research.    By sequencing the complete genomes of families affected with Mendelian diseases, which likely have a significant genetic component, we believe the genetic causes of these diseases can be discovered, which could lead to the development of novel diagnostics and therapeutics.

 

 

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  §  

Rare Variant Disease Research.    Large-scale genomic studies of central nervous system disorders, cardiac disease and certain metabolic disorders may help to identify disrupted pathways and lead to the development of novel diagnostics and therapeutics.

 

  §  

Clinical Trial Optimization.    We believe that selecting or stratifying patients on the basis of their genetic profiles could enable the preferential admission of high responders into clinical trials, lowering costs and resulting in faster clinical trials and drug commercialization.

In addition to these research studies, we expect future clinical applications to include:

 

  §  

Companion Diagnostics.    We believe that therapeutics that are not first-line treatments for the general population may be elevated to first-line treatments or used in combination therapies for subsets of the population that share a common genetic profile. Complete human genome studies may unlock new market opportunities for these therapies or combination therapies.

 

  §  

Cancer Pathology.    We believe that analyzing complex cancer genomes that involve large and unpredictable structural changes will be most reliably and economically implemented using complete human genome sequencing.

 

  §  

Universal Diagnostics.    As medical records technology and public health policy advance, we believe that large numbers of people will have their complete human genomes sequenced and stored in their electronic medical records for use by their physicians in managing their health care decisions.

Competitive Strengths

We believe that our competitive strengths are as follows:

 

  §  

Proprietary Human Genome Sequencing Technology.    Our proprietary sequencing technology achieves accuracy levels of 99.999% at a total cost that is significantly less than the total cost of purchasing and operating commercially available DNA sequencing instruments.

 

  §  

Fully Integrated Advanced Informatics and Data Management Software.    Our solution enables our customers to manage and gain useful information from the massive data sets generated in complete human genome sequencing.

 

  §  

Highly Scalable and Capital-Efficient Business Model.    Consolidating volume across our entire customer base enables us to sequence large numbers of genomes while avoiding the cost and complexity of employing a large field installation and support organization. By implementing a high degree of automation, we have reduced the possibility of human errors that could adversely affect quality and increase costs.

 

  §  

Unique Insight Into Customer Needs.    We interact directly with our customers on their discovery projects, which enables us to develop and enhance our analysis software to meet our customers’ specific needs while expanding our understanding of variation in the human genome.

 

  §  

Fast and Efficient Deployment of Operational and Technological Enhancements.    Because our sequencing operations and data center are centralized, we can rapidly upgrade our technology and deliver the benefits to our customers. In addition, our access to genomic data allows our software engineers to continually refine and improve our software with each genome we sequence.

 

  §  

Expanded Market Opportunity.    We believe our outsourced model will expand the potential addressable market by providing academic and biopharmaceutical researchers who lack sufficient budgets or the specialized personnel necessary to build and operate a sequencing laboratory with access to high-quality, low-cost complete human genome data.

 

 

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Our Strategy

We intend to become the leading complete human genome sequencing and analysis company and the preferred platform for human genome discovery by:

 

  §  

continuing to deliver the highest quality genomic data and analysis at a low total cost;

 

  §  

maintaining and strengthening our technological leadership position;

 

  §  

capitalizing on our scalable model;

 

  §  

establishing ourselves as the leader in outsourced complete human genome sequencing;

 

  §  

expanding globally to increase capacity and reach new markets; and

 

  §  

expanding applications for the use of our technology.

Risks Associated with our Business

Our business is subject to numerous risks, as discussed more fully in the section entitled “Risk Factors” immediately following this prospectus summary. These risks include the following, among others:

 

  §  

We are an early, commercial-stage company and have a limited operating history.

 

  §  

We have a history of losses, and we may not achieve or sustain profitability in the future, on a quarterly or annual basis.

 

  §  

We may need substantial additional capital in the future in order to maintain and expand our business.

 

  §  

Our only source of revenue is our human genome sequencing service, which is a new business model in an emerging industry, and failure to achieve market acceptance will harm our business.

 

  §  

Our success depends on the growth of markets for analysis of genetic variation and biological function, and the shift of these markets to complete human genome sequencing.

 

  §  

We face significant competition from large, well-capitalized companies. The emergence of new competitive genome sequencing technologies may also harm our business.

 

  §  

We must significantly expand our capacity in order to meet projected demand.

 

  §  

If our Mountain View genome sequencing facility becomes inoperable, we will be unable to perform our genome sequencing services, and our business will be harmed.

 

  §  

If third parties assert that we have infringed their patents or other proprietary rights or challenge the validity of our patents or other proprietary rights, we may become involved in costly and time-consuming disputes and litigation that could affect our ability to sell our services.

Corporate Information

We were incorporated in the state of Delaware on June 14, 2005. The address of our principal executive offices is 2071 Stierlin Court, Mountain View, California 94043, and our telephone number is (650) 943-2800. Our website address is www.completegenomics.com. We do not incorporate the information on, or that can be accessed through, our website into this prospectus, and you should not consider it part of this prospectus.

 

 

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The Offering

 

Common stock offered by Complete Genomics

             shares (or              shares if the underwriters exercise their over-allotment option in full).

 

Common stock to be outstanding after this offering

             shares (or              shares if the underwriters exercise their over-allotment option in full).

 

Proposed NASDAQ Global Market symbol

“GNOM”

 

Use of proceeds

We currently intend to use the net proceeds of this offering to finance the further development and commercialization of our technology and for sales and marketing activities, capital expenditures to expand our facilities and operations and working capital and other general corporate purposes, including the costs associated with being a public company. Please see “Use of Proceeds.”

 

Risk factors

See “Risk Factors” starting on page 12 of this prospectus for a discussion of factors you should carefully consider before deciding to invest in our common stock.

The number of shares of common stock to be outstanding after this offering is based on              shares outstanding as of July 15, 2010 and excludes:

 

  §  

2,248,953 shares of common stock issuable upon exercise of options outstanding as of July 15, 2010 with a weighted-average exercise price of $1.50 per share;

 

  §  

1,217,868 shares of common stock reserved for future issuance under our 2006 Equity Incentive Plan as of July 15, 2010, which will become available for issuance under our 2010 Equity Incentive Award Plan after completion of this offering;

 

  §  

             shares of common stock that will be reserved for future issuance under our 2010 Equity Incentive Award Plan, as well as any automatic increases in the number of shares of our common stock reserved for future issuance under this benefit plan, which will become effective immediately prior to the consummation of this offering;

 

  §  

             shares of common stock subject to warrants outstanding as of July 15, 2010 that will not expire upon completion of this offering, with a weighted-average exercise price of $             per share; and

 

  §  

up to              shares of common stock issuable upon conversion of the $22,121,452 aggregate principal amount of convertible notes that we issued in April, May and June of 2010, if the holders of those notes elect to convert their notes in connection with this offering.

The number of shares of our common stock outstanding after this offering assumes:

 

  §  

the conversion of all 7,819,758 shares of our convertible preferred stock outstanding on July 15, 2010 into an aggregate of 10,533,490 shares of our common stock, which will be effective immediately prior to the consummation of this offering;

 

  §  

the exercise, on a net issuance basis, of warrants outstanding as of July 15, 2010, which will expire upon completion of this offering if unexercised, to purchase shares of our common stock, resulting in the issuance of              shares of common stock, assuming an initial public offering price of $             per share (the midpoint of the price range set forth on the cover page of this prospectus); and

 

 

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  §  

the exercise, on a net issuance basis, of warrants outstanding as of July 15, 2010, which will expire upon completion of this offering if unexercised, to purchase shares of our convertible preferred stock, and the conversion of those shares of preferred stock immediately prior to the consummation of this offering, resulting in the issuance of              shares of common stock, assuming an initial public offering price of $             per share (the midpoint of the price range set forth on the cover page of this prospectus).

Except as otherwise indicated, all information in this prospectus reflects or assumes no exercise of the underwriters’ over-allotment option.

We refer to our Series A, Series B, Series C and Series D preferred stock collectively as “convertible preferred stock” for financial reporting purposes and in the financial tables included in this prospectus, as more fully explained in Note 6 to our financial statements. In other parts of this prospectus, we refer to our Series A, Series B, Series C and Series D preferred stock collectively as “preferred stock.”

 

 

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Summary Financial Data

The following tables set forth a summary of our historical financial data as of, and for the periods ended on, the dates indicated. You should read these tables together with our financial statements and the related notes, “Selected Financial Data” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this prospectus. The statement of operations data for the years ended December 31, 2007, 2008 and 2009 are derived from our audited financial statements included elsewhere in this prospectus. The statement of operations data for the three months ended March 31, 2009 and 2010 and for the cumulative period from June 14, 2005 (date of inception) to March 31, 2010, and the balance sheet data as of March 31, 2010 are derived from our unaudited financial statements included elsewhere in this prospectus. The unaudited financial statements have been prepared on a basis consistent with our audited financial statements and include, in the opinion of management, all adjustments, consisting only of normal recurring adjustments, necessary for the fair presentation of the financial information in those statements. Our historical results are not necessarily indicative of the results to be expected in any future period, and the results for the three months ended March 31, 2010 are not necessarily indicative of the results to be expected for the year ending December 31, 2010.

The unaudited pro forma and pro forma as adjusted financial data is presented for informational purposes only and does not purport to represent what our results of operations or financial position actually would have been had the transactions reflected occurred on the dates indicated or to project our financial condition as of any future date or results of operations for any future period.

 

    Years ended December 31,     Three months ended
March 31,
    Cumulative
period from
June 14, 2005
(date of
inception) to
March 31,

2010
 
     2007     2008     2009     2009     2010    
    (in thousands, except share and per share amounts)  

Statement of Operations Data:

           

Revenue

  $      $      $ 623      $      $ 336      $ 959   

Operating expenses:

           

Start-up production costs(1)

                  5,033        326        4,077        9,110   

Research and development(1)

    10,305        23,633        22,424        6,746        6,169        66,263   

General and administrative(1)

    1,896        3,179        4,953        1,298        3,099        14,078   

Sales and marketing(1)

           1,045        1,798        427        1,226        4,069   
                                               

Total operating expenses(1)

    12,201        27,857        34,208        8,797        14,571        93,520   
                                               

Loss from operations

    (12,201     (27,857     (33,585     (8,797     (14,235     (92,561

Interest expense

    (215     (974     (3,465     (679     (311     (4,976

Interest and other income (expense), net

    163        437        1,101        (22     210        2,040   
                                               

Net loss

  $ (12,253   $ (28,394   $ (35,949   $ (9,498   $ (14,336   $ (95,497
                                               

Net loss per share, basic and diluted

  $ (211.00   $ (369.36   $ (386.56   $ (105.92   $ (51.15  
                                         

Weighted-average shares of common stock outstanding used in computing net loss per share, basic and diluted

    58,072        76,873        92,998        89,673        280,283     
                                         

Pro forma net loss per share of common stock, basic and diluted (unaudited)(2)

      $ (6.59     $ (1.45  
                       

Net loss used in computing pro forma net loss per share of common stock, basic and diluted (unaudited)(2)

      $ (37,037     $ (14,545  
                       

Weighted-average shares of common stock outstanding used in computing the pro forma net loss per share of common stock, basic and diluted (unaudited)(2)

        5,619,600          10,062,693     
                       

(footnotes on following page)

 

 

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(1) Includes stock-based compensation expense as follows:

 

     Years ended December 31,    Three months ended
March 31,
   Cumulative
period from
June 14, 2005

(date of
inception) to
March 31,

2010
        2007        2008        2009      2009    2010   
     (in thousands)

Start-up production costs

   $    $    $ 81    $ 4    $ 61    $ 142

Research and development

     78      246      992      116      250      1,576

General and administrative

     22      90      262      39      200      576

Sales and marketing

               75      14      29      104
                                         

Total stock-based compensation expense

   $ 100    $ 336    $ 1,410    $ 173    $ 540    $ 2,398
                                         

 

(2) Net loss used in computing pro forma basic and diluted net loss per share of common stock, and the number of weighted-average common shares used in computing pro forma basic and diluted net loss per share of common stock, in the table above assume the conversion of all of our outstanding convertible preferred stock into common stock immediately prior to the consummation of this offering. See Note 2 to our financial statements for an explanation of the method used to compute pro forma basic and diluted net loss per share of common stock and the number of shares used in computing those per share amounts.

The table below presents our balance sheet data as of March 31, 2010:

 

  §  

on an actual basis;

 

  §  

on a pro forma basis to give effect to our issuance and sale, during April, May and June 2010, of an aggregate of $22,121,452 in principal amount of convertible notes, and warrants to purchase an aggregate of              shares of our common stock at an exercise price of $1.50 per share; and

 

  §  

on a pro forma as adjusted basis to give further effect to:

 

  §  

the sale of              shares of common stock in this offering at an assumed initial public offering price of $              per share (the midpoint of the price range set forth on the cover page of this prospectus), after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us;

 

  §  

the conversion of all 7,819,758 shares of our convertible preferred stock outstanding on March 31, 2010 into an aggregate of 10,533,490 shares of our common stock, which will be effective immediately prior to the consummation of this offering;

 

  §  

the conversion of all of our warrants for convertible preferred stock into warrants for common stock immediately prior to the consummation of this offering, and the related reclassification of convertible preferred stock warrant liability to additional paid-in capital;

 

  §  

the exercise, on a net issuance basis, of warrants outstanding as of March 31, 2010, which will expire upon completion of this offering if unexercised, to purchase shares of our common stock, resulting in the issuance of              shares of common stock, assuming an initial public offering price of $              per share (the midpoint of the price range set forth on the cover page of this prospectus); and

 

  §  

the exercise, on a net issuance basis, of warrants outstanding as of March 31, 2010, which will expire upon completion of this offering if unexercised, to purchase shares of our convertible preferred stock, and the conversion of those shares of preferred stock immediately prior to the consummation of this offering, resulting in the issuance of              shares of common stock, assuming an initial public offering price of $              per share (the midpoint of the price range set forth on the cover page of this prospectus).

 

 

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     March 31, 2010
      Actual     Pro forma     Pro forma
as  adjusted(1)
     (in thousands)

Balance Sheet Data:

      

Cash and cash equivalents(2)

   $ 2,371      $ 24,492     

Working capital (deficit)(2)

     (10,620     11,501     

Total assets(2)

     30,818        52,939     

Current and long-term notes payable(2)

     6,928        23,676     

Convertible preferred stock warrant liability

     1,344        1,344     

Convertible preferred stock

     95,893        95,893     

Total stockholders’ equity (deficit)

     (89,638     (84,264  

 

(1) A $1.00 increase (decrease) in the assumed initial public offering price of $              per share (the midpoint of the price range set forth on the cover page of this prospectus) would increase (decrease) each of pro forma as adjusted cash and cash equivalents, working capital, total assets and stockholders’ equity (deficit) by approximately $              million, assuming that the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same. We may also increase or decrease the number of shares we are offering. An increase (decrease) of 1,000,000 in the number of shares we are offering would increase (decrease) each of pro forma as adjusted cash and cash equivalents, working capital, total assets and stockholders’ equity (deficit) by approximately $              million, assuming the initial public offering price per share, as set forth on the cover page of this prospectus, remains the same. An increase of 1,000,000 in the number of shares we are offering, together with a $             1.00 increase in the assumed initial public offering price per share, would increase each of pro forma as adjusted cash and cash equivalents, working capital, total assets and stockholders’ equity (deficit) by approximately $ million. A decrease of 1,000,000 in the number of shares we are offering, together with a $1.00 decrease in the assumed initial public offering price per share, would decrease each of pro forma as adjusted cash and cash equivalents, working capital, total assets and stockholders’ equity (deficit) by approximately $              million. The pro forma as adjusted information is illustrative only, and we will adjust this information based on the actual initial public offering price and other terms of this offering determined at pricing.
(2) The outstanding principal of, and interest on, the $22,121,452 aggregate principal amount of convertible notes we issued and sold during April, May and June 2010 will become due upon the closing of this offering, subject to the right of the holders of these notes to elect instead to convert their notes into shares of our preferred stock. However, if we issue and sell a new series of preferred stock before the closing of this offering, resulting in aggregate gross cash proceeds of at least $17.0 million, then these convertible notes will instead convert into shares of that series of preferred stock, which will convert into shares of our common stock immediately prior to the consummation of this offering.

 

 

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Risk Factors

Investing in our common stock involves a high degree of risk. You should carefully consider the following risk factors, as well as the other information in this prospectus, before deciding whether to invest in shares of our common stock. The occurrence of any of the events described below could harm our business, financial condition, results of operations and growth prospects. In such an event, the trading price of our common stock may decline and you may lose all or part of your investment.

Risks Related to Our Limited Operating History, Financial Condition and Capital Requirements

We are an early, commercial-stage company and have a limited operating history, which may make it difficult to evaluate our current business and predict our future performance.

We are an early, commercial-stage company and have a limited operating history. We were incorporated in Delaware in June 2005 and began operations in March 2006. From March 2006 until mid-2009, our operations focused on research and developing our DNA sequencing technology platform. In December 2009, we recognized our first revenue from the sale of our genome sequencing services. Our limited operating history, particularly in light of our novel, service-based business model in the rapidly evolving genome sequencing industry, may make it difficult to evaluate our current business and predict our future performance. Our lack of a long operating history, and especially our very short history as a revenue-generating company, make any assessment of our profitability or prediction about our future success or viability subject to significant uncertainty. We have encountered and will continue to encounter risks and difficulties frequently experienced by early, commercial-stage companies in rapidly evolving industries. If we do not address these risks successfully, our business will suffer.

Our quarterly operating results may fluctuate in the future. As a result, we may fail to meet or exceed the expectations of research analysts or investors, which could cause our stock price to decline.

Our financial condition and operating results may fluctuate from quarter to quarter and year to year in the future due to a variety of factors, many of which are beyond our control. Factors relating to our business that may contribute to these fluctuations include the following, as well as other factors described elsewhere in this prospectus:

 

  §  

our ability to achieve profitability;

 

  §  

the size and frequency of customer orders;

 

  §  

our ability to expand our sequencing operations;

 

  §  

our need for and ability to obtain capital necessary to operate and expand our business;

 

  §  

the cost of our sequencing services;

 

  §  

the demand for the sequencing of complete human genomes;

 

  §  

the existence and extent of government funding for research and development relating to genome sequencing;

 

  §  

the emergence of alternative genome sequencing technologies;

 

  §  

risks associated with expanding our business into international markets;

 

  §  

our ability to lower the average cost per genome that we sequence;

 

  §  

our dependence on single-source suppliers;

 

  §  

our ability to manage our growth;

 

  §  

our ability to successfully partner with other businesses in joint ventures or collaborations, or integrate any businesses we may acquire with our business;

 

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  §  

our dependence on, and the need to attract and retain, key management and qualified sales personnel;

 

  §  

our ability to obtain, protect and enforce our intellectual property rights and avoid infringing the intellectual property rights of others;

 

  §  

our ability to prevent the theft or misappropriation of our know-how or technologies;

 

  §  

lawsuits brought against us by third parties;

 

  §  

business interruptions, such as earthquakes and other natural disasters;

 

  §  

public concerns about the ethical, legal and social concerns related to the use of genetic information;

 

  §  

our ability to comply with current laws and regulations and new or expanded regulatory schemes;

 

  §  

our ability to properly handle and dispose of hazardous materials used in our business and biological waste; and

 

  §  

our ability to use our net operating loss carryforwards to offset future taxable income.

Due to the various factors mentioned above, and others, the results of any prior quarterly or annual periods are not necessarily indicative of our future operating performance.

We have a history of losses, and we may not achieve or sustain profitability in the future, on a quarterly or annual basis.

We have not been profitable in any quarterly period since we were formed. We incurred net losses of $12.3 million, $28.4 million and $35.9 million for the years ended December 31, 2007, 2008 and 2009, respectively, and $14.3 million for the three months ended March 31, 2010. As of March 31, 2010, our deficit accumulated during the development stage was $95.5 million. As a result of our historical losses from operations since inception and negative cash flow from operations, our independent registered public accounting firm’s report on our financial statements as of and for the year ended December 31, 2009 includes an explanatory paragraph expressing substantial doubt about our ability to continue as a going concern. Based on our current operating plans and assumptions, we do not expect to achieve profitability on an annual basis in the near future. In addition, we expect our cash expenditures to increase significantly in the near term, including significant expenditures for the expansion of our Mountain View, California sequencing facility and the development of additional sequencing centers, research and development, sales and marketing and general and administrative expenses. In order to continue operations, we must obtain additional debt or equity financing. As a public company, we will also incur significant legal, accounting and other expenses that we did not incur as a private company. In addition, we may encounter unforeseen difficulties, complications and delays in expanding our Mountain View sequencing facility or in establishing additional genome sequencing centers and other unforeseen factors that require additional expenditures. These costs, among other factors, have had and will continue to have an adverse effect on our working capital and stockholders’ equity. We will have to generate and sustain substantially increased revenue to achieve and maintain profitability, which we may never do. If we are unable to achieve and then maintain profitability, the market value of our common stock will decline.

We may need substantial additional capital in the future in order to maintain and expand our business.

Our future capital requirements may be substantial, particularly as we further develop our business, expand the sequencing capacity in our Mountain View, California facility and establish additional genome sequencing centers. Historically, we have financed our operations through private placements of preferred stock and convertible debt and borrowings under our credit facility.

We believe that, based on our current level of operations and anticipated growth, the net proceeds from this offering, together with our cash and cash equivalent balances and interest income we earn on these balances, will be sufficient to meet our anticipated cash requirements through at least the next 12 months. However, we may

 

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need additional capital if our current plans and assumptions change. Our need for additional capital will depend on many factors, including:

 

  §  

the financial success of our genome sequencing business;

 

  §  

our ability to increase the genome sequencing capacity in our Mountain View facility;

 

  §  

the rate at which we establish additional genome sequencing centers and whether we can find suitable partners to establish such centers;

 

  §  

whether we are successful in obtaining payments from customers;

 

  §  

whether we can enter into collaborations or establish a recurring customer base;

 

  §  

the progress and scope of our research and development projects;

 

  §  

the effect of any joint ventures or acquisitions of other businesses or technologies that we may enter into or make in the future;

 

  §  

the filing, prosecution and enforcement of patent claims; and

 

  §  

lawsuits brought against us by third parties.

If our capital resources are insufficient to meet our capital requirements, and we are unable to enter into joint ventures or collaborations with partners able or willing to fund our development efforts or purchase our genome sequencing services, we will have to raise additional funds. If future financings involve the issuance of equity securities, our existing stockholders would suffer dilution. If we raise additional debt financing, we may be subject to restrictive covenants that limit our ability to conduct our business. We may not be able to raise sufficient additional funds on terms that are favorable to us, if at all. If we fail to raise sufficient funds and continue to incur losses, our ability to fund our operations, take advantage of strategic opportunities, further develop and enhance our technology or otherwise respond to competitive pressures could significantly suffer. If this happens, we may be forced to:

 

  §  

slow or halt the expansion of our Mountain View facility and the establishment of additional genome sequencing centers;

 

  §  

slow the commercialization of our services;

 

  §  

delay or terminate research or development programs;

 

  §  

curtail or cease operations; or

 

  §  

seek to obtain funds through collaborative and licensing arrangements, which may require us to relinquish commercial rights or grant licenses on terms that are not favorable to us.

Risks Related to Our Business

Our only source of revenue is our human genome sequencing service, which is a new business model in an emerging industry, and failure to achieve market acceptance will harm our business.

Since our inception, all of our efforts have been focused on the creation of a technology platform for our human genome sequencing service, which we have only just recently commercialized. We expect to generate all of our revenue from our human genome sequencing service for the foreseeable future. As a result, market acceptance of our human genome sequencing service is critical to our future success.

Providing genome sequencing as a service is a new and unproven business model in a relatively new and rapidly evolving industry. We are using proprietary technology, involving multiple scientific and engineering disciplines, and a novel service model to bring complete human genome sequencing to an unproven market. Historically, companies in this industry have sold sequencing instruments directly to customers, and the customer performs the sequencing itself. We do not know if the purchasers and users of sequencing instruments will adopt our

 

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service model. For example, many potential customers want to sequence human genomes for proprietary studies that may lead to discoveries which they would seek to exploit, either commercially or through the publication of scientific literature. Accordingly, these potential customers may have significant reservations about allowing a third party to control the sequencing processes for their proprietary studies. Alternatively, other potential customers may want to sequence only portions of human genomes, rather than complete human genomes. There are many reasons why our services might not become widely adopted, ranging from logistical or quality problems to a failure by our sales force to engage potential customers, and including the other reasons stated in this “Risk Factors” section. As a result, our genome sequencing service may not achieve sufficient market acceptance to allow us to become profitable.

Our success depends on the growth of markets for analysis of genetic variation and biological function, and the shift of these markets to complete human genome sequencing.

We are currently targeting customers for our genome sequencing service in academic and government research institutions and in the pharmaceutical and other life science industries. Our customers are using our service for large-scale human genome studies for a wide variety of diagnostic and discovery applications. These markets are new and emerging, and they may not develop as quickly as we anticipate, or reach their full potential. The development of the market for complete human genome sequencing and the success of our service depend in part on the following factors:

 

  §  

demand by researchers for complete human genome sequencing;

 

  §  

the usefulness of genomic data in identifying or treating disease;

 

  §  

the ability of our customers to successfully analyze the genomic data we provide;

 

  §  

the ability of researchers to convert genomic data into medically valuable information;

 

  §  

the capacity and scalability of the hardware storage components necessary to store, manage, backup, retain and safeguard genomic data; and

 

  §  

the development of software tools to efficiently search, correlate and manage genomic data.

For instance, demand for our genome sequencing service may decrease if researchers fail to find meaningful correlations between genetic variation and disease susceptibility through genome-wide association studies. In addition, factors affecting research and development spending generally, such as changes in the regulatory environment affecting pharmaceutical and other life science companies and changes in government programs that provide funding to companies and research institutions, could harm our business. If our target markets do not develop in a timely manner, demand for our service may grow at a slower rate than we expect, or may fall, and we may not achieve profitability.

To date, relatively few complete human genomes have been sequenced, in large part due to the high cost of large-scale sequencing. Our business plan assumes that the demand for sequencing complete human genomes will increase significantly as the cost of complete human genome sequencing decreases. This assumption may prove to be incorrect, or the increase in demand may take significantly more time than we anticipate. For example, potential customers may not think our cost reductions are sufficient to permit or justify large-scale sequencing. Moreover, some companies and institutions have focused on sequencing targeted areas of the genome that are believed to be primarily associated with disorders and diseases, as opposed to the entire genome. Demand for sequencing complete human genomes may not increase if these targeted sequencing strategies, such as exome sequencing, where selected regions containing key portions of genes are sequenced, prove to be more cost effective or are viewed as a more efficient method of genetic analysis than complete human genome sequencing.

We face significant competition. Our failure to compete effectively could adversely affect our sales and results of operations.

We currently compete with companies that develop, manufacture and market genome sequencing instruments or provide genome sequencing services. We expect competition to increase as our competitors develop new,

 

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improved or cheaper instruments or expand their businesses to include sequencing services, and as new companies enter the market with innovative technologies.

The market for genome sequencing technology is highly competitive and is served by several large companies with significant market shares. For example, established companies such as Illumina, Inc., Life Technologies Corporation and Roche Diagnostics Corporation are marketing instruments for genetic sequencing that are directly competitive with our services, and these companies have significantly greater financial, technical, marketing and other resources than we do to invest in new technologies and have substantial intellectual property portfolios and substantial experience in product development and regulatory expertise. Also, there are many smaller companies, such as Ion Torrent Systems, Inc., NABsys, Inc., Oxford Nanopore Technologies, Ltd., Pacific Biosciences, Inc. and Helicos Biosciences Corporation, that are developing sequencing technology that would compete with ours. Moreover, large established companies may acquire smaller companies, such as these, with emerging technologies and use their extensive resources to develop and commercialize such technologies or incorporate such technologies into their instruments and services.

In addition, there are many research, academic and other non-profit institutions that are pursuing new sequencing technologies. These institutions often have access to significant government and other funding. For example, BGI (formerly known as Beijing Genomics Institute) in the People’s Republic of China offers a service that is similar to ours and is funded by the government of China. In the United States, agencies such as the National Human Genome Research Institute provide funding to institutions to discover new sequencing technology. We may compete directly with these institutions, or these institutions may license their technologies to third parties with whom we would compete.

While many of our existing competitors primarily sell sequencing instruments, they may also begin to provide sequencing services like us. Since these competitors have already developed their own sequencing technology, they will not experience significant technological barriers to entry and can likely enter the sequencing services market fairly quickly and with little additional cost. For example, Illumina has recently announced that it will be providing individual genome sequencing services for as low as $9,500 per genome, and Life Technologies has recently announced a collaboration to build a genome sequencing facility. Illumina also announced that it is pursuing a global program designed to provide researchers with access to academic and commercial institutions that can perform large-scale whole human genome sequencing projects using Illumina’s technology. Furthermore, many of these instrumentation companies have already established a significant market presence and are trusted by customers in the industry. As established instrumentation companies enter the sequencing services market, many potential customers may purchase sequencing services from these companies instead of us, even if we offer superior technology and services.

For more information regarding our existing and potential competitors, please see “Business—Competition.”

The emergence of competitive genome sequencing technologies may harm our business.

The success of our genome sequencing services will depend, in part, on our ability to continue to enhance the performance and decrease the cost of our genome sequencing technology. A number of genome sequencing technologies exist, and new methods and improvement to existing methods are currently being developed, including technology platforms developed by companies that we expect will directly compete with us as providers of sequencing services or instruments. These new technologies may result in faster, more cost-effective and more accurate sequencing methods than ours. For example, our sequencing technology does not currently cover all of the nucleotides in the genome. If competitive technologies emerge that sequence portions of the genome that our technology does not, our business could suffer if those portions contain important genomic information. We expect to face competition from emerging companies, including Ion Torrent Systems, NABsys, Oxford Nanopore Technologies and Pacific Biosciences. As a result of the emergence of these competitive sequencing technologies, demand for our service may decline or never develop sufficiently to sustain our operations.

Our industry is rapidly changing, with emerging and continually evolving technologies that increase the efficiency and reduce the cost of sequencing genomes. As new technologies emerge, we believe that the cost

 

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and error rates of, and the time required to, sequence human genomes will eventually decrease to a level where competition in the industry will shift to other factors, such as providing related services and analytical technologies. We may not be able to maintain any technological advantage over these new sequencing technologies, and if we fail to compete effectively on other factors relevant to our customers, our business will suffer.

Our order backlog may never be completed, and we may never earn revenue on backlogged contracts to sequence genomes.

In various sections of this prospectus, we have disclosed that, as of July 20, 2010, we have an order backlog for the sequencing of over 500 genomes. This figure represents the number of genomes for which we have executed purchase orders from our customers that we believe are firm and for which we have not yet recognized revenue. We have also disclosed that, as of March 31, 2010, our order backlog for which we believe we will sequence, bill and gain customer acceptance within twelve months was $7.0 million. We may never sequence these genomes or receive revenue from these backlogged orders, and the order backlog we report may not be indicative of our future revenue.

Many events can cause a backlogged order not to be completed. Currently, many orders are considered backlog because we do not presently have sufficient capacity to immediately sequence all the genomes which we have agreed to sequence. If we delay fulfilling customer orders, those customers may seek to cancel their contracts with us or may turn to one of our competitors. For example, we have in the past had a customer cancel a contract with us due, in part, to a delay in sequencing their samples. If our backlogged orders do not result in sales, our operating results will suffer.

We must significantly increase our production capabilities in order to meet expected demand.

We have only just recently commercialized our complete human genome sequencing service, and we have very limited experience in running a commercial-scale production facility. We have only one sequencing facility, and we project that facility to have the capacity to sequence over 400 complete human genomes per month by the end of 2010. This capacity is significantly less than what would be required to achieve profitability, if demand for our sequencing services grows as anticipated. Our business plan assumes that we will be able to increase our capacity multiple fold.

We plan to increase the capacity of our sequencing facility by installing additional sequencing machines, improving our software and purchasing higher resolution cameras to image the DNA arrays. We also plan to construct additional genome sequencing centers in the United States and elsewhere. We may encounter difficulties in expanding our sequencing infrastructure, and we may not build and improve this infrastructure in time to meet the volume, quality or timing requirements necessary to be successful. Manufacturing and supply quality issues may arise, including due to third parties who provide the components of our technology platform. Implementing improvements to our sequencing technology may involve significant changes, which may result in delays, or may not achieve expected results. For example, we are experimenting with increasing the density of the silicon wafers that we use for our DNA arrays by reducing the grid size of those wafers and correspondingly reducing the diameter of our DNA nanoballs, or DNBs, and the sticky spots on those wafers. These experiments may be unsuccessful and may not lead to feasible technological improvements that increase the capacity or reduce the costs of our sequencing services. If capacity or cost limitations prevent us from meeting our customers’ expectations, we will lose revenue and our potential customers may take their business to our competitors.

Our genome sequencing technology platform was developed for human DNA and is not currently optimized to sequence non-human DNA.

Our technology platform was developed and has been optimized for sequencing human DNA, and we do not intend to sequence non-human DNA. We face significant competition from established companies who sell genome sequencing instruments that can sequence both human and non-human DNA. Many of the academic and research institutions that are our target customers conduct studies on both human and non-human DNA. Prospective customers may choose to purchase sequencing instruments from a competitor because of their broader sequencing application. Our competitors may also choose to provide sequencing services for non-human

 

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DNA. As a result, there may not be sufficient demand for our human genome sequencing service, which will harm our business.

We depend on a limited number of suppliers, including single-source suppliers, of various critical components for our sequencing process. The loss of these suppliers, or their failure to supply us with the necessary components on a timely basis, could cause delays in our sequencing center and adversely affect our business.

We depend on a limited number of suppliers, including some single-source suppliers, of various critical components for our sequencing process. We do not have long-term contracts with our suppliers or service providers. Because we do not have long-term contracts, our suppliers generally are not required to provide us with any guaranteed minimum production levels. As a result, we may not be able to obtain sufficient quantities of critical components in the future.

A delay or interruption by our suppliers may harm our business. For example, the wafers that comprise the base of our sample slide are fabricated by SVTC Technologies, L.L.C. We currently do not have an alternative source for the supply of these wafers, which are critical to our sequencing process, and the custom manner in which these wafers are made may make it difficult to locate other semiconductor suppliers to manufacture them for us. We recently experienced a significant delay in the delivery, from one of our suppliers, of certain components for our sequencing system, which delayed our planned expansion of our Mountain View sequencing facility. Similarly, an interruption of services by Amazon Web Services, on whom we rely to deliver finished genomic data to our customers, would result in our customers not receiving their data on time.

In addition, the lead time needed to establish a relationship with a new supplier can be lengthy, and we may experience delays in meeting demand in the event we must switch to a new supplier. The time and effort to qualify a new supplier could result in additional costs, diversion of resources or reduced manufacturing yields, any of which would negatively impact our operating results. Our dependence on single-source suppliers exposes us to numerous risks, including the following:

 

  §  

our suppliers may cease or reduce production or deliveries, raise prices or renegotiate terms;

 

  §  

delays by our suppliers could significantly limit our ability to sequence customer data;

 

  §  

we may be unable to locate a suitable replacement on acceptable terms or on a timely basis, if at all; and

 

  §  

delays caused by supply issues may harm our reputation, frustrate our customers and cause them to turn to our competitors for future projects.

If our Mountain View genome sequencing facility becomes inoperable, we will be unable to perform our genome sequencing services and our business will be harmed.

We currently do not have redundant sequencing facilities on a scale that could support our business. We perform all of our commercial genome sequencing in our facility located in Mountain View, California. Mountain View is situated on or near earthquake fault lines. Our facility, the equipment we use to perform our sequencing services and our other business process systems are costly to replace and could require substantial time to repair or replace. The facility may be harmed or rendered inoperable by natural or man-made disasters, including earthquakes, wildfires, floods, acts of terrorism or other criminal activities, infectious disease outbreaks and power outages, which may render it difficult or impossible for us to sequence genomes for some period of time. In addition, these events may temporarily interrupt our ability to receive samples from our customers or materials from our suppliers and our access to our various systems necessary to operate our business. The inability to perform our sequencing service would result in the loss of customers and harm our reputation. Our insurance covering damage to our property and the disruption of our business may not be sufficient to cover all of our potential losses and may not continue to be available to us on acceptable terms, or at all.

 

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Failure to achieve expected sequencing process yields, or variability in our sequencing process yields, could harm our operating results and damage our reputation.

Our sequencing process, like any other commercial-scale production process, is not flawless. For example, our DNBs may not adhere to all of the “sticky” spots on the surface of the silicon wafers we use to sequence DNA, or parts of the wafers may be unreadable. We refer to the efficiency of our sequencing process as its yield. The sequencing process yields we achieve depend on the design and operation of our sequencing process, which uses a number of complex and sophisticated biochemical, informatics, optical and mechanical processes. An operational or technology failure in one of these complex processes may result in sequencing processing yields that are lower than we anticipate or that vary between sequencing runs. In addition, we are regularly evaluating and refining our sequencing process. These refinements may initially result in unanticipated issues that further reduce our sequencing process yields or increase the variability of our sequencing yields. Low sequencing yields, or higher than anticipated variability, increases total sequencing costs and reduces the number of genomes we can sequence in a given time period, which can cause variability in our operating results and damage our reputation.

We may have to resequence genomes due to contamination of DNA samples in the sequencing process, and we may inadvertently mishandle our customers’ samples.

In the past, we have had to resequence various genome samples as a result of contamination occurring in the sample preparation and library construction process. The sequencing process is highly sensitive, and the presence of any foreign substances during the preparation of the slide samples can corrupt the results of the sequencing process. Resequencing requires additional expense, time and capacity and delays the recognition of revenue from the service. Samples may be contaminated in the future, which may damage our reputation and decrease the demand for our service.

In addition, we may unintentionally mishandle DNA samples. For example, if customer samples or sequencing results are switched, our customers would receive the wrong sequencing data, which could have significant consequences, particularly if that data is used to diagnose or treat disease. Mishandling customer samples or data would harm our reputation and could result in litigation against us.

If we are not successful in reducing the average cost of our sequencing service, demand for our services, and therefore our business, will suffer.

Our ability to expand our customer base depends highly on our ability to reduce the average cost of sequencing a human genome. For example, certain academic or government-sponsored research organizations may forgo or delay whole genome-wide studies based on the cost required to sequence complete human genomes, in favor of other less expensive studies. Additionally, certain of our target customers may decide it is more cost-effective to purchase sequencing instruments from a competitor than contract for our sequencing service. To compete effectively with competitors who sell and market sequencing instruments, our service must provide cost advantages, superior quality and time savings over the purchase of sequencing instruments. In addition, as new competitors enter the market or expand their business model to include sequencing services, we expect increased pricing pressure, which may force us to decrease the price of our genome sequencing service. Our gross profit and operating results will suffer if we are unable to offset any reductions in our prices by reducing our costs by developing new or enhanced technologies or methods, or increasing our sales volumes.

 

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Reduction or delay in research and development budgets and government funding may adversely impact our sales.

We expect that for the foreseeable future, our revenue will be derived primarily from selling our genome sequencing service to a relatively small number of academic, governmental and other research institutions, as well as pharmaceutical and other life science companies. Our revenue may decline substantially due to reductions and delays in research and development expenditures by these customers, which depend, in part, on their budgets and the availability of government funding. Factors that could affect the spending levels of our customers include:

 

  §  

weakness in the global economy and changing market conditions that affect our customers;

 

  §  

changes in the extent to which the pharmaceutical and life science industry may use genetic information and genetic testing as a methodology for drug discovery and development;

 

  §  

changes in government programs that provide funding to companies and research institutions;

 

  §  

changes in the regulatory environment affecting pharmaceutical and life science companies and research;

 

  §  

impact of consolidation within the pharmaceutical and life science industry; and

 

  §  

cost-reduction initiatives of customers.

Also, government funding of research and development is subject to the political process, which is inherently unpredictable. Any reduction in the funding of life science research and development or delay surrounding the approval of government budget proposals may cause our customers to delay or forgo purchases of our services. A reduction or delay in demand for our service will adversely affect our ability to achieve profitability.

The timing and extent of funding provided by the American Recovery and Reinvestment Act of 2009 could adversely affect our business, financial condition or results of operations.

In February 2009, the U.S. government enacted the American Recovery and Reinvestment Act of 2009, which we refer to as the Recovery Act, to provide stimulus to the U.S. economy in the wake of the economic downturn. As part of the Recovery Act, over $10 billion in research funding was provided to the National Institutes of Health, or NIH, through September 2010 to support the advancement of scientific research. A portion of the stimulus funding supported the analysis of genetic variation and biological function and may have a significant positive long-term impact on our business and the industry generally. In the short-term, however, potential customers may delay or forgo their purchases of our services as they wait to learn whether, and to what extent, they will receive stimulus funding. If potential customers are unable to obtain stimulus money, they may reduce their research and development budgets, resulting in a decrease in demand for our service. In addition, even if potential customers receive these stimulus funds, they may not purchase our services, and we may not benefit from the Recovery Act.

Ethical, legal and social concerns related to the use of genetic information could reduce demand for our genome sequencing services.

Our genome sequencing services are intended to facilitate large-scale human genome studies for a wide variety of diagnostic and discovery applications. However, genetic testing has raised ethical, legal and social issues regarding privacy and the appropriate uses of the resulting information. Governmental authorities could, for social or other purposes, limit or regulate the use of genetic testing or prohibit testing for genetic predisposition to certain conditions, particularly for those that have no known cure. Similarly, these concerns may lead individuals to refuse to use genetics tests even if permissible.

In addition, we do not control how our customers use the genomic data we provide. In most cases, we do not know the identity of the individuals whose DNA we sequence, the reason why their DNA is being sequenced or the intended use of the genomic data we provide. If our customers use our services or the resulting genomic data irresponsibly or in violation of legal restrictions, our reputation could be harmed and litigation may be brought against us.

 

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Ethical and social concerns may also influence U.S. and foreign patent offices and courts with regard to patent protection for technology relevant to our business. These and other ethical, legal and social concerns may limit market acceptance of our technology for certain applications or reduce the potential markets for our technology, either of which could have an adverse effect on our business, financial condition or results of operations.

We use biological and hazardous materials that require considerable expertise and expense for handling, storage and disposal and may result in claims against us.

We work with materials, including chemicals, biological agents and compounds and DNA samples, that could be hazardous to human health and safety or the environment. Our operations also produce hazardous and biological waste products. Federal, state and local laws and regulations govern the use, generation, manufacture, storage, handling and disposal of these materials and wastes. Compliance with applicable environmental laws and regulations is expensive, and current or future environmental laws and regulations may restrict our operations. If we do not comply with applicable regulations, we may be subject to fines and penalties.

In addition, we cannot eliminate the risk of accidental injury or contamination from these materials or wastes. Our general liability insurance and workers’ compensation insurance policies may not cover damages and fines arising from biological or hazardous waste exposure or contamination. Accordingly, in the event of contamination or injury, we could be liable for damages or penalized with fines in an amount exceeding our resources and our operations could be suspended or otherwise adversely affected.

We have limited selling and marketing resources and may be unable to successfully commercialize our human genome sequencing service.

We currently have a small sales and marketing team. To grow our business as planned, we must expand our sales, marketing and customer support capabilities. We may be unable to attract, retain and manage the specialized workforce necessary to gain market acceptance and successfully commercialize our services. In addition, developing these functions is time consuming and expensive.

The sale of genome sequencing services involves extensive knowledge about genomic research and sequencing technology, including the sequencing technology of our competitors. To be successful, our sales force and related personnel must be technically proficient in a variety of disciplines. For example, many of our existing salespersons have Ph.D. degrees in various scientific fields. There are relatively few people that have the necessary knowledge and qualifications to be successful salespersons or support personnel in our industry. We may not be able to recruit a sufficient number of these people, many of whom do not reside close to the locations of our existing and planned future sequencing centers.

In certain regions or markets, we may seek to partner with others to assist us with sales, marketing and customer support functions. However, we may be unable to find appropriate third parties with whom to enter into these arrangements. Furthermore, if we do enter into these arrangements, these third parties may not perform as expected.

Our software may incorrectly analyze the raw genomic data produced by our sequencing equipment.

Our sequencing instruments generate raw genomic data from various segments of the genome being sequenced. This data must be arranged into the correct order to reconstruct the original genomic structure of the sample. We have developed software algorithms that facilitate this reconstruction. However, these algorithms rely on statistical models that provide only relative assurance, and not absolute assurance, that the original genomic structure has been reconstructed.

In addition, the genomic data we provide our customers includes a comparison of the sequenced genome against a reference genome to help identify possible mutations or variations. This reference genome is designed to approximate a “standard” human genome. However, this approximation may not be accurate.

If the algorithms we use to reconstruct genomic data incorrectly reconstruct the sequenced genome, or if our reference genome is significantly flawed, the genomic data we deliver could be inaccurate and of little or no use to our customers.

 

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An inability to manage our planned growth or expansion of our operations could adversely affect our business, financial condition or results of operations.

Our business has grown rapidly, and we expect this growth to continue as we expand our sequencing capacity. For example, we had three employees at the end of 2005 and 159 employees as of June 30, 2010. The rapid expansion of our business and addition of new personnel may place a strain on our management and operational systems. To effectively manage our operations and growth, we must continue to expend funds to enhance our operational, financial and management controls, reporting systems and procedures and to attract and retain sufficient numbers of talented employees. If we are unable to expand our genome sequencing capacity and implement improvements to our control systems efficiently and quickly, or if we encounter deficiencies in existing systems and controls, then we will not be able to successfully expand the commercialization of our services. In addition to enhancing our sequencing capacity, our future operating results will depend on our management’s ability to:

 

  §  

implement and improve our sales, marketing and customer support programs and our research and development efforts;

 

  §  

enhance our operational and financial control systems;

 

  §  

expand, train and manage our employee base;

 

  §  

integrate acquired businesses, if applicable; and

 

  §  

effectively address new issues related to our growth as they arise.

We may not manage our expansion successfully, which could adversely affect our business, financial condition or results of operations.

If we expand our operations outside of the United States, we will face risks that may increase our operating costs.

We plan to expand our operations to include additional genome sequencing centers outside of the United States. Because the laws of certain countries currently prohibit the export of DNA, we will have to establish local facilities to access those markets and establish a presence in other markets. To date, we have not expanded our operations outside the United States. Operating in international markets requires significant resources and management attention and will subject us to regulatory, economic and political risks that are different from those in the United States. Because of our limited experience with international operations, our international expansion efforts may be unsuccessful. In addition, we will face risks in doing business internationally that could increase our operating costs, including the following:

 

  §  

economic conditions in various parts of the world;

 

  §  

unexpected and more restrictive laws and regulations, including those laws governing ownership of intellectual property, collection and use of personal information and other privacy considerations, hazardous materials and other activities important to our business;

 

  §  

new and different sources of competition;

 

  §  

multiple, conflicting and changing tax laws and regulations that may affect both our international and domestic tax liabilities and result in increased complexity and costs;

 

  §  

the difficulty of managing and staffing additional genome sequencing centers and the increased travel, infrastructure and legal compliance costs associated with multiple international locations;

 

  §  

difficulties in enforcing contracts and collecting accounts receivable, especially in developing countries;

 

  §  

fluctuations in exchange rates; and

 

  §  

tariffs and trade barriers, import/export controls and other regulatory or contractual limitations on our ability to sell or develop our services in certain foreign markets.

 

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The success of the expansion of our business internationally will depend, in part, on our ability to anticipate and effectively manage these and other risks associated with international operations. Our failure to manage any of these risks successfully could increase our operating costs.

Certain of our potential customers may require that we become certified under the Clinical Laboratory Improvement Amendments of 1988.

Although we are not currently subject to the Clinical Laboratory Improvement Amendment of 1988, or CLIA, we may in the future be required by certain customers to obtain a CLIA certification. CLIA, which extends federal oversight over clinical laboratories by requiring that they be certified by the federal government or by a federally approved accreditation agency, is designed to ensure the quality and reliability of clinical laboratories by mandating specific standards in the areas of personnel qualifications, administration and participation in proficiency testing, patient test management, quality control, quality assurance and inspections. If our customers require a CLIA certification, we will have to continually expend time, money and effort to ensure that we meet the applicable quality and safety requirements, which may divert the attention of management and disrupt our core business operations.

Because the market for genome sequencing is relatively new and rapidly evolving, we may become subject to additional future governmental regulation, which may place additional cost and time burdens on our operations.

We are subject, both directly and indirectly, to the adverse impact of existing and potential future government regulation of our operations and markets. The life sciences and pharmaceutical industries, which are significant target markets for our services, have historically been heavily regulated. There are comprehensive federal and state laws regarding matters such as the privacy of patient information and research in genetic engineering. For example, if we inadvertently disclose private patient information in the course of providing our sequencing services, we could be prosecuted for violations of federal law.

Legislative bodies or regulatory authorities may adopt additional regulation that adversely affects our market opportunities. They could also extend existing regulations to cover our services. For example, medical diagnostic products may, depending on their intended use, be regulated as medical devices by the Food and Drug Administration, or FDA, if they are:

 

  §  

used in the diagnosis of disease or other conditions;

 

  §  

used in the cure, mitigation, treatment or prevention of disease; or

 

  §  

intended to affect the structure or any function of the body.

Medical devices generally cannot be marketed without first receiving clearance or approval (depending on the regulatory pathway) from the FDA. We do not believe that our sequencing services are currently subject to the FDA’s medical device requirements because we do not intend our services to be used for the diagnosis of disease. However, we cannot control how the genomic information we provide will be used by our customers.

In addition, the FDA is focusing on our market, which has created uncertainty regarding the regulatory landscape. The FDA has recently taken actions suggesting that it interprets the applicable regulations expansively to cover certain genomic devices and services, particularly those sold directly to consumers. Since June 2010, the FDA has sent numerous letters to certain companies in this market, including 23andMe, Inc., deCODE Genetics, Knome, Inc., Navigenics, Inc. and Pathway Genomics. In these letters, the FDA noted that it considers genetic tests marketed by these companies to be subject to FDA regulation and, accordingly, unapproved medical devices. The FDA may extend this position to services such as ours. In addition, the FDA may implement new regulations that may be broad enough to cover our operations. Changes to the current regulatory framework, including the imposition of new regulations, could arise anytime, and we may be unable to obtain or maintain FDA or comparable regulatory approval or clearance for our services, if required. For example, the FDA may impose restrictions on the types of customers to which we can market and sell our services and the types of persons whose DNA we may sequence. Also, future legislation may require that patients provide specific consent

 

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to have their DNA sequenced. This could require our customers to obtain new consents before they can submit DNA samples to us for sequencing.

In any event, if we expand our business to include sequencing services intended to be used for the diagnosis of disease, we will likely become subject to regulation by the FDA or other comparable agencies of other countries, which may require us to obtain regulatory approval or clearance before we can market those services.

These regulatory approval processes may be expensive, time-consuming and uncertain, and our failure to obtain or comply with these approvals or clearances could harm our business, financial condition or operating results.

Disruption to or failure of our data center or other technical systems may disrupt our business and harm our operating results.

We rely on our network infrastructure, data centers, enterprise applications and technology systems for the development and support of our sequencing service, including the preparation, analysis and transmission of data from our sequencing center, as well as for the internal operation of our business. These systems are susceptible to disruption or failure in the event of natural disasters such as a major earthquake, fire, flood, cyber-attack, terrorist attack, telecommunications failure, power outage or other catastrophic event. Further, our data center and our sequencing facility, which houses certain of our technology systems, are located near major earthquake faults. Disruptions to or the failure of our data center or any of these technology systems, including the network connection between our Mountain View facility and our data center, and the resulting loss of critical data, could cause delays in the transmission and analysis of the sequencing data, prevent us from fulfilling our customers’ orders and severely affect our ability to conduct normal business operations.

Our credit facility contains restrictions that limit our flexibility in operating our business.

In July 2008, we entered into a loan and security agreement, which we refer to as our credit facility. Our credit facility contains various covenants that limit our ability to engage in specified types of transactions. These covenants limit our ability to, among other things:

 

  §  

sell, transfer, lease or dispose of our assets;

 

  §  

create, incur or assume additional indebtedness;

 

  §  

encumber or permit liens on certain of our assets;

 

  §  

make restricted payments, including paying dividends on, repurchasing or making distributions with respect to our common stock;

 

  §  

make specified investments (including loans and advances);

 

  §  

consolidate, merge, sell or otherwise dispose of all or substantially all of our assets; and

 

  §  

enter into certain transactions with our affiliates.

A breach of any of these covenants could result in a default under our credit facility. Upon the occurrence of an event of default under our credit facility, our lenders could elect to declare all amounts outstanding under our credit facility to be immediately due and payable and terminate all commitments to extend further credit. If we were unable to repay those amounts, the lenders under our credit facility could proceed against the collateral granted to them to secure such indebtedness. We have pledged substantially all of our assets, other than our intellectual property, as collateral under our credit facility.

If we fail to retain the services of our key executives or if we are unable to attract and retain skilled personnel, our ability to grow our business and our competitive position would be impaired.

We believe our future success will depend in large part upon our ability to attract, retain and motivate highly skilled personnel. In particular, we depend highly on the contributions of Clifford A. Reid, Ph.D., our President and Chief Executive Officer, and Radoje Drmanac, Ph.D., our Chief Scientific Officer. The loss of either of these

 

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executives could make it more difficult to manage our operations and research and development activities, reduce our employee retention and revenue and impair our ability to compete. If either of these key executives were to leave us unexpectedly, we could face substantial difficulty in hiring qualified successors and could experience a loss in productivity, both during the search for, and integration of, any such successor.

Our research and development, operations and sales and marketing personnel represent a significant asset and serve as the source of our business strategy, scientific and technological innovations and sales and marketing initiatives. As a result, our success substantially depends on our ability to attract additional personnel for all areas of our organization, particularly in our research and development department. Competition for qualified personnel is intense, and we may not be successful in attracting and retaining qualified personnel on a timely basis or on competitive terms, if at all. In addition, many qualified personnel are located outside of Northern California, where we are located, and some qualified personnel that we may recruit may not be interested in relocating. If we are unable to attract and retain the necessary personnel on a cost-effective basis, our ability to grow our business and our competitive position would be impaired.

We may engage in joint ventures or acquisitions that could disrupt our business, cause dilution to our stockholders, reduce our financial resources and result in increased expenses.

In the future, we may enter into joint ventures or acquire other businesses, products or technologies. Because we have not entered into any joint ventures or made any acquisitions to date, our ability to do so successfully is unproven. We may not be able to find suitable partners or acquisition candidates, and we may not be able to complete such transactions on favorable terms, if at all, or successfully integrate any acquired business, products or technologies into our operations. If we do enter into any joint ventures or complete acquisitions, we may not strengthen our competitive position or achieve our goals, or these transactions may be viewed negatively by customers or investors. In addition, we may have difficulty integrating and motivating personnel, technologies and operations from acquired businesses and retaining and motivating key personnel from those businesses. Joint ventures and acquisitions may disrupt our ongoing operations, divert management from day-to-day responsibilities and increase our expenses. Future acquisitions may reduce our cash available for operations and other uses, and could result in an increase in amortization expense related to identifiable intangible assets acquired, potentially dilutive issuances of equity securities or the incurrence of debt. We cannot predict the number, timing or size of future joint ventures or acquisitions, or the effect that any such transactions might have on our operating results.

We will incur significant costs as a result of operating as a public company, and our management will devote substantial time to new compliance initiatives. We may fail to comply with the rules that apply to public companies, including section 404 of the Sarbanes-Oxley Act of 2002.

We will incur significant legal, accounting and other expenses as a public company, including costs resulting from public company reporting obligations under the Securities Exchange Act of 1934, as amended, and regulations regarding corporate governance practices. The listing requirements of The NASDAQ Global Market require that we satisfy certain corporate governance requirements relating to director independence, distributing annual and interim reports, stockholder meetings, approvals and voting, soliciting proxies, conflicts of interest and a code of conduct. Our management and other personnel will need to devote a substantial amount of time to all of these requirements. Moreover, the reporting requirements, rules and regulations will increase our legal and financial compliance costs and will make some activities more time-consuming and costly. These reporting requirements, rules and regulations, coupled with the increase in potential litigation exposure associated with being a public company, could make it more difficult for us to attract and retain qualified persons to serve on our board of directors or board committees or to serve as executive officers.

After this offering, we will be subject to section 404 of The Sarbanes-Oxley Act of 2002 and the related rules of the Securities and Exchange Commission, which generally require our management and independent registered public accounting firm to report on the effectiveness of our internal control over financial reporting. We expect that our management and independent registered public accounting firm will have to provide the first of such reports with our annual report for the fiscal year ending December 31, 2011. To date, we have never conducted a

 

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review of our internal control for the purpose of providing the reports required by these rules. During the course of our review and testing, we may identify deficiencies and be unable to remediate them before we must provide the required reports. We or our independent registered public accounting firm may not be able to conclude on an ongoing basis that we have effective internal control over financial reporting, which could harm our operating results, cause investors to lose confidence in our reported financial information and cause the trading price of our stock to fall.

Our ability to use our net operating loss carryforwards to offset future taxable income may be subject to certain limitations.

In general, under Section 382 of the Internal Revenue Code of 1986, as amended, or the Code, a corporation that undergoes an “ownership change” is subject to limitations on its ability to use its pre-change net operating loss carryforwards, or NOLs, to offset future taxable income. If the Internal Revenue Service challenges our analysis that our existing NOLs will not expire before utilization due to previous ownership changes, or if we undergo an ownership change in connection with or after this public offering, our ability to use our NOLs could be limited by Section 382 of the Code. Future changes in our stock ownership, some of which are outside of our control, could result in an ownership change under Section 382 of the Code. Furthermore, our ability to use NOLs of companies that we may acquire in the future may be subject to limitations. For these reasons, we may not be able to use a material portion of the NOLs reflected on our balance sheet, even if we attain profitability.

Unfavorable global economic conditions could adversely affect our business, financial condition or results of operations.

Our results of operations could be adversely affected by general conditions in the global economy and in the global financial markets. The recent global financial crisis caused extreme volatility and disruptions in the capital and credit markets. A severe or prolonged economic downturn, such as the recent global financial crisis, could result in a variety of risks to our business, including, reductions or delays in planned research and development and other expenditures by our customers or decreased funding of genomic research by governmental entities. A weak or declining economy could also put strain on our suppliers, possibly resulting in supply disruption, or cause our customers to delay making payments for our services. Any of the foregoing could harm our business.

Risks Related to Intellectual Property

We could become subject to litigation regarding patent and other proprietary rights that could harm our business.

Our commercial success depends in part on not infringing patents and proprietary rights of third parties. As we enter our markets, we expect that competitors will likely claim that our services infringe their intellectual property rights as part of a business strategy to impede our successful entry into those markets. Such competitors and other third parties may have obtained and may in the future obtain patents covering products or processes that are similar to or may include steps or processes used in our sequencing technology, allowing them to claim that the use of our technologies infringes these patents. In particular, we are aware of issued U.S. patents owned by competitors and other third parties to which we do not have licenses that may relate to our sequencing technology and which pertain to, among other things:

 

  §  

sample preparation techniques;

 

  §  

processes for making nucleic acid templates (“library construction”);

 

  §  

processes for making DNBs from nucleic acid templates;

 

  §  

nucleic acid arrays;

 

  §  

methods of making arrays of DNBs;

 

  §  

sequencing methods, including those involving ligation;

 

  §  

identifying genomic sequences on nucleic acid arrays;

 

  §  

devices and apparatus used in nucleic acid detection systems, including optical systems; and

 

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  §  

information processing systems including software for base calling, sequence mapping and assembly.

Some of the third parties that own these patents have strong economic incentives, and substantial financial resources, to claim that we are infringing their patent rights. If a third party asserts a patent infringement claim against us, we may assert, as a defense, that we do not infringe the relevant patent claims, that the patent is invalid or both. The strength of our defenses will depend on the patents asserted, the interpretation of these patents, our ability to identify invalidating “prior art” (that is, publication of the patent holder’s invention or technology prior to the stated invention date) in order to invalidate the asserted patent and on other factors. However, we could be unsuccessful in advancing non-infringement and/or invalidity arguments in our defense if we are sued. In the United States, issued patents enjoy a presumption of validity, and the party challenging the validity of a patent claim must present clear and convincing evidence of invalidity, which is a high burden of proof. Conversely, the patent owner need only prove infringement by a preponderance of the evidence, which is a lower burden of proof.

If we were found by a court to have infringed a valid patent claim, we could be prevented from using the patented technology or be required to pay the owner of the patent rights for the rights to use that technology. If we decide to pursue a license to one or more of these patents, we may not be able to obtain such a license on commercially reasonable terms, if at all, or the license we obtain may require us to pay substantial royalties or grant cross licenses to our patent rights. For example, if the relevant patent is owned by a competitor, that competitor may choose not to license patent rights to us, as it would be under no obligation to do so. If we decide to develop alternative technology, we may not be able to do so on a timely or cost-effective manner, if at all.

In addition, because patent applications can take years to issue and are often afforded confidentiality for some period of time, there may currently be pending applications, unknown to us, which later result in issued patents that processes in our sequencing technology infringe. Processes in our sequencing technology may also infringe existing issued patents of which we are currently unaware. Even though we own or have other rights to patents, these patents do not provide us with the freedom to offer our sequencing services unimpeded by the patent rights of others. For example, we may be required to pursue or defend a patent infringement action in order to protect our intellectual property rights or practice our sequencing technology.

In light of the above, we expect that we may in the future receive, particularly as a public company, communications from competitors and other companies alleging that we may be infringing their patents, trade secrets or other intellectual property rights or offering licenses to such intellectual property or threatening litigation. In addition to patent infringement claims, third parties may assert copyright, trademark or other proprietary rights against us. We may not be able to successfully defend these claims, and our business may suffer if these claims are brought against us.

We may not be able to protect our patent rights or other intellectual property which could impair our ability to compete effectively.

We depend on proprietary technology for our success and ability to compete. If others are able to reproduce our technology, our business will suffer significantly unless we can prevent them from competing with us. To protect our proprietary technology, we rely on patents and other intellectual property laws, as well as nondisclosure agreements, licensing arrangements and confidentiality provisions. U.S. patent, copyright and trade secret laws afford us only limited protection, and the laws of some foreign countries do not protect proprietary rights to the same extent.

We have licensed, from Callida Genomics, Inc., U.S. and international patents and patent applications relating to our business. Because the issuance of a patent is not conclusive of its validity or enforceability, our existing patent rights, and rights we may obtain in the future, may not provide us with meaningful protection. The patent rights on which we rely may be challenged and invalidated or may be interpreted not to be broad enough to cover the critical components of our technology. Our pending patent applications may have their claims limited or may not result in issued patents. Moreover, our patent rights become more limited as owned or licensed patents begin to expire in 2014. We will be able to protect our technologies from unauthorized use by third parties only to the extent that valid and enforceable patents or other proprietary rights cover them. Even if we have valid and

 

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enforceable patents or other proprietary rights, competitors may be able to design alternative methods or devices that avoid infringement of those patents or rights.

Our key patent rights are licensed from Callida, which is owned by our chief scientific officer and his spouse. If we breach the terms of these licenses, or if our relationship with Callida or its owners deteriorates, Callida may seek to terminate the licenses. If we lose our rights to use these patents, we may be forced to re-design our sequencing technology, which would be expensive and may not be possible.

The patent positions of biotechnology companies, including us, can be highly uncertain and involve complex and evolving legal and factual questions. No consistent policy regarding the breadth of claims allowed in biotechnology patents has emerged to date in the United States. Legal developments may preclude or limit the patent protection available for our sequencing technology.

Despite our efforts to protect our proprietary rights, attempts may be made to copy or reverse engineer aspects of our sequencing technology or to obtain and use information that we regard as proprietary. Accordingly, we may be unable to protect our proprietary rights against unauthorized third-party copying or use. Furthermore, policing the unauthorized use of our intellectual property is difficult. Litigation may be necessary in the future to enforce our intellectual property rights, to protect our trade secrets or to determine the validity and scope of the proprietary rights of others. Litigation could result in substantial costs and diversion of resources and could harm our business.

We may incur substantial costs as a result of litigation or other proceedings relating to patent and other proprietary rights.

The genomic sequencing industry includes several large companies that have rights to many broad issued patents and pending patent applications. Competitors in this industry have fiercely litigated their patent positions and alleged infringements by others. For example, Illumina and Affymetrix were recently involved in long and expensive patent litigation relating to DNA sequencing technology. This litigation resulted in a settlement involving the payment of $90 million by one party to the other.

Our involvement in intellectual property litigation or administrative proceedings could result in significant expense. Some of our competitors, such as Illumina, Life Technologies and Affymetrix, have considerable resources available to them. We, on the other hand, are an early-stage commercial company with comparatively few resources available to us to engage in costly and protracted litigation. Intellectual property infringement claims asserted against us, whether with or without merit, could be costly to defend and could limit our ability to use some technologies in the future. They will be time consuming, will divert our management’s and scientific personnels’ attention and may result in liability for substantial damages. In addition, our standard customer contract requires us to indemnify our customers for claims alleging that any of our products misappropriate or violate any third party patent, copyright, trade secret or other intellectual property or proprietary rights.

If third parties file patent applications or are issued patents claiming technology also claimed by us in pending applications, we may be required to participate in interference proceedings with the U.S. Patent Office or in other proceedings outside the United States, including oppositions, to determine priority of invention or patentability. Even if we are successful in these proceedings, we may incur substantial costs, and the time and attention of our management and scientific personnel will be diverted in pursuit of these proceedings.

We may not be able to enforce our intellectual property rights throughout the world.

The laws of some foreign countries do not protect intellectual property rights to the same extent as the laws of the United States. Many companies have encountered significant problems in protecting and defending intellectual property rights in certain foreign jurisdictions. The legal systems of some countries, particularly developing countries, do not favor the enforcement of patents and other intellectual property protection, especially those relating to biotechnology. This could make it difficult for us to stop the infringement of our patents or the misappropriation of our other intellectual property rights. For example, many foreign countries have compulsory licensing laws under which a patent owner must grant licenses to third parties. In addition, many countries limit the enforceability of patents against third parties, including government agencies or government contractors. In these countries, patents may provide limited or no benefit.

 

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Proceedings to enforce our patent rights in foreign jurisdictions could result in substantial costs and divert our efforts and attention from other aspects of our business. Accordingly, our efforts to protect our intellectual property rights in such countries may be inadequate. In addition, changes in the law and legal decisions by courts in the U.S. and foreign countries may affect our ability to obtain adequate protection for our technology and the enforcement of intellectual property.

Confidentiality agreements with employees and others may not adequately prevent disclosures of our trade secrets and other proprietary information.

We rely in part on trade secret protection to protect our confidential and proprietary information and processes. However, trade secrets are difficult to protect. We have taken measures to protect our trade secrets and proprietary information, but these measures may not be effective. We require new employees and consultants to execute confidentiality agreements upon the commencement of an employment or consulting arrangement with us. These agreements generally require that all confidential information developed by the individual or made known to the individual by us during the course of the individual’s relationship with us be kept confidential and not disclosed to third parties. These agreements also generally provide that inventions conceived by the individual in the course of rendering services to us will be our exclusive property. Despite these measures, our proprietary information may be disclosed, third parties could reverse engineer our sequencing technologies and others may independently develop substantially equivalent proprietary information and techniques or otherwise gain access to our trade secrets. Costly and time-consuming litigation could be necessary to enforce and determine the scope of our proprietary rights, and failure to obtain or maintain trade secret protection could adversely affect our competitive business position.

Risks Related to This Offering and Ownership of Our Common Stock

An active, liquid and orderly market for our common stock may not develop, our stock price may be volatile and you may not be able to resell shares of our common stock at or above the price you paid.

Prior to this offering, there has been no public market for shares of our common stock, and an active public market for our shares may not develop or be sustained after this offering. We and the representatives of the underwriters will determine the initial public offering price of our common stock through negotiation. This price will not necessarily reflect the price at which investors in the market will be willing to buy and sell our shares following this offering. In addition, the trading price of our common stock following this offering could be highly volatile and could be subject to wide fluctuations in response to various factors, some of which are beyond our control. These factors include those discussed in this “Risk Factors” section of this prospectus and others such as:

 

  §  

quarterly variations in our results of operations or those of our competitors;

 

  §  

changes in earnings estimates or recommendations by securities analysts;

 

  §  

announcements by us or our competitors of new products or services, significant contracts, commercial relationships, acquisitions or capital commitments;

 

  §  

developments with respect to intellectual property rights;

 

  §  

our commencement of, or involvement in, litigation;

 

  §  

changes in financial estimates or guidance, including our ability to meet our future revenue and operating profit or loss estimates or guidance;

 

  §  

any major changes in our board of directors or management;

 

  §  

changes in governmental regulations; and

 

  §  

a decrease in government funding of research and development or a slowdown in the general economy.

 

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In recent years, the stock market in general, and the market for technology/life science companies in particular, has experienced extreme price and volume fluctuations that have often been unrelated or disproportionate to the operating performance of those companies. Broad market and industry factors may seriously affect the market price of our common stock, regardless of our actual operating performance. These fluctuations may be even more pronounced in the trading market for our stock shortly following this offering. In addition, in the past, following periods of volatility in the overall market and the market price of a particular company’s securities, securities class action litigation has often been instituted against these companies. This litigation, if instituted against us, could result in substantial costs and divert our management’s attention and resources.

If securities or industry analysts do not publish research or reports about our business, or if they issue an adverse or misleading opinion regarding our stock, our stock price and trading volume could decline.

The trading market for our common stock will be influenced by the research and reports that industry or securities analysts publish about us or our business. We do not currently have and may never obtain research coverage by securities and industry analysts. If no securities or industry analysts commence coverage of us, the trading price for our stock would be negatively impacted. In the event we obtain securities or industry analyst coverage, if any of the analysts who cover us issue an adverse or misleading opinion regarding us, business model, technology or stock performance, our stock price would likely decline. If one or more of these analysts cease coverage of us or fail to publish reports on us regularly, we could lose visibility in the financial markets, which in turn could cause our stock price or trading volume to decline.

Our directors, executive officers and principal stockholders and their respective affiliates will continue to have substantial influence over us after this offering and could delay or prevent a change in corporate control.

After this offering, our directors, executive officers and holders of more than 5% of our common stock, together with their affiliates, will beneficially own, in the aggregate, approximately     % of our outstanding common stock, assuming no exercise of the underwriters’ option to purchase additional shares of our common stock in this offering. As a result, these stockholders, acting together, would have significant influence over the outcome of matters submitted to our stockholders for approval, including the election of directors and any merger, consolidation or sale of all or substantially all of our assets. In addition, these stockholders, acting together, would have significant influence over our management and affairs. Accordingly, this concentration of ownership might harm the market price of our common stock by:

 

  §  

delaying, deferring or preventing a change in control;

 

  §  

impeding a merger, consolidation, takeover or other business combination involving us; or

 

  §  

discouraging a potential acquiror from making a tender offer or otherwise attempting to obtain control of us.

Future sales of shares by existing stockholders could cause our stock price to decline.

If our existing stockholders sell, or if the market believes our existing stockholders will sell, substantial amounts of our common stock in the public market, the trading price of our common stock could decline significantly. Based on shares outstanding as of July 15, 2010, upon the completion of this offering, we will have outstanding              shares of common stock, assuming the automatic conversion, upon the completion of this offering, of our preferred stock outstanding as of that date into shares of our common stock. Of these shares,              shares of common stock, plus any shares sold pursuant to the underwriters’ option to purchase additional shares, will be immediately freely tradable, without restriction, in the public market. UBS Investment Bank and Jefferies & Company may, in their sole discretion, permit our officers, directors, employees and current stockholders to sell shares prior to the expiration of the lock-up agreements.

After the lock-up agreements pertaining to this offering expire and based on shares outstanding as of July 15, 2010, an additional              shares will be eligible for sale in the public market. In addition,              shares may become eligible for sale in the public market in the future, subject to certain legal and contractual limitations as of July 15, 2010:

 

  §  

2,248,953 shares subject to outstanding options under our 2006 Equity Incentive Plan;

 

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  §  

             shares reserved for future issuance under our 2010 Equity Incentive Award Plan, as well as any automatic increases in the number of shares of our common stock reserved for future issuance under this benefit plan, which will become effective immediately prior to the consummation of this offering; and

 

  §  

1,217,868 shares remaining available for issuance under our 2006 Equity Incentive Plan, which will become available for issuance under our 2010 Equity Incentive Award Plan after completion of this offering.

If these additional shares are sold, or if it is perceived that they will be sold, in the public market, the price of our common stock could decline substantially.

Purchasers in this offering will experience immediate and substantial dilution in the book value of their investment.

The initial public offering price of our common stock is substantially higher than the pro forma as adjusted net tangible book value per share of our common stock before giving effect to this offering. Accordingly, if you purchase our common stock in this offering, you will incur an immediate substantial dilution of approximately $             per share, based on an assumed public offering price of $             per share and our pro forma as adjusted net tangible book value as of March 31, 2010. In addition, following this offering, and assuming the sale by us of              shares of our common stock in this offering at an initial public offering price of $             per share, purchasers in this offering will have contributed approximately     % of the total gross consideration paid by stockholders to us to purchase shares of our common stock, through March 31, 2010, but will own only approximately     % of the shares of common stock outstanding immediately after this offering. Furthermore, if the underwriters exercise their over-allotment option, or outstanding options and warrants are exercised, you could experience further dilution. For a further description of the dilution that you will experience immediately after this offering, see the section titled “Dilution.”

We have broad discretion to determine how to use the funds raised in this offering, and may use them in ways that may not enhance our operating results or the price of our common stock.

Our management will have broad discretion over the use of proceeds from this offering, and we could spend the proceeds from this offering in ways our stockholders may not agree with or that do not yield a favorable return, if at all. We currently intend to use the net proceeds of this offering to finance the further development and commercialization of our technology and for sales and marketing activities, capital expenditures to expand our facilities and operations and working capital and other general corporate purposes, including the costs associated with being a public company. If we do not invest or apply the proceeds of this offering in ways that improve our operating results, we may fail to achieve expected financial results, which could cause our stock price to decline.

Provisions in our charter documents and under Delaware law could discourage a takeover that stockholders may consider favorable and may lead to entrenchment of management.

Our amended and restated certificate of incorporation and amended and restated bylaws that will be in effect immediately prior to the consummation of this offering will contain provisions that could delay or prevent changes in control or changes in our management without the consent of our board of directors. These provisions will include the following:

 

  §  

a classified board of directors with three-year staggered terms, which may delay the ability of stockholders to change the membership of a majority of our board of directors;

 

  §  

no cumulative voting in the election of directors, which limits the ability of minority stockholders to elect director candidates;

 

  §  

the exclusive right of our board of directors to elect a director to fill a vacancy created by the expansion of the board of directors or the resignation, death or removal of a director, which prevents stockholders from being able to fill vacancies on our board of directors;

 

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  §  

the ability of our board of directors to authorize the issuance of shares of preferred stock and to determine the price and other terms of those shares, including preferences and voting rights, without stockholder approval, which could be used to significantly dilute the ownership of a hostile acquiror;

 

  §  

the ability of our board of directors to alter our bylaws without obtaining stockholder approval;

 

  §  

the required approval of at least 66 2 /3% of the shares entitled to vote at an election of directors to adopt, amend or repeal our bylaws or repeal the provisions of our amended and restated certificate of incorporation regarding the election and removal of directors;

 

  §  

a prohibition on stockholder action by written consent, which forces stockholder action to be taken at an annual or special meeting of our stockholders;

 

  §  

the requirement that a special meeting of stockholders may be called only by the chairman of the board of directors, the chief executive officer or the board of directors, which may delay the ability of our stockholders to force consideration of a proposal or to take action, including the removal of directors; and

 

  §  

advance notice procedures that stockholders must comply with in order to nominate candidates to our board of directors or to propose matters to be acted upon at a stockholders’ meeting, which may discourage or deter a potential acquiror from conducting a solicitation of proxies to elect the acquiror’s own slate of directors or otherwise attempting to obtain control of us.

We are also subject to the anti-takeover provisions contained in Section 203 of the Delaware General Corporation Law. Under Section 203, a corporation may not, in general, engage in a business combination with any holder of 15% or more of its capital stock unless the holder has held the stock for three years or, among other exceptions, the board of directors has approved the transaction. For a description of our capital stock, see the section titled “Description of Capital Stock.”

We do not currently intend to pay dividends on our common stock, and, consequently, your ability to achieve a return on your investment will depend on appreciation in the price of our common stock.

We do not currently intend to pay any cash dividends on our common stock for the foreseeable future. We currently intend to invest our future earnings, if any, to fund our growth. Additionally, the terms of our credit facility restrict our ability to pay dividends. Therefore, you are not likely to receive any dividends on your common stock for the foreseeable future.

 

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Special Note Regarding Forward-Looking Statements

This prospectus contains forward-looking statements that involve risks and uncertainties. The forward-looking statements are contained principally in the sections entitled “Prospectus Summary,” “Risk Factors,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Business.” These statements relate to future events or our future financial or operational performance and involve known and unknown risks, uncertainties and other factors that could cause our actual results, levels of activity, performance or achievement to differ materially from those expressed or implied by these forward-looking statements. These risks and uncertainties are contained principally in the section entitled “Risk Factors.”

Forward-looking statements include all statements that are not historical facts. In some cases, you can identify forward-looking statements by terms such as “may,” “will,” “should,” “intend,” “could,” “would,” “continue,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “project,” “predict,” “potential” or the negative of those terms, and similar expressions and comparable terminology intended to identify forward-looking statements. These statements reflect our current views with respect to future events and are based on assumptions and subject to risks and uncertainties. Given these uncertainties, you should not place undue reliance on these forward-looking statements. These forward-looking statements represent our estimates and assumptions only as of the date of this prospectus, and, except as required by law, we undertake no obligation to update or revise publicly any forward-looking statements, whether as a result of new information, future events or otherwise after the date of this prospectus.

This prospectus also contains estimates and other information concerning our current and target markets that are based on industry publications, surveys and forecasts, including those generated by Scienta Advisors. These estimates and information involve a number of assumptions and limitations, and you are cautioned not to give undue weight to these estimates and information. These industry publications, surveys and forecasts generally indicate that their information has been obtained from sources believed to be reliable. The industry in which we operate is subject to a high degree of uncertainty and risk due to a variety of factors, including those described in “Risk Factors.” These and other factors could cause actual results to differ materially from those expressed in these publications, surveys and forecasts.

 

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Use of Proceeds

We estimate that we will receive net proceeds of approximately $             million from the sale of              shares of common stock offered in this offering, or approximately $             million if the underwriters exercise their over-allotment option in full, based on an assumed initial public offering price of $             per share (the midpoint of the price range set forth on the cover page of this prospectus) and after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us. Each $1.00 increase (decrease) in the assumed initial public offering price of $             per share (the midpoint of the price range set forth on the cover page of this prospectus) would increase (decrease) the net proceeds to us from this offering, after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us, by approximately $             million, assuming that the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same. We may also increase or decrease the number of shares we are offering. An increase (decrease) of 1,000,000 in the number of shares we are offering would increase (decrease) the net proceeds to us from this offering, after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us, by approximately $             million, assuming the initial public offering price stays the same. An increase of 1,000,000 in the number of shares we are offering, together with a $1.00 increase in the assumed initial public offering price per share, would increase the net proceeds to us from this offering, after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us, by approximately $             million. A decrease of 1,000,000 in the number of shares we are offering, together with a $1.00 decrease in the assumed initial public offering price per share, would decrease the net proceeds to us from this offering, after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us, by approximately $             million. We do not expect that a change in the offering price or the number of shares by these amounts would have a material effect on our intended uses of the net proceeds from this offering, although it may impact the amount of time prior to which we may need to seek additional capital.

We currently intend to use the net proceeds of this offering to finance the further development and commercialization of our technology and for sales and marketing activities, capital expenditures to expand our facilities and operations and working capital and other general corporate purposes, including the costs associated with being a public company.

The expected use of net proceeds of this offering represents our current intentions based upon our present plan and business conditions. As of the date of this prospectus, we cannot specify with certainty all of the particular uses for the net proceeds to be received upon the completion of this offering. Accordingly, we will have broad discretion in the application of the net proceeds, and investors will be relying on our judgment regarding the application of the proceeds of this offering.

Until we use the net proceeds of this offering, we intend to invest the net proceeds in short-term, interest-bearing, investment-grade securities. We cannot predict whether the proceeds invested will yield a favorable return, if any.

 

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Dividend Policy

We have never declared or paid cash dividends on our common stock and currently do not plan to declare dividends on shares of our common stock in the foreseeable future. In addition, the terms of our credit facility currently prohibit us from paying cash dividends on our common stock. We expect to retain our future earnings, if any, for use in the operation and expansion of our business. The payment of cash dividends in the future, if any, will be at the discretion of our board of directors and will depend upon such factors as earnings levels, capital requirements, requirements under the Delaware General Corporation Law, restrictions and covenants pursuant to any other credit facilities we may enter into, our overall financial condition and any other factors deemed relevant by our board of directors.

 

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Capitalization

The following table sets forth our capitalization as of March 31, 2010:

 

  §  

on an actual basis;

 

  §  

on a pro forma basis to give effect to our issuance and sale, during April, May and June 2010, of an aggregate of $22,121,452 in principal amount of convertible notes and warrants to purchase an aggregate of              shares of our common stock at an exercise price of $1.50 per share; and

 

  §  

on a pro forma as adjusted basis to give further effect to:

 

  §  

the sale of              shares of common stock in this offering at an assumed initial public offering price of $              per share (the midpoint of the price range set forth on the cover page of this prospectus), after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us;

 

  §  

the conversion of all 7,819,758 shares of our convertible preferred stock outstanding on March 31, 2010 into an aggregate of 10,533,490 shares of our common stock, which will be effective immediately prior to the consummation of this offering;

 

  §  

the conversion of all of our warrants for convertible preferred stock into warrants for common stock immediately prior to the consummation of this offering and the related reclassification of convertible preferred stock warrant liability to additional paid-in capital;

 

  §  

the exercise, on a net issuance basis, of warrants outstanding as of March 31, 2010, which will expire upon completion of this offering if unexercised, to purchase shares of our common stock, resulting in the issuance of shares of common stock, assuming an initial public offering price of $             per share (the midpoint of the price range set forth on the cover page of this prospectus);

 

  §  

the exercise, on a net issuance basis, of warrants outstanding as of March 31, 2010, which will expire upon completion of this offering if unexercised, to purchase shares of our convertible preferred stock, and the conversion of those shares of preferred stock immediately prior to the consummation of this offering, resulting in the issuance of              shares of common stock, assuming an initial public offering price of $             per share (the midpoint of the price range set forth on the cover page of this prospectus); and

 

  §  

the filing and effectiveness of our amended and restated certificate of incorporation, which will occur immediately prior to this consummation of this offering.

 

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You should read this table together with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our financial statements and the related notes appearing elsewhere in this prospectus.

 

     As of March 31, 2010
      Actual     Pro forma     Pro forma
as adjusted
           (unaudited)      
       (in thousands, except share and per share amounts)  

Notes payable, net of current portion

   $ 2,366      $ 2,366      $  

Convertible notes(1)

            16,748     

Convertible preferred stock warrant liability

     1,344        1,344       

Convertible preferred stock, $0.001 par value per share; 8,280,094 shares authorized, 7,819,758 shares issued and outstanding, actual and pro forma; no shares authorized, no shares issued and outstanding, pro forma as adjusted

     95,893        95,893       
                      

Stockholders’ equity (deficit):

      

Preferred stock, $0.001 par value per share; no shares authorized, issued and outstanding, actual and pro forma;             shares authorized, no shares issued and outstanding, pro forma as adjusted

                  

Common stock, $0.001 par value per share; 16,285,798 shares authorized, 886,329 issued and outstanding, actual and pro forma; shares authorized,             shares issued and outstanding, pro forma as adjusted

     1        1     

Additional paid-in capital

     5,858        11,232     

Deficit accumulated during the development stage

     (95,497     (95,497  
                      

Total stockholders’ equity (deficit)

     (89,638     (84,264  
                      

Total capitalization(1)

   $ 9,965      $ 32,087      $  
                      

 

(1) The outstanding principal of, and interest on, the $22,121,452 aggregate principal amount of convertible notes we issued and sold during April, May and June 2010 will become due upon the closing of this offering, subject to the right of the holders of these notes to elect instead to convert their notes into shares of our preferred stock. However, if we issue and sell a new series of preferred stock before the closing of this offering, resulting in aggregate gross cash proceeds of at least $17.0 million, then these convertible notes will instead convert into shares of that series of preferred stock, which will convert into shares of our common stock immediately prior to the consummation of this offering.

A $1.00 increase (decrease) in the assumed initial public offering price of $             per share (the midpoint of the price range set forth on the cover page of this prospectus) would increase (decrease) each of pro forma as adjusted additional paid-in capital, stockholders’ equity (deficit) and total capitalization by approximately $             million, assuming that the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same. We may also increase or decrease the number of shares we are offering. An increase (decrease) of 1,000,000 in the number of shares we are offering would increase (decrease) each of pro forma as adjusted additional paid-in capital, stockholders’ equity (deficit) and total capitalization by approximately $             million, assuming the initial public offering price per share, as set forth on the cover page of this prospectus, remains the same. An increase of 1,000,000 in the number of shares we are offering, together with a $1.00 increase in the assumed initial public offering price per share, would increase each of pro forma as adjusted additional paid-in capital, stockholders’ equity (deficit) and total capitalization by approximately $             million. A decrease of 1,000,000 in the number of shares we are offering, together with a $1.00 decrease in the assumed initial public offering price per share, would decrease each of pro forma as adjusted additional paid-in capital, stockholders’ equity (deficit) and total capitalization by approximately $             million. The pro forma as adjusted information is illustrative only, and we will adjust this information based on the actual initial public offering price and other terms of this offering determined at pricing.

The outstanding share information in the table above excludes:

 

  §  

2,430,287 shares of common stock issuable upon the exercise of options outstanding as of March 31, 2010, with a weighted-average exercise price of $1.50 per share;

 

  §  

1,100,698 shares of common stock reserved for future issuance under our 2006 Equity Incentive Plan as of March 31, 2010, which will become available for issuance under our 2010 Equity Incentive Award Plan after completion of this offering;

 

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  §  

             shares of common stock that will be reserved for future issuance under our 2010 Equity Incentive Award Plan, as well as any automatic increases in the number of shares of our common stock reserved for future issuance under this benefit plan, which will become effective immediately prior to the consummation of this offering;

 

  §  

116,630 shares of common stock subject to warrants outstanding as of March 31, 2010 that will not expire upon completion of this offering, with a weighted-average exercise price of $7.97 per share;

 

  §  

             shares of common stock subject to warrants issued during April, May and June 2010 that will not expire upon completion of this offering, with a weighted-average exercise price of $1.50 per share; and

 

  §  

up to              shares of common stock issuable upon conversion of the $22,121,452 aggregate principal amount of convertible notes that we issued in April, May and June of 2010, if the holders of those notes elect to convert their notes in connection with this offering.

 

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Dilution

If you invest in our common stock, you will experience dilution to the extent of the difference between the public offering price per share of our common stock you pay in this offering and the net tangible book value per share of our common stock after this offering.

As of March 31, 2010, our net tangible book value was $(89.6) million, or $(101.13) per share of our common stock. Our net tangible book value represents total tangible assets less total liabilities and convertible preferred stock, all divided by the number of shares of common stock outstanding on March 31, 2010. Our pro forma as adjusted net tangible book value at March 31, 2010, before giving effect to this offering, was $            , or $             per share of our common stock. Pro forma as adjusted net tangible book value, before the issuance and sale of shares in this offering, gives effect to:

 

  §  

our issuance and sale, during April, May and June 2010, of an aggregate of $22,121,452 in principal amount of convertible notes and warrants to purchase an aggregate of              shares of our common stock at an exercise price of $1.50 per share;

 

  §  

the conversion of all 7,819,758 shares of our convertible preferred stock outstanding on March 31, 2010 into an aggregate of 10,533,490 shares of our common stock, which will be effective immediately prior to the consummation of this offering;

 

  §  

the conversion of all of our warrants for convertible preferred stock into warrants for common stock immediately prior to the consummation of this offering and the related reclassification of convertible preferred stock warrant liability to additional paid-in capital;

 

  §  

the exercise, on a net issuance basis, of warrants outstanding as of March 31, 2010, which will expire upon completion of this offering if unexercised, to purchase shares of our common stock, resulting in the issuance of              shares of common stock, assuming an initial public offering price of $             per share (the midpoint of the price range set forth on the cover page of this prospectus); and

 

  §  

the exercise, on a net issuance basis, of warrants outstanding as of March 31, 2010, which will expire upon completion of this offering if unexercised, to purchase shares of our convertible preferred stock, and the conversion of those shares of preferred stock immediately prior to the consummation of this offering, resulting in the issuance of              shares of common stock, assuming an initial public offering price of $         per share (the midpoint of the price range set forth on the cover page of this prospectus).

 

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After giving effect to the sale of              shares of common stock in this offering at an assumed initial public offering price of $             per share (the midpoint of the price range set forth on the cover page of this prospectus) and after deducting the estimated underwriting discounts and commissions and estimated offering expenses, our pro forma as adjusted net tangible book value at March 31, 2010 would have been approximately $             million, or $             per share. This represents an immediate increase in pro forma as adjusted net tangible book value of $             per share to existing stockholders and an immediate dilution of $             per share to new investors. The following table illustrates this per share dilution:

 

              

Assumed initial public offering price per share

    $             

Historical net tangible book value per share as of March 31, 2010

  $ (101.13  

Increase attributable to the pro forma adjustments described above

   
         

Pro forma as adjusted net tangible book value per share as of March 31, 2010, before the issuance and sale of shares in this offering

   

Increase per share attributable to the issuance and sale of shares in this offering

   
         

Pro forma as adjusted net tangible book value per share after this offering

   
       

Dilution per share to investors in this offering(1)

    $  
       

 

(1) Does not give effect to the payment or conversion of the outstanding principal of, and interest on, the $22,121,452 aggregate principal amount of convertible notes we issued and sold during April, May and June 2010. These notes will become due upon the closing of this offering, subject to the right of the holders of these notes to elect instead to convert their notes into shares of our preferred stock. However, if we issue and sell a new series of preferred stock before the closing of this offering, resulting in aggregate gross cash proceeds of at least $17.0 million, then these convertible notes will instead convert into shares of that series of preferred stock, which will convert into shares of our common stock immediately prior to the consummation of this offering.

A $1.00 increase (decrease) in the assumed initial public offering price of $             per share (the midpoint of the price range set forth on the cover page of this prospectus) would increase (decrease) our pro forma as adjusted net tangible book value as of March 31, 2010 after this offering by approximately $             million, or approximately $             per share, and would decrease (increase) dilution to investors in this offering by approximately $             per share, assuming that the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same, after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us. We may also increase or decrease the number of shares we are offering. An increase (decrease) of 1,000,000 in the number of shares we are offering would increase (decrease) our pro forma as adjusted net tangible book value as of March 31, 2010 after this offering by approximately $             million, or approximately $             per share, and would decrease (increase) dilution to investors in this offering by approximately $             per share, assuming the initial public offering price per share remains the same, after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us. An increase of 1,000,000 in the number of shares we are offering, together with a $1.00 increase in the assumed initial public offering price per share, would increase our pro forma as adjusted net tangible book value as of March 31, 2010 after this offering by approximately $             million, or approximately $             per share, and would decrease dilution to investors in this offering by approximately $             per share, after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us. A decrease of 1,000,000 in the number of shares we are offering, together with a $1.00 decrease in the assumed initial public offering price per share, would decrease our pro forma as adjusted net tangible book value as of March 31, 2010 after this offering by approximately $             million, or approximately $             per share, and would increase dilution to investors in this offering by approximately $             per share, after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us. The pro forma as adjusted information is illustrative only, and we will adjust this information based on the actual initial public offering price and other terms of this offering determined at pricing.

If the underwriters fully exercise their over-allotment option, pro forma as adjusted net tangible book value after this offering would increase to approximately $             per share, and there would be an immediate dilution of approximately $             per share to new investors.

 

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To the extent that outstanding options or warrants with an exercise price per share that is less than the pro forma as adjusted net tangible book value per share, before giving effect to the issuance and sale of shares in this offering, are exercised, you will experience further dilution. If all of our outstanding options and warrants described above were exercised, our pro forma as adjusted net tangible book value as of March 31, 2010, before giving effect to the issuance and sale of shares in this offering, would have been approximately $             million, or approximately $             per share, and our pro forma as adjusted net tangible book value as of March 31, 2010 after this offering would have been approximately $             million, or approximately $             per share, causing dilution to new investors of approximately $             per share.

In addition, we may choose to raise additional capital due to market conditions or strategic considerations even if we believe we have sufficient funds for our current or future operating plans. To the extent that we raise additional capital through the sale of equity or convertible debt securities, the issuance of these securities could result in further dilution to our stockholders.

The following table shows, as of March 31, 2010, on a pro forma as adjusted basis, after giving effect to the pro forma adjustments described above, the number of shares of common stock purchased from us, the total consideration paid to us and the average price paid per share by existing stockholders and by new investors purchasing common stock in this offering at an assumed initial public offering price of $             per share, before deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us.

 

     Shares purchased
from us
    Total consideration
to us
    Average
price per
share
      Number    Percent     Amount    Percent    

Existing stockholders

                $     $             

New investors

            
                          

Total

      100.0      $ 100.0   $  
                          

The table above, and the information below, assume that our existing stockholders do not purchase any shares in this offering.

A $1.00 increase (decrease) in the assumed initial public offering price of $             per share (the midpoint of the price range set forth on the cover page of this prospectus) would increase (decrease) total consideration paid by new investors, total consideration paid by all stockholders and the average price per share paid by all stockholders by $            , $             and $            , respectively, assuming the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same. We may also increase or decrease the number of shares we are offering. An increase (decrease) of 1,000,000 in the number of shares we are offering would increase (decrease) total consideration paid by new investors, total consideration paid by all stockholders and the average price per share paid by all stockholders by $            , $             and $            , respectively, assuming the initial public offering price stays the same. An increase of 1,000,000 in the number of shares we are offering, together with a $1.00 increase in the assumed initial public offering price per share, would increase total consideration paid by new investors, total consideration paid by all stockholders and the average price per share paid by all stockholders by $            , $             and $            , respectively. A decrease of 1,000,000 in the number of shares we are offering, together with a $1.00 decrease in the assumed initial public offering price per share, would decrease total consideration paid by new investors, total consideration paid by all stockholders and the average price per share paid by all stockholders by $            , $             and $            , respectively. The pro forma as adjusted information is illustrative only, and we will adjust this information based on the actual initial public offering price and other terms of this offering determined at pricing.

The information and tables in this section are based on 886,329 shares of common stock issued and outstanding as of March 31, 2010 and exclude:

 

  §  

2,430,287 shares of common stock issuable upon the exercise of options outstanding as of March 31, 2010 with a weighted-average exercise price of $1.50 per share;

 

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  §  

1,100,698 shares of common stock reserved for future issuance under our 2006 Equity Incentive Plan as of March 31, 2010, which will become available for issuance under our 2010 Equity Incentive Award Plan after completion of this offering;

 

  §  

             shares of common stock that will be reserved for future issuance under our 2010 Equity Incentive Award Plan, as well as any automatic increases in the number of shares of our common stock reserved for future issuance under this benefit plan, which will become effective immediately prior to the consummation of this offering;

 

  §  

116,630 shares of common stock subject to warrants outstanding as of March 31, 2010 that will not expire upon completion of this offering, with a weighted-average exercise price of $7.97 per share;

 

  §  

             shares of common stock subject to warrants issued during April, May and June 2010 that will not expire upon completion of this offering, with a weighted-average exercise price of $1.50 per share; and

 

  §  

up to              shares of common stock issuable upon conversion of the $22,121,452 aggregate principal amount of convertible notes that we issued in April, May and June of 2010, if the holders of those notes elect to convert their notes in connection with this offering.

If the underwriters exercise their over-allotment option in full, the following will occur:

 

  §  

the pro forma as adjusted number of shares of our common stock held by existing stockholders would decrease to approximately     % of the pro forma as adjusted total number of shares of our common stock outstanding after this offering; and

 

  §  

the pro forma as adjusted number of shares of our common stock held by new investors would increase to approximately     % of the pro forma as adjusted total number of shares of our common stock outstanding after this offering.

 

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Selected Financial Data

The following selected financial data should be read together with our financial statements and accompanying notes and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” appearing elsewhere in this prospectus. The selected financial data in this section is not intended to replace our financial statements and the accompanying notes.

We derived the statement of operations data for the years ended December 31, 2007, 2008 and 2009 and the balance sheet data as of December 31, 2008 and 2009 from our audited financial statements appearing elsewhere in this prospectus. The statement of operations data for the cumulative period from June 14, 2005 (date of inception) to December 31, 2005 and the year ended December 31, 2006 and the balance sheet data as of December 31, 2005, 2006 and 2007 have been derived from our audited financial statements not included in this prospectus. The statement of operations data for the three months ended March 31, 2009 and 2010 and for the cumulative period from June 14, 2005 (date of inception) to March 31, 2010 and the balance sheet data as of March 31, 2010 are derived from our unaudited financial statements appearing elsewhere in this prospectus. The unaudited financial statements have been prepared on a basis consistent with our audited financial statements and include, in the opinion of management, all adjustments, consisting only of normal recurring adjustments, necessary for the fair presentation of the financial information in those statements. Our historical results are not necessarily indicative of the results to be expected in any future period, and the results for the three months ended March 31, 2010 are not necessarily indicative of the results to be expected for the year ending December 31, 2010.

 

     Cumulative
period from
June 14, 2005
(date of
inception) to
December 31,

2005
  Year ended December 31,     Three months ended
March 31,
    Cumulative
period from
June 14, 2005
(date  of
inception)

to March 31,
2010
 
    2006     2007     2008     2009     2009     2010    
    (in thousands, except share and per share amounts)  

Statement of Operations Data:

               

Revenue

  $   $      $      $      $ 623      $      $ 336      $ 959   

Operating expenses:

               

Start-up production costs(1)

                             5,033        326        4,077        9,110   

Research and development(1)

        3,732        10,305        23,633        22,424        6,746        6,169        66,263   

General and administrative(1)

        951        1,896        3,179        4,953        1,298        3,099        14,078   

Sales and marketing(1)

                      1,045        1,798        427        1,226        4,069   
                                                             

Total operating expenses(1)

        4,683        12,201        27,857        34,208        8,797        14,571        93,520   
                                                             

Loss from operations

        (4,683     (12,201     (27,857     (33,585     (8,797     (14,235     (92,561

Interest expense

        (11     (215     (974     (3,465     (679     (311     (4,976

Interest and other income (expense), net

        129        163        437        1,101        (22     210        2,040   
                                                             

Net loss

  $   $ (4,565   $ (12,253   $ (28,394   $ (35,949   $ (9,498   $ (14,336   $ (95,497
                                                             

Net loss per share, basic and diluted

    $ (123.58   $ (211.00   $ (369.36   $ (386.56   $ (105.92   $ (51.15  
                                                   

Weighted-average shares outstanding used in computing net loss per share, basic and diluted

      36,941        58,072        76,873        92,998        89,673        280,283     
                                                   

Pro forma net loss per share of common stock, basic and diluted (unaudited)(2)

          $ (6.59     $ (1.45  
                           

 

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     Cumulative
period from
June 14, 2005
(date of
inception) to
December 31,

2005
  Year ended December 31,     Three months ended
March 31,
    Cumulative
period from
June 14, 2005
(date  of
inception)

to March 31,
2010
    2006   2007   2008   2009     2009   2010    
    (in thousands, except share and per share amounts)

Net loss used in computing pro forma net loss per share of common stock, basic and diluted (unaudited)(2)

          $ (37,037     $ (14,545  
                           

Weighted-average shares of common stock outstanding used in computing pro forma net loss per share of common stock, basic and diluted (unaudited)(2)

            5,619,600          10,062,693     
                           

 

(1) Includes stock-based compensation expense as follows:

 

     Period  from
June 14, 2005
(date of
inception) to
December 31,

2005
  Year ended
December 31,
  Three months ended
March 31,
  Cumulative
period from
June 14, 2005
(date  of
inception) to
March 31,

2010
    2006   2007   2008   2009   2009   2010  
    (in thousands)

Start-up production costs

  $   $   $   $   $ 81   $ 4   $ 61   $ 142

Research and development

        10     78     246     992     116     250     1,576

General and administrative

        2     22     90     262     39     200     576

Sales and marketing

                    75     14     29     104
                                               

Total stock-based compensation expense

  $   $ 12   $ 100   $ 336   $ 1,410   $ 173   $ 540   $ 2,398
                                               

 

(2) Net loss used in computing pro forma basic and diluted net loss per share of common stock, and the number of weighted-average common shares used in computing pro forma basic and diluted net loss per share of common stock, in the table above assume the conversion of all of our outstanding convertible preferred stock into common stock immediately prior to the consummation of this offering. See Note 2 to our financial statements for an explanation of the method used to compute pro forma basic and diluted net loss per share of common stock and the number of shares used in computing those per share amounts.

 

     December 31,     March  31,
2010
 
      2005    2006     2007     2008     2009    
     (in thousands)  

Balance Sheet Data:

             

Cash and cash equivalents

   $ 2    $ 1,632      $ 4,260      $ 6,186      $ 7,765      $ 2,371   

Working capital (deficit)

     2      1,047        1,845        741        2,964        (10,620

Total assets

     2      2,748        8,762        15,754        30,278        30,818   

Current and long-term notes payable

          1,000        3,473        11,697        7,950        6,928   

Convertible preferred stock warrant liability

          39        386        1,100        1,553        1,344   

Convertible preferred stock

          6,236        20,223        45,622        85,833        95,893   

Total stockholders’ equity (deficit)

     2      (4,852     (17,121     (45,154     (77,690     (89,638

 

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Management’s Discussion and Analysis of

Financial Condition and Results of Operations

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our financial statements and related notes that appear elsewhere in this prospectus. In addition to historical financial information, the following discussion contains forward-looking statements that involve risks and uncertainties. Our actual results may differ materially from those discussed below. Factors that could cause or contribute to these differences include those discussed below and elsewhere in this prospectus, particularly under the caption “Risk Factors.”

Overview

We are a life sciences company that has developed and commercialized an innovative DNA sequencing platform that we believe will become the preferred solution for complete human genome sequencing and analysis. Our Complete Genomics Analysis Platform, or CGA Platform, combines our proprietary human genome sequencing technology with our advanced informatics and data management software and our innovative, end-to-end, outsourced service model to provide our customers with data that is immediately ready to be used for genome-based research. We believe that our solution will provide academic and biopharmaceutical researchers with complete human genomic data and analysis at an unprecedented quality, cost and scale without requiring them to invest in in-house sequencing instruments, high-performance computing resources and specialized personnel. By removing these constraints and broadly enabling researchers to conduct large-scale complete human genome studies, we believe that our solution has the potential to revolutionize medical research and expand understanding of the basis, treatment and prevention of complex diseases.

We were incorporated in Delaware in June 2005 and began operations in March 2006. From March 2006 through mid-2009, our operations focused on research and developing our sequencing technology platform. We recognized our first revenue from the sale of our genome sequencing services in the fourth quarter of 2009. As of March 31, 2010, we were considered to be a development stage enterprise.

We have targeted our complete human genome sequencing service at academic, governmental and other research institutions, as well as pharmaceutical and other life science companies. We perform our sequencing service at our Mountain View, California headquarters facility, which began commercial operation in May 2010. In the near term, we expect to make significant expenditures related to the expansion of our Mountain View sequencing facility and our research and development initiatives, as well as to increase our sales and marketing and general and administrative expenses to support our commercial operations and anticipated growth. In future years, we plan to construct additional genome centers in the United States and in other strategic markets to accommodate an expected growing global demand for high-quality, low-cost complete human genome sequencing on a large scale.

We have not been profitable in any quarterly period since we were formed. We incurred net losses of $12.3 million, $28.4 million and $35.9 million for the years ended December 31, 2007, 2008 and 2009, respectively, and $14.3 million for the three months ended March 31, 2010. For the three months ended March 31, 2010, we recognized revenue of $0.3 million, and for the year ended December 31, 2009, we recognized revenue of $0.6 million. As of March 31, 2010, our deficit accumulated during the development stage was $95.5 million. Although we do not anticipate any material seasonal effects, given our limited operating history as a revenue generating company, our sales cycle is uncertain. Seven customers accounted for the revenue we recognized for the year ended December 31, 2009. University of Texas Southwestern Medical Center accounted for 17% of our revenue, four customers, Pfizer Inc., The Broad Institute, the Flanders Institute for Biotechnology and Johns Hopkins University, each accounted for 16% of our revenue, and the Institute for Systems Biology accounted for 13% of our revenue. Five customers accounted for the revenue we recognized for the three months ended March 31, 2010, and three customers, The International Mesothelioma Program at Brigham and Women’s Hospital, Scripps Genomic Medicine and the Ontario Institute for Cancer Research, each accounted for 30% of that revenue. If demand for our services expands as expected, we do not anticipate that the

 

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loss of any of the customers named above would have a material adverse effect on our future results of operations.

Key Financial Measures

Revenue

Our revenue is derived from selling our human genome sequencing service. We sell our service to our customers through a direct field sales and support organization. Our customers enter into purchase orders, and, in some cases, genome service contracts with us. For most arrangements, we recognize revenue upon shipment of genomic data to the customer. The per genome price of our sequencing service is based on the number of genomes to be sequenced in the arrangement. We anticipate periodically reducing the price per genome for our service as the costs of sequencing go down and competitive conditions change. We expect that our primary source of revenue for the foreseeable future will be derived from our human genome sequencing service.

Operating Expenses

Start-up Production Costs

Start-up production costs primarily consist of costs related to the acceptance testing of customer genomic samples, sample sequencing preparation, sample sequencing and the processing of data generated by the sequencing instruments. These costs primarily include personnel-related expenses and stock-based compensation, chemical reagents and engineering materials and supplies, consultant fees, depreciation of equipment and facilities-related costs. Prior to 2009, we were primarily involved in developing our sequencing technology platform, and, as a result, most of these expenses were accounted for as research and development. In 2009, we began providing our genome sequencing service to customers and began accounting for these costs as start-up production costs.

Research and Development Expenses

Research and development expenses consist of costs associated with scientific research activities, software and hardware engineering development efforts and process automation. These costs primarily include personnel-related expenses, including stock-based compensation, chemical reagents and engineering materials and supplies, depreciation of equipment, consulting fees and facilities-related costs.

In 2007, we were awarded a grant from the National Institute of Science and Technology, or NIST, through which we are eligible to receive reimbursement of a portion of our research and development expenses and certain administrative expenses. In each of 2008 and 2009, we recognized a $0.8 million reduction in research and development expenses for activities funded by NIST.

General and Administrative Expenses

General and administrative expenses consist principally of personnel-related expenses, including stock-based compensation for our finance, human resources and certain executive personnel, professional services fees, such as consulting, audit, tax and legal fees, general corporate costs and facilities-related costs. We are eligible to receive reimbursement for a portion of our administrative expenses pursuant to our NIST grant. In each of 2008 and 2009, we recognized a $0.2 million reduction in general and administrative expenses for activities funded by NIST.

Sales and Marketing Expenses

Sales and marketing expenses consist principally of personnel-related expenses, including stock-based compensation for our sales and marketing personal, costs related to sales and marketing activities, marketing research and facilities-related costs.

Interest Expense

Interest expense consists of interest on our notes payable and issuance costs associated with our borrowings.

 

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Interest and Other Income (Expense), Net

Interest and other income (expense), net, consists of interest earned on our cash and cash equivalents and changes in the fair value of our convertible preferred stock warrant liability.

Income Taxes

As of December 31, 2009, we had federal and state net operating loss carryforwards of approximately $59.7 million each and federal and state research and development tax credit carryforwards of approximately $1.9 million and $2.0 million, respectively. Our federal net operating loss and research and development tax credit carryforwards begin expiring in 2026 unless used prior to that date. Our state net operating loss carryforwards will begin to expire in 2016, if not used, and our state research and development tax credit carryforwards do not expire. Our ability to use net operating loss and tax credit carryforwards is subject to ownership change rules as provided under the Internal Revenue Code and similar state provisions. We have performed an analysis to determine whether an ownership change has occurred from inception to December 31, 2009. Our analysis determined that two ownership changes have occurred during that period. Due to these ownership changes, the use of these net operating losses and research and development credits are subject to annual limitation. However, we concluded that as of December 31, 2009, no net operating losses or research and development credits will expire before utilization due to these ownership changes. In the event we have a subsequent change in ownership, net operating loss and research and development credit carryovers could be further limited and may expire unutilized.

Critical Accounting Policies and Estimates

Our financial statements have been prepared in conformity with generally accepted accounting principles in the United States, or GAAP. The preparation of our financial statements requires our management to make estimates, assumptions and judgments that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the applicable periods. Management bases its estimates, assumptions and judgments on historical experience and on various other factors that it believes to be reasonable under the circumstances. Different assumptions and judgments would change the estimates used in the preparation of our financial statements, which, in turn, could materially change the results from those reported. Our management evaluates its estimates, assumptions and judgments on an ongoing basis. Historically, our critical accounting estimates have not differed materially from actual results. However, actual results may differ from these estimates under different conditions. If actual results differ from these estimates and other considerations used in estimating amounts reflected in the financial statements, the resulting changes could have a material adverse effect on our statements of operations, liquidity and financial condition.

The estimates described below represent our critical accounting estimates. For more information regarding our critical accounting policies and estimates, please see Note 2 of the notes to our audited financial statements included elsewhere in this prospectus.

Revenue Recognition

We generate revenue from selling our human genome sequencing services under purchase orders or contracts. Revenues are recognized when all of the following criteria are met: persuasive evidence of an arrangement exists, title has transferred, the price is fixed or determinable and collectability is reasonably assured. Upon completion of the sequencing process, we ship the research-ready genomic data to the customer. We use shipping documents and third-party evidence to verify shipment of the data. In order to determine whether collectability is reasonably assured, we assess a number of factors, including past transaction history with the customer and the creditworthiness of the customer. If we determine that collectability is not reasonably assured, we defer the recognition of revenue until collectability becomes reasonably assured. We also receive down payments from customers prior to the commencement of the genome sequencing process.

 

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For revenue generated under purchase orders, we have established standard terms and conditions that are specified for all orders. We use the purchase order to establish persuasive evidence of an arrangement and whether there is a fixed and determinable price for the order. Revenue is recognized based upon the shipment of genomic data to customers and satisfaction of all terms and conditions contained in the purchase order. Any down payments received are recorded as deferred revenue until we meet all revenue recognition criteria.

For revenue generated under contracts, we consider each contract’s terms and conditions to determine our obligations associated with the contract. We will defer revenue until all significant obligations, as defined in the contract, have been met. Any down payments received are recorded as deferred revenue, and revenue is recognized upon shipment of genomic data and satisfaction of all remaining obligations.

Allowance for Doubtful Accounts

We currently do not have any significant accounts receivable balances, and receipt of payment on our existing receivables has been reasonably assured such that we do not believe that an allowance for doubtful accounts is currently required. If our revenue increases as expected and our accounts receivable balance grows, we intend to perform regular evaluations of our customers’ creditworthiness and continuously monitor collections and payments to estimate an allowance for doubtful accounts that is based on the aging of the underlying receivables and our experiences with regard to specific collection issues.

Estimated Useful Lives of Property and Equipment

We depreciate our property and equipment using a straight line method over its estimated useful lives. Our property primarily consists of lease improvements, and our equipment primarily consists of our sequencing instruments and computer equipment used in the sequencing process. While we use our best judgment to determine the useful lives of our sequencing instruments and computer equipment, a significant change in technology or the emergence of an advanced technology could result in a shorter useful life than we initially anticipated. Our equipment represents the largest asset on our balance sheet, and a subsequent reduction in the useful lives of equipment could have a material impact on our statement of operations.

Convertible Preferred Stock Warrants

Freestanding warrants to purchase shares of our convertible preferred stock are classified as liabilities on our balance sheets at fair value because the warrants may conditionally obligate us to redeem the underlying convertible preferred stock at some point in the future. The warrants are subject to remeasurement at each balance sheet date, and any change in fair value is recognized as a component of interest and other income (expense), net, in the statements of operations. We estimated the fair value of these warrants at the respective balance sheet dates using the Black-Scholes option pricing model. We use a number of assumptions to estimate the fair value including the remaining contractual terms of the warrants, risk-free interest rates, expected dividend yield and expected volatility of the price of the underlying common stock. These assumptions are highly judgmental and could differ significantly in the future.

For the years ended December 31, 2007, 2008 and 2009, we recorded a charge of $0.2 million and gains of $0.1 million and $1.1 million to interest and other income (expense), net, respectively, to reflect the change in the fair value of the warrants. During the three months ended March 31, 2009 and 2010, we recorded a charge of $27,000 and a gain of $0.2 million, respectively, to interest and other income (expense), net, respectively, to reflect the change in fair value of the warrants.

We will continue to record adjustments to the fair value of the warrants until they are either exercised, converted into warrants to purchase common stock or expire, at which time the warrants will no longer be remeasured at each balance sheet date. Immediately prior to the consummation of this offering and the conversion of the underlying preferred stock to common stock, our outstanding preferred stock warrants will automatically convert into warrants to purchase shares of our common stock. The then-current aggregate fair value of these warrants will be reclassified from liabilities to additional paid-in capital, and we will cease to record any related periodic fair value adjustments.

 

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Inventory

Inventory consists of the raw materials we use in our sequencing process, work in process and finished goods. Inventories are stated at the lower of cost or market value. Cost is determined using standard costs, which approximate actual costs, on a first-in, first-out basis. Market value is determined as the lower of replacement cost or net realizable value. We regularly review inventory quantities on hand for excess and obsolete inventories, giving consideration to potential obsolescence, our product life cycle and development plans, product expiration and quality issues. To date, these factors have not been significant as our inventory amounts have been immaterial. However, we anticipate that these estimates will become more significant if our sequencing volumes increase as expected.

Valuation of Long-Lived Assets

We assess our long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of a long-lived asset may not be recoverable. These indicators may include, but are not limited to, significant decreases in the market value of an asset and significant changes in the extent or manner in which an asset is used. If these or other indicators are present, we test for recoverability by measuring the carrying amount of the assets against future net cash flows which the assets are expected to generate. If these assets are considered to be impaired, the impairment recognized is measured by the amount by which the carrying amount of the assets exceeds the projected discounted future net cash flows arising from the assets. We make estimates and judgments about future undiscounted cash flows and fair values. Although our cash flow forecasts are based on assumptions that are consistent with our plans, there is significant exercise of judgment involved in determining the cash flow attributable to a long-lived asset over its estimated remaining useful life. Our estimates of anticipated cash flows could be reduced significantly in the future. As a result, the carrying amounts of our long-lived assets could be reduced through impairment charges in the future. There have been no such impairments of long-lived assets to date. However, we anticipate that a future impairment could have a material impact on our financial statements in light of the dollar significance of the long-lived assets carried on our balance sheet.

Stock-Based Compensation

We recognize compensation expense related to the awarding of employee stock options, based on the estimated fair value of the awards granted using the Black-Scholes option-pricing model. We also use the Black-Scholes option-pricing model to determine the fair value of non-employee stock option grants. In accordance with authoritative guidance, the fair value of non-employee stock option grants is re-measured as they vest, and the resulting increase in value, if any, is recognized as expense during the period the related services are rendered.

 

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The Black-Scholes option-pricing model requires the input of our expected stock-price volatility, the expected life of the options, risk-free interest rate and expected dividends. Determining these assumptions requires significant judgment. We determined the expected life and volatility rate of the employee stock-option grants based on that of selected, publicly traded companies in a similar industry, approximating our life cycle, revenue level and market capitalization. We will continue to analyze the historical expected term and stock price volatility assumptions as more historical data for our own options and common stock, respectively, becomes available. The expected life of the non-employee option grants was based on their remaining contractual life at the measurement date. The risk-free interest rate assumption was based on U.S. Treasury instruments whose terms were consistent with the option’s expected life. The expected dividend assumption was based on our history and expectation of dividend payouts. The following table sets forth these assumptions for our employee stock options for the periods provided:

 

     Year ended December 31,      Three months ended  
March 31,
      2008    2009    2010
               (unaudited)

Expected volatility

   82.05% – 84.79%    74.03% – 92.44%    80.54% – 80.79%

Expected life (in years)

   6.08    5.32 – 6.10    5.50

Risk-free interest rate

   2.79% – 3.62%    1.80% – 2.72%    2.57% – 2.63%

Expected dividend yield

   0.00%    0.00%    0.00%

In accordance with the authoritative guidance on stock compensation, we only record stock-based compensation expense for awards that are expected to vest. As a result, judgment is also required in estimating the amount of stock-based awards that are expected to be forfeited. Although we estimate forfeitures based on historical experience, actual forfeitures may differ. If actual results differ significantly from these estimates, stock-based compensation expense and our statements of operations could be materially impacted when we record a true-up for the difference in the period that the awards vest.

The following table summarizes the options granted from May 2, 2008 through March 31, 2010 with their exercise prices, the fair value of the underlying common stock and the intrinsic value per share, if any. We did not grant any options from January 1, 2008 through May 1, 2008.

 

Grant date    Number of
options
granted
  

Exercise price

per share(1)

   Fair value of
common stock
per share
    Intrinsic
value(3)

May 2, 2008

   13,377    $ 35.40    $ 35.40      $

July 23, 2008

   2,863      35.40      35.40       

November 11, 2008

   21,850      76.20      76.20       

January 21, 2009

   4,006      76.20      76.20       

March 13, 2009

   6,548      76.20      76.20       

November 13, 2009

   1,235,570      1.50      1.82 (2)      0.32

November 19, 2009

   17,499      1.50      1.85 (2)      0.35

December 28, 2009

   199,998      1.50      2.02 (2)      0.52

January 28, 2010

   104,895      1.50      2.16 (2)      0.66

February 24, 2010

   619,169      1.50      2.28 (2)      0.78

March 19, 2010

   63,125      1.50      2.38 (2)      0.88

March 22, 2010

   128,000      1.50      2.39 (2)      0.89

 

(1) In January 2010, we approved a stock option modification, pursuant to which all outstanding unexercised options that were granted prior to January 28, 2010 under our 2006 Equity Incentive Plan and had an exercise price greater than $1.50 per share were modified to decrease the exercise price of these stock options to $1.50 per share. For more information see “—Stock Option Modification” below.
(2) We reassessed the fair value of our common stock subsequent to the grant date of these options.
(3) Intrinsic value represents the difference between the exercise price and the fair value of the common stock underlying the award.

All options granted by our board of directors on the dates noted above were intended to be exercisable at the fair value of our stock at the time of grant, based on information known at that time. For the purposes of recording stock-based compensation expense, we reviewed the historical pattern of our common stock and subsequently reassessed the fair value of our stock for the options granted from November 13, 2009 through March 22, 2010.

 

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The fair values of the common stock underlying our stock options were estimated contemporaneously by our board of directors with input from management based on several factors, including progress and milestones attained in our business, projected sales and earnings for multiple future periods and estimated probabilities of various financing and liquidation events. In the absence of a public trading market for our common stock, our board of directors has determined the fair value of the common stock using methodologies, approaches and assumptions consistent with the American Institute of Certified Public Accountants Practice Guide, Valuation of Privately-Held-Company Equity Securities Issued as Compensation, or the AICPA Practice Guide. In addition, our board of directors considered numerous objective and subjective factors, including, among others, the following factors:

 

  §  

the prices of preferred stock issued by us to sophisticated investors in arms-length transactions;

 

  §  

the rights, preferences and privileges of our preferred stock issued in financings relative to our common stock;

 

  §  

the execution of customer contracts and receipt of customer purchase orders;

 

  §  

the hiring of key personnel;

 

  §  

the status of development and implementation of our sequencing process;

 

  §  

our stage of development and business strategy;

 

  §  

the lack of an active public market for our common and preferred stock;

 

  §  

trends in the genome sequencing industry and performance of specific competitors; and

 

  §  

the likelihood of achieving a liquidity event for the shares of common stock underlying these stock options, such as an initial public offering or sale of the company, in light of the then-prevailing market conditions.

For our contemporaneous valuations, our board of directors used the option pricing model, or OPM, if the valuation date approximated the close of recent financings by third parties and, in other situations, the probability-weighted expected return method, or PWERM. To ensure the reasonableness of the results of either method used, the results of the OPM allocation method were reconciled to the results of the PWERM allocation method, and the PWERM results were reconciled to the OPM results, if appropriate.

Under the PWERM method, the value of the common stock is estimated based on an analysis of future values for the company assuming various future outcomes. Stock value is based on the probability-weighted present value of expected future investment returns, considering each of the possible future outcomes available, as well as the rights of each class of stock. The future outcomes we considered were:

 

  §  

initial public offering;

 

  §  

merger or sale;

 

  §  

liquidation; and

 

  §  

continuing operations as a viable private company.

The OPM model treats the rights of the holders of preferred and common stock as equivalent to that of call options on any value of the enterprise above certain break points of value based on the liquidation preferences of the holders of preferred stock, as well as their rights to participation and conversion. Accordingly, the value of the common stock is determined by estimating the value of its portion of each of these call option rights. In order to determine the break points, we made estimates of the anticipated timing of a potential liquidity event and estimates of the volatility of our equity securities. The anticipated timing was based on our plans toward the liquidity event and on our board of directors’ judgment. Estimating the volatility of the stock price of a privately held company is complex because there is no readily available market for the shares. We estimated the volatility of our stock based on available information on volatility of stocks of publicly traded companies in the industry.

 

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Discussion of Specific Valuation Factors from February 2008 through March 2010

We granted stock options in 2008, 2009 and 2010 with exercise prices between $1.50 and $76.20 per share. No single event caused the valuation of our common stock to increase or decrease from May 2008 to March 2010. Rather it has been a combination of the following factors that led to the changes in the fair value of the underlying common stock.

February 28, 2008 to July 23, 2008.    Our board of directors determined the fair value of our common stock to be $35.40 per share as of each grant date between February 28, 2008 and July 23, 2008, primarily based on the OPM allocation method. The OPM allocation method assumed an enterprise value of $65 million, which was based on the recent closing of our Series C preferred stock in February 2008 at a price of $159.30 to several venture capital and private equity firms. Based on this enterprise value, we determined the minimum and maximum ranges of values at which our debt and preferred and common equity holders would receive value, or the break points. We applied the Black-Scholes option model with option strike prices equal to the break points and the current stock price equal to our enterprise value. The expected term of the debt and preferred and common equity was defined as the average expected holding period of the investors in the security until a liquidity event and was determined to be 2.1 years. The volatility was based on the average volatility over the expected term for our peer companies and was determined to be 53%. The risk-free interest rate was 1.89%, based on U.S. Treasury Securities matching the expected term. Based on this information, we determined the total value of each security. We applied a discount of 25.2% for lack of marketability to the value of the common stock. This valuation indicated a fair value of $35.40 per share for our common stock.

July 24, 2008 to September 29, 2008.    No options were granted, and our board of directors did not make any determination of the fair value of our common stock.

September 30, 2008 to March 13, 2009.    Our board of directors determined the fair value of our common stock to be $76.20 per share as of each grant date between September 30, 2008 and March 13, 2009, primarily based on the PWERM allocation method. The common stock valuation was performed following the successful sequencing of our first genome in September 2008. The PWERM allocation method used a risk-adjusted discount of 35%, a marketability discount of 29.9% and a weighted-average estimated time to an initial public offering or a strategic merger or sale of 2.6 years. The expected outcomes were weighted toward the respective liquidity events as follows:

 

  §  

5% toward an initial public offering in 2010;

 

  §  

10% toward a strategic merger or sale in 2009;

 

  §  

20% toward a strategic merger or sale in 2010;

 

  §  

30% toward a dissolution of us with no value to common stock holders; and

 

  §  

35% toward remaining a private company.

This valuation indicated a fair value of $76.20 per share for our common stock. After September 2008 and through March 13, 2009, there was a significant negative change in the financial capital markets and a macro-economic downturn. However, neither the extent of the change nor the duration of the economic downturn was known to us. Accordingly, we continued to grant stock options in the first quarter of 2009 at an exercise price of $76.20 per share.

March 14, 2009 to August 30, 2009.    No options were granted, and our board of directors did not make any determination of the fair value of our common stock.

August 31, 2009 to March 22, 2010.    Our board of directors determined the fair value of our common stock to be $1.50 per share as of each grant date between August 31, 2009 and March 22, 2010, based on the OPM valuation method. Prior to August 31, 2009, as a result of the severe macro-economic downturn we temporarily reduced spending by reducing employee compensation and delaying any start-up and pre-production related expenditures. This delay in spending slowed the completion of our sequencing production facilities. As a result, our sales efforts and related revenue projections were also delayed. The board of directors did not consider the

 

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PWERM allocation method for this valuation as the method seemed inappropriate given our stage of development and the uncertainty surrounding the probable liquidity exits for us. The OPM allocation method assumed an enterprise value of $67 million, which was based on the recent closing of our Series D preferred stock in August 2009 at a price of $7.56 per share to several venture capital and private equity firms, which represented only a small increase in our enterprise value from July 2008. Based on this enterprise value, we determined the minimum and maximum ranges of values at which our debt and preferred and common equity holders would receive value. We applied the Black-Scholes option model with option strike prices equal to these break points and the current stock price equal to our enterprise value. The expected term until liquidity was determined to be 1.6 years. The volatility was based on the average volatility over the expected term for our peer companies and was determined to be 85%. The risk-free interest rate was 0.74%, based on U.S. Treasury Securities matching the expected term. Based on this information, we determined the total value of each security. We applied a discount of 21.2% for lack of marketability to the value of the common stock. This valuation indicated a fair value of $1.50 per share for our common stock.

March 23, 2010 to March 30, 2010.    No options were granted, and our board of directors did not make any determination of the fair value of our common stock.

March 31, 2010.    Our board of directors determined the fair value of our common stock to be $2.43 per share as of March 31, 2010, primarily based on the PWERM allocation method. The common stock valuation was performed following an additional closing of our Series D preferred stock financing at a price of $7.56 per share to several venture capital and private equity firms. The PWERM allocation method used a risk-adjusted discount of 25%, a marketability discount of 15% and a weighted-average estimated time to an initial public offering or a strategic merger or sale of 1.9 years. The expected outcomes were weighted toward the respective liquidity events as follows:

 

  §  

17.5% toward an initial public offering in 2010;

 

  §  

17.5% toward an initial public offering in 2011;

 

  §  

5% toward a strategic merger or sale in 2011;

 

  §  

5% toward a strategic merger or sale in 2012;

 

  §  

35% toward a dissolution of us with no value to common stock holders; and

 

  §  

20% toward a dissolution of us in which creditors are repaid and preferred investors will receive up to 0.5x of their original investment from the liquidation of assets and no value will be available to common stock holders.

The increase in the probability of a liquidity event from prior valuations was primarily related to the commencement of commercial operations and the achievement of revenue in the fourth quarter of 2009 and first quarter of 2010. However, substantial uncertainty still existed regarding our ability to sequence genomes on a cost-effective basis. This valuation indicated a fair value of $2.43 per share for our common stock.

Stock Option Modification

In January 2010, our board of directors approved a modification of outstanding unexercised stock options held by then-current employees and consultants to decrease the exercise price of these stock options to $1.50 per share. Other than a reduced exercise price, the terms and conditions of the stock options remained the same. All 85,477 unexercised options that were granted under our 2006 Equity Incentive Plan on or before January 28, 2010 and which had an exercise price greater than $1.50 per share were modified. The incremental stock-based compensation expense due to the modification was immaterial to our financial statements.

Income Taxes

We are subject to income taxes in the United States, and we use estimates in determining our provision for income taxes. We use the asset and liability method of accounting for income taxes. Under this method, deferred

 

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tax asset or liability account balances are calculated at the balance sheet date using current tax laws and rates in effect for the year in which the differences are expected to affect taxable income.

Recognition of deferred tax assets is appropriate when realization of such assets is more likely than not. We recognize a valuation allowance against our net deferred tax assets if it is more likely than not that some portion of the deferred tax assets will not be fully realizable. This assessment requires judgment as to the likelihood and amounts of future taxable income by tax jurisdiction. At December 31, 2009, we had a full valuation allowance against all of our deferred tax assets.

Effective January 1, 2007, we adopted the new authoritative guidance to account for uncertain tax positions. None of our currently unrecognized tax benefits would affect our effective income tax rate if recognized, due to the valuation allowance that currently offsets our deferred tax assets. We do not anticipate the total amount of unrecognized income tax benefits relating to tax positions existing at December 31, 2009 will significantly increase or decrease in the next 12 months.

We assess all material positions taken in any income tax return, including all significant uncertain positions, in all tax years that are still subject to assessment or challenge by relevant taxing authorities. Assessing an uncertain tax position begins with the initial determination of the position’s sustainability and is measured at the largest amount of benefit that is greater than 50% likely to be realized upon ultimate settlement. As of each balance sheet date, unresolved uncertain tax positions must be reassessed, and we will determine whether:

 

  §  

the factors underlying the sustainability assertion have changed; and

 

  §  

the amount of the recognized tax benefit is still appropriate.

The recognition and measurement of tax benefits requires significant judgment. Judgments concerning the recognition and measurement of a tax benefit might change as new information becomes available.

As of December 31, 2009, we had federal and state net operating loss carryforwards in each case of $59.7 million. The federal net operating loss carryforwards will begin to expire in 2026, and the state net operating loss carryforwards will begin to expire in 2016. In addition, as of December 31, 2009, we had federal and state research and development tax credit carryforwards of $1.9 million and $2.0 million, respectively. The federal research and development tax credit carryforwards will expire in 2026, if not used, and the state research and development tax credit carryforwards do not expire. Because of the net operating loss and credit carryforwards, all of our tax years, dating to inception in 2005, remain open to federal tax examinations. Most state tax jurisdictions have four open tax years at any point in time.

Under federal and similar state tax statutes, substantial changes in our ownership, including as a result of this offering, may limit our ability to use our available net operating loss and tax credit carryforwards. The annual limitation, as a result of a change-in-control, may result in the expiration of net operating losses and credits before utilization. We conducted an analysis through December 31, 2009 to determine whether ownership changes occurred. We concluded that two ownership changes had occurred. However, as of December 31, 2009, no net operating losses or tax credits will expire unused as a result of these changes.

Results of Operations

During the year ended December 31, 2009, our results of operations were impacted by the following events, which should be considered when reading the discussion of our results of operations comparing the years ended December 31, 2008 and 2009 and the three months ended March 31, 2009 and 2010:

 

  §  

In 2009, we initiated start-up production activities using resources from our research and development organization. Using these research and development resources for production activities decreased research and development expenses during 2009 by approximately $4.7 million.

 

  §  

In the second quarter of 2009, we implemented temporary cost-reduction initiatives to conserve cash in light of macro-economic conditions. The temporary cost-reduction initiatives included a salary reduction for all company employees that averaged approximately 50%. The impact of the temporary cost-reduction initiatives on our 2009 operating results was approximately $3.4 million, including reductions in employee salaries and benefits of approximately $2.0 million, consulting and outside engineering

 

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services by approximately $0.6 million and prototype equipment expenses by approximately $0.4 million. In the second quarter of 2009, as a result of these cost-reduction initiatives, research and development, general and administrative and sales and marketing expenses decreased $2.7 million, $0.5 million and $0.2 million, respectively, compared to the first quarter of 2009.

 

  §  

During the fourth quarter of 2009, we reevaluated the expected useful lives of our equipment and determined that for certain of our equipment, the useful life should be shortened. Accordingly, we accelerated depreciation of this equipment, resulting in an additional $1.0 million in depreciation expense in the fourth quarter of 2009. Of this $1.0 million charge, approximately $0.5 million was recorded as start-up production costs and approximately $0.5 million was recorded as research and development expense.

Comparison of Three Months Ended March 31, 2009 and 2010

The following table shows the amounts of the listed items from our statements of operations for the periods presented, showing period-over-period changes (in thousands, except for percentages).

 

     Three months ended
March 31,
    2010 vs. 2009  
      2009     2010     $ Change     % Change  

Revenue

   $      $ 336      $ 336      *
                              

Operating expenses:

        

Start-up production costs

     326        4,077        3,751      1,151

Research and development

     6,746        6,169        (577   (9 )% 

General and administrative

     1,298        3,099        1,801      139

Sales and marketing

     427        1,226        799      187
                              

Total operating expenses

     8,797        14,571        5,774      66
                              

Loss from operations

     (8,797     (14,235     (5,438   62

Interest expense

     (679     (311     368      (54 )% 

Interest and other income (expense), net

     (22     210        232      (1,055 )% 
                              

Net loss

   $ (9,498   $ (14,336   $ (4,838   51
                              

 

* Percentage not meaningful.

Revenue

We recognized revenue of $0.3 million in the first quarter of 2010 representing sales to five customers. We did not recognize revenue during the first quarter of 2009.

Start-up Production Costs

During the first quarter of 2010, we incurred $4.1 million of start-up production costs to support our genome sequencing service, compared to $0.3 million in the first quarter of 2009. These activities include the acceptance testing of customer genomic samples, sample sequencing preparation and sample sequencing in addition to the processing of data generated by the sequencing instrument. The increase in start-up production costs was primarily due to employee salaries and benefits and stock-based compensation expenses of $1.3 million and $0.1 million, respectively, depreciation expense of $0.7 million, facilities and maintenance costs of $0.6 million, reagents, materials and supplies expenses of $0.4 million, data communication charges of $0.4 million and consulting expenses of $0.1 million. As in 2009, we continued to incur considerable start-up costs in excess of revenue during the first quarter of 2010 to initiate and bring our human genome sequencing production process to commercial-scale. We continued to commit significant personnel and equipment resources to our production process in advance of our achieving significant production volume. As only a portion of our production expenses varies with our revenue, our production costs will be greater than our revenue until we achieve significant product volume and revenues.

 

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We anticipate that our start-up production costs will decrease as we continue to improve and automate our human genome sequencing processes and increase the throughput of our sequencing technology. Conversely, we anticipate that our costs of providing sequencing services will increase if we sequence additional genomes and our revenue grows as we anticipate.

Research and Development

Research and development expenses were $6.2 million during the quarter ended March 31, 2010 compared to $6.7 million during the quarter ended March 31, 2009, representing a decrease of $0.6 million, or 9%, as we allocated costs to start-up production activities. The decrease in research and development expenses is principally due to a reduction in depreciation expense of $0.6 million, a decrease in consulting expense and outside engineering services of $0.3 million and a reduction relating to equipment, reagents, materials and supplies and prototype equipment expenses of $0.2 million. These decreases in research and development expense were offset by an increase in salaries and benefits expense and stock-based compensation expense of $0.5 million and $0.1 million, respectively, and an increase in facilities and maintenance costs of $0.2 million associated with the expansion of our facilities in 2009.

We expect to continue to invest in research and development activities as we seek to enhance our sequencing processes, components and systems to improve the yield and throughputs and reduce the cost of our sequencing service. We anticipate a continued investment in research and development and believe that in the near future, our research and development expenses will increase.

General and Administrative

General and administrative expenses were $3.1 million for the three months ended March 31, 2010 compared to $1.3 million for the three months ended March 31, 2009, representing an increase of $1.8 million, or 139%. The increase in general and administrative expenses was due to increases in employee salaries and benefits and stock-based compensation expense of $1.5 million and $0.2 million, respectively, associated with increased administrative headcount to support the overall growth of the company. In addition, consulting expense increased by $0.2 million, and outside services expenses for legal and accounting support increased by $0.1 million. The overall increase in general and administrative expenses was offset by a decrease in facilities and maintenance costs of $0.2 million.

We expect that general and administrative expenses will increase in 2010 and beyond as we increase the headcount of our finance and administrative staff as we operate as a public company. We anticipate that we will incur increased expenses related to audit, legal, regulatory and tax-related services associated with maintaining compliance with exchange listing and Securities and Exchange Commission requirements, directors’ and officers’ insurance and investor relation programs.

Sales and Marketing

Sales and marketing expenses were $1.2 million during the quarter ended March 31, 2010 compared to $0.4 million during the quarter ended March 31, 2009, representing an increase of $0.8 million, or 187%. The increase in sales and marketing expenses is due primarily to an increase in employee salaries and benefits of $0.4 million associated with the growth of our sales and marketing organization, an increase in marketing research and public relations expenses of $0.2 million and an increase in facilities and maintenance costs of $0.1 million as a result of an increase in headcount.

We expect that sales and marketing expenses will increase significantly in 2010 as we increase our headcount for sales, marketing and service personnel to support our expected growth in revenue and expansion of our customer base.

Interest Expense

During the first quarter of 2010, we incurred interest expense of $0.3 million compared to $0.7 million during the first quarter of 2009. The decrease in interest expense was a result of a lower outstanding balance on our credit

 

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facility during the first quarter of 2010 compared to the first quarter of 2009 and lower amortization of the initial value of our preferred stock warrants that were issued in connection with our borrowings.

Interest and Other Income (Expense), Net

The increase in interest and other income (expense), net, of $0.2 million between first quarter of 2010 and the first quarter of 2009 was due primarily to the change in the valuation of our convertible preferred stock warrants.

Comparison of Years Ended December 31, 2007, 2008 and 2009

The following table shows the amounts of the listed items from our statements of operations for the periods presented, showing period-over-period changes (in thousands, except percentages).

 

    Years ended December 31,     2008 vs. 2007     2009 vs. 2008  
     2007     2008     2009     $ Change     % Change     $ Change         % Change      

Revenue

  $      $      $ 623      $        $ 623      *

Operating expenses:

             

Start-up production costs

                  5,033                 5,033      *

Research and development

    10,305        23,633        22,424        13,328      129     (1,209   (5 )% 

General and administrative

    1,896        3,179        4,953        1,283      68     1,774      56

Sales and marketing

           1,045        1,798        1,045      *     753      72
                                                   

Total operating expenses

    12,201        27,857        34,208        15,656      128     6,351      23
                                                   

Loss from operations

    (12,201     (27,857     (33,585     (15,656   128     (5,728   21

Interest expense

    (215     (974     (3,465     (759   353     (2,491   256

Interest and other income (expense), net

    163        437        1,101        274      168     664      152
                                                   

Net loss

  $ (12,253   $ (28,394   $ (35,949   $ (16,141   132   $ (7,555   27
                                                   

 

* Percentage not meaningful.

Revenue

We recognized our first revenue of $0.6 million in the fourth quarter of 2009, representing sales to seven customers.

Start-up Production Costs

During 2009, we incurred $5.0 million of start-up production costs to support our genome sequencing service. These activities include the acceptance testing of customer genomic samples, sample sequencing preparation and sample sequencing in addition to the processing of data generated by the sequencing instrument. These costs primarily consisted of employee salaries and benefits and stock-based compensation expense of $1.7 million and $0.1 million, respectively, depreciation expense of $1.5 million, facilities and maintenance costs of $0.6 million, reagents, materials and supplies expense of $0.3 million, data communication charges of $0.2 million, equipment expense of $0.2 million and consulting expenses of $0.2 million. We incurred considerable start-up production costs in excess of revenue during 2009 to initiate and bring our human genome sequencing production process to commercial scale. We committed significant personnel and equipment resources to our production process in advance of our achieving significant production volume. Only a portion of our production expenses varies with our service revenue. Accordingly, unless we approach significant production volume and revenue, our production costs will be greater than our revenue.

Research and Development

Research and development expenses decreased $1.2 million, or 5%, from 2008 to 2009 as we used resources from our research organization to initiate commercial operations and implemented temporary cost-reduction initiatives in the second quarter of 2009. This decrease reflects a reduction in equipment, reagents, materials and supplies and prototype equipment expense of $1.5 million. The reduction in equipment, reagents, materials and

 

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supplies expenses primarily reflects their usage in start-up production activities. The reduction in prototype equipment expense reflects our transition to developing production equipment as well as cost-reduction measures in the second quarter of 2009. In addition, the decrease in research and development expense reflects a reduction in licensing arrangements expense of $1.2 million, of which, $1.0 million represents a one-time payment to Callida Genomics, Inc. in 2008 pursuant to our intellectual property license arrangement. The decrease in research and development expense also reflects a reduction in consulting expense and outside engineering services of $0.9 million and the disposal of obsolete equipment in 2008 of $0.5 million. These decreases in research and development expense were offset by increased equipment depreciation expense of $0.9 million related to investments in computing and other equipment and software and acceleration of depreciation expense for certain equipment, increased employee salaries and benefits of $0.6 million related to increased headcount. The decrease in research and development expense was further offset by increased stock-based compensation expense of $0.7 million, increased facilities and maintenance costs of $0.6 million associated with the expansion of our facilities in 2009 and increased data communication costs of $0.5 million related to the expansion of our offsite data center.

Research and development expenses increased $13.3 million, or 129%, from 2007 to 2008 reflecting increased salaries and benefits of $4.7 million relating to increased headcount, increased employee recruiting fees of $0.6 million and increased stock-based compensation expense of $0.2 million. In addition, the increase in research and development expenses reflects increased consumption of reagents, materials and supplies and prototype equipment of $2.1 million, increased depreciation expense of $2.0 million primarily related to investments in computing and storage equipment, increased facilities and maintenance costs of $1.2 million related to occupying a larger facility beginning in September 2007, increased license fees of $1.0 million related to our intellectual property license arrangement with Callida Genomics, increased consulting expense and outside engineering services of $0.7 million and the disposal of obsolete equipment of $0.5 million.

General and Administrative

General and administrative expenses increased $1.8 million, or 56%, from 2008 to 2009 primarily reflecting increased facilities and maintenance costs of $1.1 million. During 2009, significant portions of our facility were renovated to accommodate our genome sequencing center. During the period of renovation, the space being renovated was unoccupied, and associated costs were recorded as general and administrative expense. In addition, general and administrative expenses reflect increased employee salaries and benefits and stock-based compensation expense of $0.1 million and $0.2 million, respectively, legal expenses of $0.2 million, primarily related to intellectual property matters and patent prosecution, increased consulting expenses of $0.1 million related to financial and human resources consultants and increased payroll and benefits servicing fees of $0.1 million.

General and administrative expenses increased $1.3 million, or 68%, from 2007 to 2008 reflecting increased employee salaries and benefits and stock-based compensation expense of $0.5 million and $0.1 million, respectively, related to increased headcount to support our growing research and development organization, legal expenses of $0.4 million primarily related to intellectual property matters and patent prosecution, increased facilities and maintenance expenses of $0.1 million, increased financial and human resources consultants expenses of $0.1 million and increased payroll and benefits servicing fees of $0.1 million.

Sales and Marketing

Sales and marketing expenses increased $0.8 million, or 72%, from 2008 to 2009 reflecting increased employee salaries and benefits and stock-based compensation expense of $0.7 million and $0.1 million, respectively, related to increased headcount, increased facilities and maintenance costs of $0.1 million and increased travel expenses $0.1 million. The increase in sales and marketing expenses was partially offset by decreased marketing research and public relations expenses of $0.3 million. Our sales and marketing expenses in 2008 reflects our initial investment in marketing activities and primarily consists of marketing research and public relations activities. We did not incur any sales and marketing expenses in 2007.

 

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Interest Expense

Interest expense increased by $2.5 million, or 256%, from 2008 to 2009 primarily due to $1.0 million of interest expense on higher loan balances under our new credit facility and $1.5 million of interest charges related borrowings under convertible notes issued in 2009.

Interest expense increased $0.8 million, or 353%, from 2007 to 2008. During 2007, we had two credit facilities under which we had outstanding borrowings of $4.0 million. In 2008, we entered into a new credit facility for $13.0 million, a portion of which was used to repay in full the then-outstanding balances on the credit facilities. The increase in interest expense in 2008 is primarily a result of the larger loan balance and the costs associated with the prepayment of the two credit facilities.

Interest and Other Income (Expense), Net

The increase in interest and other income (expense), net, of $0.7 million from 2008 to 2009 was primarily due to the change in valuation of our convertible preferred stock warrants in 2009, offset by lower interest income due to lower cash and cash equivalents balances, as well as lower effective rates of interest earned on our cash equivalents balance.

The increase in interest and other income (expense), net, of $0.3 million from 2007 to 2008 was primarily due to the change in the valuation of our convertible preferred stock warrants.

Selected Quarterly Results of Operations

The following table presents our unaudited quarterly results of operations for the eight fiscal quarters ended March 31, 2010. This unaudited quarterly information has been prepared on the same basis as our audited financial statements and includes all adjustments, consisting of only normal recurring adjustments, necessary for the fair statement of the information for the quarters presented. You should read this table in conjunction with our financial statements and the related notes thereto included in this prospectus. The results of operations for any quarter are not necessarily indicative of the results of operations for any future period.

 

    Fiscal 2008, quarter ended     Fiscal 2009, quarter ended     Fiscal  2010,
quarter
ended

Mar. 31
 
     Jun. 30     Sept. 30     Dec. 31     Mar. 31     Jun. 30     Sept. 30     Dec. 31    
    (in thousands)  

Statements of Operations Data:

               

Revenue

  $      $      $      $      $      $      $ 623      $ 336   

Operating expenses:

               

Start-up production costs(1)

                         326        687        1,258        2,762        4,077   

Research and development(1)

    5,127        5,440        8,446        6,746        3,703        5,638        6,337        6,169   

General and administrative(1)

    723        704        1,037        1,298        822        1,352        1,481        3,099   

Sales and marketing(1)

    180        511        300        427        193        366        812        1,226   
                                                               

Total operating expenses(1)

    6,030        6,655        9,783        8,797        5,405        8,614        11,392        14,571   
                                                               

Loss from operations

    (6,030     (6,655     (9,783     (8,797     (5,405     (8,614     (10,769     (14,235

Interest expense

    (127     (325     (392     (679     (1,372     (1,073     (341     (311

Interest and other income (expense), net

    123        31        62        (22     (48     439        732        210   
                                                               

Net loss

  $ (6,034   $ (6,949   $ (10,113   $ (9,498   $ (6,825   $ (9,248   $ (10,378   $ (14,336
                                                               

 

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(1) Includes stock-based compensation expense as follows:

 

     Fiscal 2008, quarter ended    Fiscal 2009, quarter ended    Fiscal  2010,
quarter
ended

Mar. 31
      Jun. 30    Sept. 30    Dec. 31    Mar. 31    Jun. 30    Sept. 30    Dec. 31   
     (in thousands)

Start-up production costs

   $    $    $    $ 4    $ 11    $ 12    $ 54    $ 61

Research and development

     59      54      101      116      109      100      667      250

General and administrative

     12      15      53      39      39      42      142      200

Sales and marketing

                    14      11      12      38      29
                                                       

Total stock-based compensation expense

   $ 71    $ 69    $ 154    $ 173    $ 170    $ 166    $ 901    $ 540
                                                       

Liquidity and Capital Resources

Since our inception, we have generated operating losses in every quarter, resulting in a deficit accumulated during the development stage of $95.5 million as of March 31, 2010. We have financed our operations to date primarily through private placements of preferred stock and convertible debt and borrowings under our credit facilities. Through March 31, 2010, we have received net proceeds of $95.9 million from the issuance of preferred stock and convertible debt. As of March 31, 2010, we had negative working capital of $(10.6) million, consisting of $5.4 million in current assets and $16.0 million in current liabilities. As of December 31, 2009, working capital was $3.0 million, consisting of $15.0 million in current assets and $12.0 million in current liabilities. Our cash is invested primarily in money market funds. Cash in excess of immediate operating requirements is invested in accordance with our investment policy, primarily with the goals of capital preservation and liquidity maintenance.

Summary Statement of Cash Flows

The following table summarizes our cash flows for the years ended December 31, 2007, 2008 and 2009 and the three months ended March 31, 2009 and 2010.

 

     Years ended December 31,     Three months ended
March 31,
 
      2007     2008     2009     2009     2010  
                       (unaudited)  
     (in thousands)  

Net cash used in operating activities

   $ (9,984   $ (24,303   $ (26,662   $ (7,390   $ (4,225

Net cash used in investing activities

     (3,729     (7,419     (9,654     (412     (10,172

Net cash provided by financing activities

     16,341        33,648        37,895        3,069        9,003   
                                        

Net increase (decrease) in cash and cash equivalents

   $ 2,628      $ 1,926      $ 1,579      $ (4,733   $ (5,394
                                        

Cash Flows for the Three Months Ended March 31, 2009 and 2010

Operating Activities

Net cash used in operating activities was $4.2 million during the three months ended March 31, 2010 and consisted of a net loss of $14.3 million, offset by noncash items of $3.6 million and a net increase in operating assets and liabilities of $6.5 million. Noncash items for the quarter ended March 31, 2010 consisted primarily of depreciation and amortization expense of $1.3 million, compensation expense for common stock issued to our founders of $1.8 million and stock-based compensation expense of $0.5 million. The significant items in the changes in operating assets and liabilities include a decrease in prepaid expenses of $4.6 million and increases in deferred revenue, accrued liabilities, accounts payable and inventory of $1.5 million, $0.5 million, $0.4 million and $0.4 million, respectively. The decrease in prepaid expenses was due to the receipt of sequencers in the first quarter of 2010 that were paid for in the fourth quarter of 2009. The increase in deferred revenue was due to advance billing arrangements during the first quarter of 2010. The increases in accrued liabilities and accounts payable were a result of payments for purchases made late in the fourth quarter of 2009 to support an increase in

 

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production. The increase in inventory was due to inventory purchases made in the first quarter of 2010 to support customer orders.

Net cash used in operating activities was $7.4 million during the three months ended March 31, 2009 and consisted of a net loss of $9.5 million, offset by noncash items of $1.6 million and a net increase in operating assets and liabilities of $0.5 million. Noncash items for the quarter ended March 31, 2009 consisted primarily of depreciation and amortization expense of $1.0 million, noncash interest expense related to our convertible notes and notes payable of $0.3 million and stock-based compensation expense of $0.2 million. The significant changes in operating assets and liabilities include an increase in accounts payable of $1.0 million, offset by a decrease in accrued liabilities of $0.2 million and an increase in other assets of $0.2 million.

Investing Activities

Net cash used in investing activities was $10.2 million and $0.4 million for the three months ended March 31, 2010 and 2009, respectively. The amounts related entirely to purchases of property and equipment. The purchases of property and equipment during the first quarter of 2010 were primarily for sequencing equipment used in production, while the purchases of property and equipment during the first quarter of 2009 were for equipment used in our research and development activities.

Financing Activities

Net cash provided by financing activities during the quarter ended March 31, 2010 of $9.0 million consisted primarily of net proceeds from the issuance and sale of Series D preferred stock in February and March 2010 of $10.1 million, offset by repayment of equipment loan borrowings of $1.1 million. Net cash provided by financing activities during the quarter ended March 31, 2009 of $3.1 million consisted primarily of proceeds from the issuance and sale of convertible notes of $4.0 million, offset by repayment of equipment loan borrowings of $1.0 million.

Cash Flows for the Years Ended December 31, 2007, 2008 and 2009

Operating Activities

Net cash used in operating activities was $26.7 million for the year ended December 31, 2009 and consisted of a net loss of $35.9 million, offset by noncash items of $8.0 million and a net increase in operating assets and liabilities of $1.3 million. Noncash items for the year ended December 31, 2009 consisted primarily of depreciation and amortization expense of $5.2 million, noncash interest expense related to our convertible notes and notes payable of $2.1 million and stock-based compensation expense of $1.4 million, offset by the change in fair value of our convertible preferred stock warrant liability of $1.1 million. The significant items in the changes in operating assets and liabilities include increases in deferred rent, deferred revenue and accounts payable of $5.0 million, $1.3 million and $1.1 million, respectively, offset by increases in prepaid expenses and accounts receivable of $4.7 million and $1.3 million, respectively. The significant change in deferred rent is due to the difference between rent amounts paid and amounts expensed during 2009 on our facility, while the significant increase in prepaid expenses is due to advance payment arrangements for our sequencers. The increase in accounts payable during 2009 is due to increased purchases associated with the start-up of our production facilities during the fourth quarter of 2009. The increases in accounts receivable and deferred revenue were due to revenue recognized in the fourth quarter of 2009 and advance billing arrangements with customers.

Net cash used in operating activities was $24.3 million for the year ended December 31, 2008 and consisted of a net loss of $28.4 million, offset by noncash items of $3.8 million and net increases in operating assets and liabilities of $0.3 million. Noncash items for the year ended December 31, 2008 consisted mainly of depreciation and amortization expense of $2.8 million, a loss on the disposal of property and equipment of $0.5 million and stock-based compensation expense of $0.3 million. Changes in operating assets and liabilities consisted of an increase in accrued liabilities of $0.7 million, offset by increases in prepaid expenses of $0.2 million and other current assets of $0.2 million.

 

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Net cash used in operating activities was $10.0 million for the year ended December 31, 2007 and consisted of a net loss of $12.3 million, offset by noncash charges of $1.1 million and a net increase in operating assets and liabilities of $1.1 million. Noncash items for the year ended December 31, 2007 consist of depreciation and amortization expense of $0.8 million, a change in the fair value of our convertible preferred stock warrant liability of $0.2 million and stock-based compensation expense of $0.1 million. The net increase in the changes in operating assets and liabilities was primarily due to increases in accrued liabilities and accounts payable of $0.8 million and $0.6 million, respectively, as a result of our increased research and development activities during the year ended December 31, 2007, offset by increases in prepaid expenses and other assets of $0.2 million and $0.1 million, respectively.

Investing Activities

Net cash used in investing activities were $9.7 million, $7.4 million and $3.7 million for the years ended December 31, 2009, 2008 and 2007, respectively, relating entirely to purchases of property and equipment. Purchases of property and equipment during 2009 consisted primarily leasehold improvements made to our facility in Mountain View, California and equipment to support the start-up of our production facilities. Purchases of property and equipment during 2008 and 2007 were primarily for equipment to support our research and development activities.

Financing Activities

Net cash provided by financing activities during the year ended December 31, 2009 of $37.9 million consisted primarily of net proceeds from the issuance of Series D preferred stock in August 2009 of $27.2 million and net proceeds from the issuance of convertible promissory notes of $14.7 million, offset by repayment of equipment loan borrowings of $4.0 million.

Net cash provided by financing activities during the year ended December 31, 2008 of $33.6 million consisted primarily of net proceeds from the issuance of Series C preferred stock in February 2008 of $25.4 million and proceeds from equipment loan borrowings of $13.2 million, offset by repayment of equipment loan borrowings of $5.0 million.

Net cash provided by financing activities during the year ended December 31, 2007 of $16.3 million consisted primarily of net proceeds from the issuance of Series B preferred stock in March 2007 of $12.9 million, proceeds from equipment loan borrowings of $2.8 million and proceeds from the issuance of convertible promissory notes of $1.0 million, offset by repayment of equipment borrowings of $0.3 million.

Operating and Capital Expenditure Requirements

To date, we have not achieved profitability on a quarterly or annual basis. We expect our cash expenditures to increase significantly in the near term, including significant expenditures for the expansion of our Mountain View sequencing facility and the possible development of additional sequencing centers, research and development, sales and marketing and general and administrative expenses. As a public company, we will also incur significant legal, accounting and other expenses that we did not incur as a private company. We anticipate that we will continue to incur net losses for the foreseeable future as we continue to expand our business and build our infrastructure.

We believe that, based on our current level of operations and anticipated growth, net proceeds from this offering, together with our cash and cash equivalent balances and interest income we earn on these balances, will be sufficient to meet our anticipated cash requirements through at least the next 12 months. If our available cash balances and net proceeds from this offering are insufficient to satisfy our liquidity requirements, we may seek to sell additional equity or convertible debt securities or enter into another credit facility. The sale of additional equity or convertible debt securities may result in dilution to our stockholders. If we raise additional funds through the issuance of convertible debt securities, these securities could have rights senior to those of our common stock and could contain covenants that restrict our operations. We may require additional capital beyond our currently forecasted amounts and additional capital may not be available on reasonable terms, if at all.

 

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Our forecast of the period of time through which our financial resources will be adequate to support our operations and the costs to support our general and administrative, sales and marketing and research and development activities are forward-looking statements and involve risks and uncertainties. Actual results could vary materially and negatively as a result of a number of factors, including the factors discussed under the caption “Risk Factors.” We have based these estimates on assumptions that may prove to be wrong, and we could use our available capital resources sooner than we currently expect.

Our future capital requirements will depend on many factors, including, but not limited to, the following:

 

  §  

the financial success of our genome sequencing business;

 

  §  

our ability to increase the genome sequencing capacity in our Mountain View facility;

 

  §  

whether we are successful in obtaining payments from customers;

 

  §  

whether we can enter into collaborations and establish a recurring customer base;

 

  §  

the progress and scope of our research and development projects;

 

  §  

the filing, prosecution and enforcement of patent claims;

 

  §  

the rate at which we establish satellite genome sequencing centers and whether we can find suitable partners to establish those centers;

 

  §  

the effect of any joint ventures or acquisitions of other businesses or technologies that we may enter into or make in the future; and

 

  §  

lawsuits brought against us by third parties.

Contractual Obligations and Commitments

The following summarizes the future commitments arising from our contractual obligations at December 31, 2009 (in thousands):

 

Contractual obligations

 

   Payment due by period
   Total    Less than
1 year
   1-3 years    3-5 years   

More than

5 years

Debt obligations(1)

   $ 7,707    $ 4,440    $ 3,267    $    $

Interest expense payments(2)

     1,276      617      659          

Operating lease obligations(3)

     17,886      2,610      5,098      5,415      4,763

Purchase obligations(4)

     6,972      6,133      428      411     
                                  

Total

   $ 33,841    $ 13,800    $ 9,452    $ 5,826    $ 4,763
                                  

 

(1) Represents our outstanding debt under our credit facility as of December 31, 2009.
(2) Represents interest payments on our outstanding debt under our credit facility as of December 31, 2009 and termination payments related to our credit facility due on the maturity date of the notes.
(3) Consists of contractual obligations under non-cancellable office space operating leases.
(4)

Consists of purchase obligations related to our data center and related connectivity and non-cancellable orders for sequencing components.

Credit Facility

In July 2008, we entered into loan and security agreement with various financial institutions to provide for a term loan of $8.0 million and an equipment credit line of up to $5.0 million. Our borrowings under this credit facility have been secured by substantially all of our assets, other than our intellectual property. Payments of accrued interest and principal are due on the first day of each month, and one final payment of the remaining unpaid balance of principal and accrued interest is due on the maturity of each of the credit extensions. Outstanding borrowings, including the accreted portion of the termination payment, under the credit facility were $8.0 million and $6.9 million as of December 31, 2009 and March 31, 2010, respectively, and no further borrowings under our credit facility are available. Interest accrues at an annual rate between 10.50% and 11.04%, as determined at the time of the draw-down.

 

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The credit facility includes various covenants. We were in compliance with all required covenants in our credit facility as of December 31, 2009 and March 31, 2010.

Indemnifications

In the normal course of business, we enter into contracts and agreements that contain a variety of representations and warranties and provide for general indemnifications. Our exposure under these agreements is unknown because it involves claims that may be made against us in the future, but have not yet been made. To date, we have not paid any claims or been required to defend any action related to our indemnification obligations. However, we may record charges in the future as a result of these indemnification obligations.

In accordance with our certificate of incorporation and bylaws, we have indemnification obligations to our officers and directors for specified events or occurrences, subject to some limits, while they are serving our request in such capacities. There have been no claims to date, and we have director and officer insurance that may enable us to recover a portion of any amounts paid for future potential claims.

Off-Balance Sheet Arrangements

Since our inception, we have not engaged in any off-balance sheet arrangements, including the use of structured finance, special purpose entities or variable interest entities.

Recent Accounting Pronouncements

In October 2009, the Financial Accounting Standards Board, or FASB, issued a new accounting standard that changes the accounting for revenue arrangements with multiple deliverables. Specifically, the new accounting standard requires an entity to allocate arrangement consideration at the inception of an arrangement to all of its deliverables based on their relative selling prices. In addition, the new standard eliminates the use of the residual method of allocation and requires the relative-selling-price method in all circumstances in which an entity recognizes revenue for an arrangement with multiple deliverables. In October 2009, the FASB also issued a new accounting standard that changes revenue recognition for tangible products containing software and hardware elements. Specifically, if certain requirements are met, revenue arrangements that contain tangible products with software elements that are essential to the functionality of the products are scoped out of the existing software revenue recognition accounting guidance and will be accounted for under these new accounting standards. Both standards will be effective for us in the first quarter of 2011. Early adoption is permitted. We are currently assessing the impact that the adoption of these standards will have on our financial statements.

In January 2010, the FASB issued an amendment to an accounting standard which requires new disclosures for fair value measures and provides clarification for existing disclosure requirements. Specifically, this amendment requires an entity to disclose separately the amounts of significant transfers in and out of Level 1 and Level 2 fair value measurements and to describe the reasons for the transfer. This amendment also requires an entity to disclose separately information about purchases, sales, issuances and settlements in the reconciliation for fair value measurements using significant unobservable inputs, or Level 3 inputs. This amendment clarifies existing disclosure requirements for the level of disaggregation used for classes of assets and liabilities measured at fair value and requires disclosure about the valuation techniques and inputs used to measure fair value for both recurring and nonrecurring fair value measurements using Level 2 and Level 3 inputs. This guidance is effective for interim and annual reporting periods beginning after December 15, 2009, except for certain Level 3 activity disclosure requirements that will be effective for reporting periods after December 15, 2010. Accordingly, we adopted this amendment on January 1, 2010, except for the additional Level 3 requirements, which will be adopted in 2011. Other than requiring additional disclosures, adoption of this new guidance did not have a material impact on our financial statements.

Quantitative and Qualitative Disclosures About Market Risk

Our exposure to market risk is principally limited to exposure to interest rate risk related to our cash and cash equivalent balances. Due to the fixed interest rates of the borrowing under our credit facility, we do not currently

 

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have any exposure to changes in our interest expense as a result of changes in interest rates. In addition, we are not exposed to material foreign exchange risk because sales to customers located outside of the United States are denominated in U.S. dollars.

Cash and Cash Equivalents

The primary objectives of our investment activity are to preserve principal, provide liquidity and maximize income without significantly increasing risk. By policy, we do not enter into investments for trading or speculative purposes. Some of the securities in which we invest, however, may be subject to interest rate risk. This means that a change in prevailing interest rates may cause the principal or stated amount of the investment to fluctuate. To minimize this risk, we invest primarily in money market funds. Due to the nature of these investments, we believe that we do not currently have any material exposure to changes in the fair value of our investment portfolio as a result of changes in interest rates.

 

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Business

Overview

We are a life sciences company that has developed and commercialized an innovative DNA sequencing platform that we believe will become the preferred solution for complete human genome sequencing and analysis. Our Complete Genomics Analysis Platform, or CGA Platform, combines our proprietary human genome sequencing technology with our advanced informatics and data management software and our innovative, end-to-end, outsourced service model to provide our customers with data that is immediately ready to be used for genome-based research. We believe that our solution will provide academic and biopharmaceutical researchers with complete human genomic data and analysis at an unprecedented quality, cost and scale without requiring them to invest in in-house sequencing instruments, high-performance computing resources and specialized personnel. By removing these constraints and broadly enabling researchers to conduct large-scale complete human genome studies, we believe that our solution has the potential to revolutionize medical research and expand understanding of the basis, treatment and prevention of complex diseases.

We believe that our human genome sequencing technology, which is based on our proprietary DNA arrays and ligation-based read technology, is superior to existing commercially available complete human genome sequencing methods in terms of quality, cost and scale. In the DNA sequencing industry, complete human genome sequencing is generally deemed to be coverage of at least 90% of the nucleotides in the genome. Because we have optimized our technology platform and our operations for the unique requirements of high-throughput complete human genome sequencing, we are able to achieve accuracy levels of 99.999% at a total cost that is significantly less than the total cost of purchasing and using commercially available DNA sequencing instruments. We believe that we will be able to further improve our accuracy levels and reduce the total cost of sequencing and analysis, enabling us to maintain significant competitive advantages over the next several years. Because our technology resides only in our centralized facilities, we can quickly and easily implement enhancements and provide their benefits to our entire customer base. We believe that we will be the first company to sequence and analyze high-quality complete human genomes, at scale, for a total cost of under $1,000 per genome.

While our competitors primarily sell DNA sequencing instruments and reagents that produce raw sequenced data, requiring their customers to invest significant additional resources to process that raw data into a form usable for research, we offer our customers an end-to-end, outsourced solution that delivers research-ready genomic data. As the cost of complete human genome sequencing declines, we believe the basis of competition in our industry will shift from the cost of sequencing to the value of the entire sequencing solution. We believe that our integrated advanced informatics and data management services will emerge as a key competitive advantage as this shift occurs.

Our genome sequencing center, which began commercial operations in May 2010, combines a high-throughput sample preparation facility, a collection of our proprietary high-throughput sequencing instruments and a large-scale data center. Our customers ship us their samples via common carrier services such as Federal Express and United Parcel Service. We then sequence and analyze these samples and provide our customers with finished, research-ready data, enabling them to focus exclusively on their single highest priority, discovery.

As of March 31, 2010, there had been approximately 24 published and 200 unpublished complete human genomes sequenced worldwide, as reported in the April 2010 edition of Nature. As of July 20, 2010, we have sequenced over 200 complete human genomes year-to-date, including more than 100 in the first three weeks of July 2010, and have an order backlog of over 500 genomes. Our customers include some of the leading global academic and government research centers and biopharmaceutical companies. By the end of 2010, we expect our facility to have the capacity to sequence and analyze over 400 complete human genomes per month. We expect this capacity to increase over threefold in 2011. In future years, we plan to construct additional genome centers in the United States and other strategic markets to accommodate an expected growing global demand for high-quality, low-cost complete human genome sequencing on a large scale.

 

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Market Overview

Background

Every organism has a genome that contains the full set of biological instructions required to build and maintain a living example of that organism. The information contained in a genome is stored, or encoded, in deoxyribonucleic acid, or DNA, a nucleic acid that is found in each cell of the organism. DNA is divided into discrete units called genes, which carry specific information necessary to perform a particular biological function, such as instructions for making proteins. The chemical building blocks that make up each gene are the molecules adenine, cytosine, guanine and thymine, labeled as A, C, G and T, respectively, which are known as nucleotide bases. Human DNA has approximately three billion nucleotide bases, and their precise order is commonly known as the DNA or genetic sequence.

Studying how genes and proteins differ between species and among individuals within a species, or genetic variations, helps scientists to determine their functions and roles in health and disease. These genetic variations can have important medical consequences. Genetic variations may, for example, cause an individual to have a predisposition to certain diseases or to respond differently to certain drug treatments. Accordingly, improving our understanding of the genome and its functions has driven and, we expect, will continue to drive advancements in medical research and diagnostics.

Genetic Analysis Market

Genetic analysis products comprise instruments and consumables, as well as associated hardware, software and services directly involved in the study of DNA and RNA. Scientia Advisors, a third-party research firm, estimated genomic revenue in 2009 to be approximately $5.8 billion and projects the market to grow to approximately $9.0 billion by 2014. The medical research market consists of laboratories generally associated with universities, medical research centers and government institutions, as well as biotechnology and pharmaceutical companies. In the longer term, we believe genetic analysis tools will likely play a critical role in molecular diagnostics. By detecting small, individual genetic differences, we believe molecular diagnostic tests could be used to identify predisposition to or the presence of a disease, to select appropriate medication and dosage and to monitor disease progression and response to treatment.

Genetic Analysis Technologies

Since the development of the first genetic engineering techniques in the 1970s, there has been an ongoing evolution toward more accurate, faster and less expensive methods to conduct genetic analysis. The primary analysis methods traditionally used by genetic researchers fall into three categories:

 

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DNA Sequencing. DNA sequencing is the process of determining the exact order, or sequence, of the individual nucleotides in a DNA strand so that this information can be correlated to the genetic activity influenced by that segment of DNA. Complete human genome sequencing is currently the most comprehensive form of genetic analysis, in which every base is compared to a reference genome to determine possible mutations or variations.

 

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Genotyping. Genotyping is the process of examining certain known mutations or variations in the DNA sequence of genes to determine whether the particular variant can be associated with a specific disease susceptibility or drug response.

 

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Gene Expression Analysis. Gene expression analysis is the process of examining the molecules that are produced when a gene is activated, or expressed, to determine whether a particular gene is expressed in a specific biological tissue.

The first major breakthrough in genetic technology was the development of the automated DNA sequencer in 1986. Subsequent versions of commercial first-generation DNA sequencers improved on speed and throughput, eventually becoming powerful enough to enable the first mapping of the human genome through the Human Genome Project, which was completed in 2003 at an overall cost of over $3 billion. The prohibitive cost of first

 

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generation sequencing technologies forced scientists to use the other primary genetic analysis technologies, genotyping and gene expression analysis. While these targeted genetic analysis technologies address the cost limitations of DNA sequencing, they generally provide only limited information to the user.

More recently, innovations in DNA sequencing have led to the development of high-throughput sequencing technologies, commonly referred to as next-generation or second-generation sequencing, which produce thousands to millions of sequences at once. These high-throughput sequencing technologies have led to a significant reduction in the time and cost required for DNA sequencing. Next-generation sequencing technologies are supplanting not only the older sequencing methods but also less comprehensive methods for assessing gene expression, protein binding and other biological information. Scientia Advisors estimated that the installed base of next-generation sequencers reached approximately 1,000 instruments worldwide, representing annual revenues of approximately $600 million as of the end of 2009.

The Importance of Complete Human Genome Sequencing and the Limitations of General Purpose Sequencing Technologies

One of the most difficult challenges facing the genetic research and analysis industry is improving our understanding of how genes contribute to diseases that have a complex pattern of inheritance. For many diseases, multiple genes each make a subtle contribution to a person’s predisposition or susceptibility to a disease or response to a drug treatment protocol. Accordingly, we believe that unraveling this complex network will be critical to understanding human health and disease. We believe that sequencing complete human genomes is the most comprehensive and accurate method by which to achieve these objectives and improve our understanding of human disease. However, the cost and complexity associated with complete human genome sequencing have been prohibitively high for researchers and have slowed our progress in understanding the genetic underpinnings of disease.

Although second-generation sequencing technologies have led to dramatic reductions in cost and improvements in quality and throughput for complete human genome sequencing, they were designed as general-purpose instruments for sequencing the DNA or RNA of plants, animals, bacteria and viruses. In particular, these second generation sequencing technologies were not designed for sequencing large numbers of complete human genomes. We believe the key limitations of using second-generation technologies for sequencing large numbers of complete human genomes include the following:

 

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High Cost. Commercially available DNA sequencing instruments cannot sequence complete human genomes at a price low enough to make large-scale complete human genome sequencing projects affordable to researchers.

 

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Insufficient Scale and Speed. Commercially available DNA sequencing instruments typically require weeks to sequence a complete human genome, which translates into months or years to sequence all of the genomes for large projects. While the timeline can be accelerated by purchasing and operating multiple DNA sequencing instruments in parallel, the capital cost is prohibitive for all but the largest research centers. Many researchers are unable to generate the complete human genome data they need from in-house instruments in an acceptable period of time.

 

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Difficulty of Data Management. Sequencing a large number of complete human genomes generates a substantial amount of data that must be managed, stored and analyzed. Many users of commercially available DNA sequencing instruments lack the costly computing resources, storage capacity, network bandwidth and specialized personnel to process and analyze these massive data sets.

Due to these limitations, many researchers have been using an alternative approach in which a small portion of the genome, referred to as the exome, is targeted, enriched and sequenced, which requires less than 5% of the sequencing compared to sequencing of a complete genome. However, important areas of the genome lie outside of the exome, such as the promoter regions that control gene expression and other conserved regions of the genome that are believed to perform regulatory functions. Moreover, current exome selection technologies are inefficient, typically enabling sequencing of less than 80% of the exome, compared to complete human genome sequencing technologies that can capture over 90% of the exome. Within the next several years, we believe that

 

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the cost of sequencing complete human genomes will be low enough and the process simple enough that the added cost of selecting exomes will make complete human genomes sequencing less expensive overall and more widely used.

Complete Genomics’ Solution

We have developed a novel approach to complete human genome sequencing. We combine our proprietary human genome sequencing technology, which achieves accuracy levels of 99.999%, with our advanced informatics and data management software and our innovative, end-to-end service model, to deliver research-ready genomic data at a total cost that is significantly less than the total cost of purchasing and using commercially available DNA sequencing instruments. We believe this novel outsourced solution overcomes the key limitations of other sequencing technologies and addresses the unmet needs of the complete human genome research market.

Proprietary Sequencing Technology

There are two primary components of our proprietary human genome sequencing technology: DNA nanoball, or DNB, arrays and combinatorial probe-anchor ligation, or cPAL, reads. Our patterned DNB arrays, due to their small size and biochemical characteristics, enable us to pack DNA very efficiently on a silicon chip. We have developed a proprietary process that causes the DNA to adhere to desired spots on the chip, while conversely preventing the DNA from adhering to the area between these spots. This enables us to affix individual particles of DNA to over 90% of these spots, leading to increased efficiency in nanoarray assembly. In addition, we have developed a highly accurate cPAL read technology, which enables us to read the DNA fragments efficiently using small concentrations of low-cost reagents while retaining extremely high single-read accuracy.

We believe this unique combination of our proprietary DNB and cPAL technologies is superior in both quality and cost to other commercially available approaches and provides us with significant competitive advantages. As reported in the January 2010 edition of Science, we sequenced a complete human genome at a consumables cost of approximately $1,800 and with a consensus error rate of approximately 1 error in 100,000 nucleotides. Our read accuracy was further independently validated by the Institute for Systems Biology, or ISB, as published in Science Express in March 2010. We have identified and are developing additional performance enhancements to our core technologies that we believe will enable us to maintain significant competitive advantages over the next several years. By implementing these technological enhancements, we believe that we will be the first company to sequence and analyze high-quality complete human genomes, at scale, for a total cost of under $1,000 per genome.

Advanced Informatics and Data Management Software

Sequencing complete human genomes generates substantial amounts of data that must be managed, stored and analyzed. While many users of instrument-based sequencing systems have historically conducted their own in-house data analysis on a limited number of genomes, many of these users lack the computing, storage and network bandwidth necessary to manage the massive data sets generated by larger scale complete human genome studies. In response to this need by our customers, we have built a genomic data processing facility with computing infrastructure for managing both small- and large-scale genomic sequencing projects.

There are two major components of our complete data management solution: assembly software and analysis software. Assembly is the process of using computers to organize all of the overlapping 70-base nucleotide sequences to reconstruct the complete human genome. Our proprietary assembly software uses advanced data analysis algorithms and statistical modeling techniques to accurately reconstruct over 90% of the complete human genome from approximately two billion 70-base reads. After assembling the genomic data, we use our analysis software to identify and annotate key differences, or variants, in each genome.

By using our analytical tools and data management software, our customers can significantly reduce their investments in computing infrastructure. Our customers are provided with reliable access to assembled and annotated sequence data in multiple formats to ease data sharing and comparative analyses. In addition, our data

 

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storage options provide flexibility and allow customers to customize their data management strategy based on their particular business and scientific requirements. We are also developing a suite of web-based analytical tools designed to enable our customers to rapidly analyze the genomic data that is generated from their samples. As the reagent cost of sequencing declines, we believe that the cost and complexity of data analysis and management will emerge as the primary limiting factor for conducting complete human genome analysis.

Innovative, End-to-End, Outsourced Solution

While our competitors primarily sell DNA sequencing instruments and reagents that produce raw sequenced data, requiring their customers to invest significant additional resources to process that raw data into a form usable for research, we offer our customers an end-to-end, outsourced solution that delivers research-ready genomic data. Our genome sequencing center combines a high-throughput sample preparation facility, a collection of our proprietary high-throughput sequencing instruments and a large-scale data center. Our customers ship us their samples via common carrier services such as Federal Express and United Parcel Service. We then sequence and analyze these samples and provide our customers with finished, research-ready genomic data, enabling them to focus exclusively on their single highest priority, discovery.

Our customers are not required to purchase expensive sequencing instruments and high-performance computing resources to sequence and analyze large sets of complete human genomes. Our outsourced service model enables our customers to offload to us the complex processes of sample preparation, sequencing, computing and data storage and management. We believe our services will expand the potential addressable market by enabling a broad base of researchers who may lack sufficient capital and the specialized personnel necessary to build and operate a sequencing laboratory, or who have historically been constrained by the high total cost of sequencing, to conduct large-scale complete human genome studies.

Customer Benefits

Our end-to-end solution provides the following advantages to our customers:

 

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High-Quality Data. Our technology delivers what we believe is the industry’s highest quality complete human genome data.

 

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Cost-Savings. Our customers are not required to purchase expensive sequencing instruments and high-performance computing resources or hire the necessary specialized personnel to sequence and analyze large sets of complete human genome data.

 

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Speed at Scale. Our customers can complete their large-scale projects more quickly by using our services than by using commercially available sequencing instruments.

 

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Ease of Use. Our customers can avoid the difficulty and time-consuming process of purchasing and operating their own sequencing instruments and can outsource the entire process to us, from sample preparation to delivery of research-ready data.

 

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Operational Flexibility. By outsourcing their large-scale complete human genome sequencing projects to us, our customers can free up the capacity of in-house instruments to run smaller or more targeted sequencing projects and applications.

 

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Technological Flexibility. As DNA sequencing technology improves, our customers avoid the risk of their expensive instruments becoming technologically obsolete.

 

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Enables Customers to Focus on Discovery. Outsourcing offloads the operational burdens of managing large-scale genome sequencing projects and enables our customers to focus their resources on research, which can reduce the time to discovery.

Competitive Strengths

We believe that our competitive strengths are as follows:

 

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Proprietary Human Genome Sequencing Technology. Our proprietary sequencing technology achieves accuracy levels of 99.999% at a total cost that is significantly less than the total cost of purchasing and using commercially available DNA sequencing instruments. We believe that our quality improvement and

 

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cost-reduction initiatives will allow us to maintain our quality and cost advantages over competing sequencing technologies for the next several years.

 

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Fully Integrated Advanced Informatics and Data Management Software. Our solution incorporates powerful informatics, analysis and data management software that enable our customers to manage and gain useful information from the massive data sets generated in complete human genome sequencing. Unlike software solutions offered by instrument manufacturers or third-party providers, we are able to continuously refine our informatics and data management software because of our significant experience in sequencing and analyzing large numbers of complete human genomes for our customers. As the reagent cost of sequencing declines, we believe that the cost and complexity of in-house data analysis and management will emerge as the primary limiting factor for researchers conducting complete human genome analysis.

 

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Highly Scalable and Capital-Efficient Business Model. Consolidating volume across our entire customer base enables us to run a large number of genomes through our sequencing process while avoiding the cost and complexity of employing a large field installation and support organization. By implementing a high degree of automation, we have reduced the possibility of human errors that could adversely affect quality and increase costs. Our service-based model allows us to reduce cost and improve quality as volume increases.

 

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Unique Insight into Customer Needs. Because of our unique, end-to-end service model, we interact directly with our customers on their discovery projects. This interaction enables us to develop and enhance our analysis software to meet our customers’ specific needs while expanding our understanding of variation in the human genome.

 

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Fast and Efficient Deployment of Operational and Technological Enhancements. Because our sequencing operations and data center are centralized, we can rapidly upgrade our technology and deliver the benefits to our customers. In addition, our access to genomic data allows our software engineers to continually refine and improve our software with each genome we sequence.

 

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Expanded Market Opportunity. We believe our outsourced model will expand the potential addressable market by providing academic and biopharmaceutical researchers who lack sufficient budgets or the specialized personnel necessary to build and operate a sequencing laboratory with access to high-quality, low-cost complete human genome data. In addition, we believe we will be able to service customers who require rapid sequencing of large numbers of complete human genomes.

Customers and Applications

Customers

As of July 20, 2010, we have sequenced over 200 complete human genomes year-to-date, including more than 100 in the first three weeks of July 2010, and have an order backlog of over 500 genomes. We have more than 30 past and current customers, including the following:

 

§Academic Medical Center University of Amsterdam

§Brigham & Women’s Hospital

§Broad Institute of MIT and Harvard

§Children’s Hospital of Philadelphia

§Eli Lilly and Company

§Erasmus Medical Centre in Rotterdam, the Netherlands

 

§Flanders Institute for Biotechnology

§Genentech, Inc.

§HudsonAlpha Institute for Biotechnology

§Institute of Cancer Research United Kingdom

§Institute of Molecular Medicine at the University of Texas Health Science Center at Houston

 

§Institute for Systems Biology

§National Cancer Institute

§Ontario Institute for Cancer Research

§Pfizer Inc.

§University of North Carolina

 

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Selected Customer Examples

SAIC-Frederick, Inc., National Cancer Institute — Pediatric Cancer Study

Our project with SAIC-Frederick, Inc., the prime contractor for the National Cancer Institute’s research and development facility in Frederick, Maryland, involves sequencing and analyzing 50 tumor-normal pairs, or 100 complete human genomes, over a six-month period, to identify patterns relating to the genesis of cancerous tumors. This study may potentially lead to improved diagnosis and treatment of pediatric cancers. This project forms part of the National Cancer Institute’s Therapeutically Applicable Research to Generate Effective Treatments, or TARGET, Initiative. TARGET seeks to use genomic technologies to rapidly identify valid therapeutic targets in childhood cancers so that new, more effective treatments can be developed. It is currently focusing on five childhood cancers: acute lymphoblastic leukemia, acute myeloid leukemia, neuroblastoma, osteosarcoma and Wilms tumor. Our contract with SAIC-Frederick contains an option for SAIC-Frederick to engage us to sequence 564 additional cancer cases, or 1,128 complete human genomes, over an additional 18-month period.

Institute for Systems Biology — Miller Syndrome Study

Our project with Dr. Leroy Hood of the ISB involved sequencing the complete genomes of a four-member nuclear family, including two healthy parents and their two children who suffer from two genetic disorders: Miller Syndrome and primary ciliary dyskinesia. The data we provided allowed ISB researchers to pinpoint the causal gene and subsequently confirm that gene’s role in Miller Syndrome, a disease in which the genetic basis had evaded detection. The results were published in Science Express in March 2010 and have led to a follow-on project with the ISB to sequence an additional 122 genomes.

Genentech, Inc. — Non-Small Cell Lung Cancer Study

Our project with Genentech, Inc. (a member of the Roche Group) compared the complete human genome sequences of a primary non-small cell lung tumor with nearby non-tumor tissue taken from the lung of a long-term smoker. This project was the first complete human genome sequence of a primary non-small cell lung tumor and matched normal tissue. Comparison of these sequences revealed both known (KRAS G12C) and novel mutations in numerous oncogenes and led to the discovery of numerous somatic mutations. The data we delivered allowed Genentech to measure the rate of smoking-induced mutations accumulated over time and resulted in a publication in Nature in May 2010.

Applications

Potential applications for our complete human genome sequencing service include:

 

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Cancer Research. Researchers are sequencing cancer genomes and comparing them to normal genomes, which are referred to as tumor-normal pairs, to identify the mutations in cancer genomes. We believe understanding these mutations will guide development of new cancer therapeutics and diagnostics and ultimately enable doctors to select the best course of therapy based on the specific mutations found in a tumor.

 

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Mendelian Disease Research. There are thousands of Mendelian diseases, or diseases that have been found to run in families, and are accordingly likely to have a significant genetic component. However, the genetic cause of most of these diseases is currently unknown. By sequencing the complete genomes of the affected families, we believe the genetic causes of these Mendelian diseases can be discovered, which could lead to the development of novel diagnostics and therapeutics.

 

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Rare Variant Disease Research. Diseases such as central nervous system disorders, cardiac disease and certain metabolic disorders that appear broadly in the population are thought to be caused by rare variants. Large-scale studies of affected individuals may help to identify the disrupted pathways and lead to the development of novel diagnostics and therapeutics.

 

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Clinical Trial Optimization. We believe that selecting or stratifying patients on the basis of their genetic profiles could enable the preferential admission of high responders into a clinical trial. This stratification could enable the trial to reach its conclusion with fewer patients and lower costs and result in faster clinical trials and drug commercialization.

 

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In addition to these research studies, we expect future clinical applications to include:

 

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Companion Diagnostics. We believe that therapeutics that are not first-line treatments for the general population may be elevated to first-line treatments or used in combination therapies for subsets of the population that share a common genetic profile. Complete human genome studies may unlock new market opportunities for these therapies or combination therapies.

 

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Cancer Pathology. We believe that analyzing complex cancer genomes that involve large and unpredictable structural changes will be most reliably and economically implemented using complete human genome sequencing. According to the National Cancer Institute SEER Cancer Statistics, there are approximately 1.5 million new cases of cancer diagnosed each year in the United States.

 

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Universal Diagnostics. As medical records technology and public health policy advance, we believe that large numbers of people will have their complete human genomes sequenced and stored in their electronic medical records for use by their physicians in managing their health care decisions.

Our Strategy

We intend to become the leading complete human genome sequencing and analysis company and the preferred platform for human genome discovery by:

 

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Continuing to Deliver the Highest Quality Genomic Data and Analysis at a Low Total Cost. By continuing to deliver the highest quality research-ready data and by enabling our customers to avoid the cost, complexity and risks associated with purchasing and operating the instruments and computing resources required to undertake complete human genome sequencing, we expect to become the preferred solution for our customers.

 

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Maintaining and Strengthening our Technological Leadership Position. We plan to continue to conduct research and product development activities to further improve quality, reduce costs, increase throughput and reduce our turnaround time. We plan to further develop the biochemistry, informatics, instrumentation and software that we believe together make up the industry’s most robust solution. We will also seek to continually improve our operational processes and analysis software.

 

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Capitalizing on our Scalable Model. Due to the highly scalable nature of our service model, we believe we are well positioned to serve customers looking to sequence a small number of genomes as well as customers who are looking to rapidly sequence a very large number of genomes.

 

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Establishing Ourselves as the Leader in Outsourced Complete Human Genome Sequencing. We intend to continue to focus exclusively on complete human genome sequencing. We believe that this focus will put us in a strong position to become the preferred platform for complete human genome sequencing.

 

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Expanding Globally to Increase Capacity and Reach New Markets. We expect to enter into partnership agreements with domestic and international organizations to build additional genome sequencing centers around the world. These genome sequencing centers will increase our sequencing capacity, provide us with improved access to global markets and expand our revenue opportunities.

 

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Expanding Applications for the Use of our Technology. While our current focus is on providing complete human genome solutions primarily to academic and biopharmaceutical researchers, we believe that as we sequence and deliver more complete human genomes to our customers, our growing understanding of the genetic basis of human disease may lead to future applications in areas such as cancer pathology.

Our Human Genome Sequencing Platform Technology

Our proprietary human genome sequencing platform consists of three major technologies: our proprietary human genome sequencing technology, our high-throughput process automation technology and our complete data management solution.

 

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Proprietary Sequencing Technology

There are two primary components of our proprietary human genome sequencing technology: DNB arrays and cPAL reads.

DNB Arrays

We have developed a novel approach to preparing fragmented DNA for reading on our sequencing instruments. Using a biochemical process for copying DNA, we reproduce each DNA fragment in a manner that connects all of the copies together in a head-to-tail configuration, forming a long single molecule of connected nucleotides. We have developed proprietary techniques for causing each long single molecule to consolidate, or ball up, into a small particle of DNA that we call a DNB. The DNBs are approximately 200-300 nanometers in average diameter. Each DNB contains hundreds of copies of the 70 bases of DNA we are seeking to read in each fragment.

The small size and biochemical characteristics of our DNBs enable us to pack them together very tightly on a silicon chip. We use established photolithography processes developed in the semiconductor industry to create a silicon chip that has a grid pattern of small spots. The small spots are approximately 300 nanometers in diameter, and the center of each spot is separated by approximately 700 nanometers from neighboring spots. Each silicon chip has approximately 2.8 billion spots in an area 25 millimeters wide and 75 millimeters long. We have developed a proprietary process that cause the DNA to adhere to these spots, which we refer to as “sticky spots,” while conversely preventing the DNA from adhering to the area between the sticky spots. When a solution of DNBs is spread across the chip, the DNBs adhere to the sticky spots, with one DNB per spot. We have also developed proprietary techniques to fill over 90% of the sticky spots with exactly one DNB. We refer to the silicon chip filled with DNBs as a DNB nanoball array. Each finished DNB nanoball array contains up to 180 billion bases of genomic DNA prepared for imaging.

cPAL Read

To read the sequence of nucleotides in each DNB, we have developed a highly accurate proprietary ligase-based DNA reading technology called cPAL. Our cPAL technology uses the naturally occurring ligase enzyme, which accurately distinguishes between the A, C, T and G nucleotides, to attach fluorescent molecules that light up with a different color for each of the four nucleotides. By imaging the color lights of a DNB array and decoding the color images, we can determine the sequence of nucleotides in each DNB. A key characteristic of our cPAL technology is its high accuracy of reading very short five-base sequences of DNA. We have developed a proprietary technique for preparing the DNA fragments so that we can read seven five-base segments from each of the two ends of the DNA fragment for a total of 70 bases from each fragment. We have also developed proprietary software that generally reconstructs over 90% of the complete human genomes from these 70 base reads from each fragment.

Advantages of our DNB arrays and our cPAL technology over other commercially available DNA sequencing technologies include:

 

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High Accuracy. Our cPAL technology has very high single-read accuracy due to the intrinsic nature (high accuracy) of the ligase enzyme. By reading each nucleotide multiple times, we achieve a consensus error rate equal to approximately 1 error in 100,000 nucleotides.

 

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No Accumulation of Errors. Many other DNA sequencing methods employ sequential processes that cause errors to accumulate as each successive nucleotide is read, which results in a higher potential error rate for each successive nucleotide. Our cPAL technology reads each nucleotide independently, and as a result there is no accumulation of errors, which enables us to read successive bases without increasing our error rate.

 

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Low Reagent Cost. Our cPAL technology uses low concentrations of low-cost commodity reagents. Our DNB arrays achieve a very high density of DNA on each array, which reduces the quantity, or volume, of reagents we use compared to other DNA array approaches. The combination of low concentration of

 

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low-cost reagents and smaller quantities results in lower reagent costs compared to other commercially available DNA sequencing methods. As reported in Science published in January 2010, we sequenced a complete human genome at a consumables cost of approximately $1,800.

High Throughput Process Automation

There are five major components of our high-throughput process automation technology: high-throughput sample preparation, high-throughput sequencing instruments, high-performance computing infrastructure, workflow automation software and service delivery technology.

High-Throughput Sample Preparation

Our high-throughput sample preparation technology consists of step-by-step protocols for preparing DNA for sequencing and pipetting robots that automatically execute these protocols. We prepare genome samples in batches of 88 and load the samples into a 96-well plate (the other eight wells in the plate contain known, or reference, DNA that we use to monitor the quality of the sample preparation process). A sample preparation run processes four 88-sample plates for a total of 352 genomes per run. We are building the instruments and staffing capacity to perform two runs in parallel for a total of 704 genomes prepared for sequencing. The result of a sample preparation run is up to 352 genomes loaded onto flow slides, ready to be loaded on sequencing instruments. Our sample preparation capacity can be scaled by adding additional sample preparation instruments and staff as needed.

High-Throughput Sequencing Instruments

Our sequencing instruments consist of a fluidics robot that pipettes multiple types of chemical reagents (including fluorescent molecules) onto the flow slides and an imaging system that records images of the fluorescent molecules attached to the DNA. Each sequencing instrument processes 18 flow slides at a time. The 18 flow slides are robotically moved back-and-forth from the fluidics robot to the imaging system. While one flow slide is being imaged, the other 17 flow slides are prepared with reagents or waiting for the imager to become available. A sequencing run takes approximately 12 days. Currently, our sequencing instruments can generate between 50 and 70 gigabases of usable data from each flow slide in a 12-day run. To sequence a complete human genome at an average redundancy of 40 times requires 120 gigabases of usable data. We expect to make continued enhancements in our technology to further increase the amount of usable data we get from each flow slide.

High-Performance Computing Infrastructure

We have built a genomic data processing facility that consists of approximately 5,000 core processors and 1,750 terabytes (a terabyte is one thousand gigabytes) of high-speed disk storage. Our sequencing instruments are connected to our data center by a network connection that transfers data at a rate of 30 gigabits per second. Our data center has the capacity to perform all of the required computation, starting with the images generated by the sequencing instruments, and ending with sequencing complete human genomes, for several hundred genomes per month. We plan to expand our data center as needed, and we expect to make continued enhancements to our software to further increase the efficiency of our data center.

Workflow Automation Software

Our workflow automation software tracks each sample from arrival at our facility to delivery of research-ready data to the customer. Sample tracking is accomplished through bar codes. Each 96-well plate of samples has a bar code, and each flow slide has a bar code. The instruments that process plates and flow slides have bar code readers attached to them. User interfaces to our workflow automation software allow us to track the progress of each sample throughout sample preparation, sequencing and computing. We are also developing a web-based customer portal to enable customers to track their projects real-time throughout the sequencing process.

 

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Service Delivery Technology

Our cloud-based data delivery system is based on our vendor relationship with Amazon Web Services, or AWS. We upload our customers’ finished genomic data to AWS, who copies the data to hard disks and ships the hard disks to our customers. Our customers also can pay AWS to store their data on an ongoing basis. As we develop additional analytical tools, we plan to host them on AWS so that customers can rapidly analyze their genomic data as soon as it is available.

Complete Data Management Solution

There are two major components of our complete data management solution: assembly software and analysis software.

Assembly Software

Assembly is the process of using computing methods to organize the overlapping 70-base nucleotide sequences to reconstruct the complete genome. We have developed a proprietary approach to assembly that uses a combination of advanced data analysis algorithms and statistical modeling techniques to reconstruct over 90% of the complete human genome from approximately two billion 70-base reads. We have designed our assembly software to run in parallel across our large network of Linux computers.

As reported in Science published in January 2010, we generated high-quality base calls in as much as 95% of the genomes sequenced, identifying between 3.2 million and 4.5 million sequence variants per genome processed. Detailed validation of one genome dataset demonstrated a consensus error rate of approximately 1 error in 100,000 nucleotides.

Analysis Software

After assembling the genomic data, we use our analysis software to identify key variants in each genome and automatically annotate the genomic data. We are also developing a suite of additional analytical tools designed to enable our customers to rapidly analyze the data we generate from their samples. Examples of analytical tools under development include a tumor-normal comparison tool designed to allow cancer researchers to compare a cancer genome to the normal genome from which it was derived, a family analysis tool designed to enable researchers to compare parental genomes with the genomes of their children and a large-scale genome browser designed to allow researchers to compare the hundreds of genomes sequenced in a large-scale study.

Technology Strategy

We plan to continue to advance our complete human genome sequencing and analysis technology and maintain our technology leadership in four major areas:

 

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Array Density. Our unique grid patterned arrays currently consist of a 700 nanometer grid. We may reduce the grid size to 250 nanometers and correspondingly reduce the diameter of the sticky spots and DNB nanoballs. If successful, this improvement will increase the density of the DNA on an array by a factor of eight, which will decrease the reagent cost of sequencing a given amount of DNA by a factor of eight.

 

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Instrument Speed. Our unique grid patterned arrays enable us to align the grid pattern of the DNA on the array with the grid pattern of the pixels in the detector, allowing us to image our arrays with very short exposure times. We may increase the speed of our instruments by acquiring and deploying new cameras that take images and transfer data at approximately six times the speed of our existing cameras. We may also increase the number of cameras per sequencing instrument from two to four.

 

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Process Automation. As our instruments get faster, we intend to improve our sample preparation, process automation and data management technologies to process and deliver an increasing number of genomes to our customers with reduced turnaround time.

 

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Analytic Software. We continue to improve and extend our analytic capabilities through the development of software designed to decrease genome assembly time and address specific application requirements of our customers. For instance, we are developing software that identifies and assembles the complex structural variants found in cancer genomes.

By implementing a combination of these technology enhancements, we believe that we will be the first company to sequence and analyze high-quality complete human genomes, at scale, for a total cost of under $1,000 per genome.

Sales, Marketing and Customer Support

We sell our complete human genome sequencing service through our direct field sales and support organizations. Our sales process with each new customer typically involves undertaking a small project, or pilot program, which enables the customer to become familiar with our outsourced solution and research-ready data. We then work with our customers to expand the relationship to larger projects.

Sales

We have assembled a highly experienced and technically qualified sales team, with most sales managers holding a Ph.D. in a relevant scientific field. Each of these sales managers brings a network of extensive contacts in our targeted customer segments. The sales group develops business opportunities and obtains orders for our complete human genome sequencing service by proactively identifying, qualifying and visiting well-funded prospects at major companies, institutions and universities.

Marketing

Our marketing group has developed and maintains the Complete Genomics brand, increases market awareness and generates demand for our solution through a variety of methods. First, we have created and continue to maintain a clear media presence via our website, press releases, interviews and articles that reinforce our market presence and scientific credibility. Second, we generate demand by promoting the company via marketing programs and by attending and exhibiting at relevant tradeshows and conferences. Third, we continue to evolve our marketing strategy by tracking market trends, understanding customer needs and developing appropriate products and programs. The marketing group also fulfills traditional product management requirements, such as defining our service and application strategy and roadmap, including partnering strategies, and developing sales tools, training materials and competitive analyses for the sales group.

Customer Support

We are committed to supporting our customers through a network of scientific applications staff based in both Mountain View and locations near our most concentrated customer bases. This team currently consists mostly of Ph.D.-level scientists with extensive bioinformatics experience. Our scientific applications team works with customers to address technical questions related to our service offering and provide detailed training and support.

Most of the training and support efforts are focused on helping customers understand and use the large amounts of data that are delivered as part of multi-human genome sequencing projects. In late 2010, we intend to supplement these efforts with a new team of Mountain View-based bioinformatics support specialists that we expect to expand quickly as the number of sequencing projects increases.

Research and Development

Our research and development team brings together a variety of technical disciplines required for the development of a high-throughput sequencing system for commercial human genome sequencing services and includes DNA engineers, biochemists, molecular biologists, chemists, mathematicians, statisticians and

 

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electrical, mechanical, optical and software engineers. As of June 30, 2010, we had approximately 75 employees engaged in research and development, including 34 scientists and engineers with Ph.D.s. These professionals apply their skills in disciplines including:

 

  §  

biochemistry (sample preparation, DNA array preparation, DNA sequencing assay);

 

  §  

hardware (optics, fluidics, mechanical design, flow slides);

 

  §  

software (algorithms, instrument software, genome sequencing software, bioinformatics);

 

  §  

information technology (high-performance data center management);

 

  §  

semiconductors (mask design, surface chemistry); and

 

  §  

process automation.

The research and development teams are engaged in optimization and automation of our human genome sequencing processes, components and systems to improve the performance of our human genome sequencing technologies, including increasing accuracy and completeness, reducing cost and increasing throughput. Notable research and development accomplishments in this area include:

 

  §  

DNA engineering of four directional adapters inserted in genomic DNA segments, providing DNA substrates for unchained DNA sequencing of 35+35 mate-pair bases;

 

  §  

clonal DNA replication in solution to create concatamers with 300-500 DNA copies folded in DNBs of approximately 200-300 nanometers in diameter;

 

  §  

high density (700 nanometer pitch) patterned DNB nanoarrays on a 25mm x 75mm silicon slide with over 2.8 billion spots and a single DNB on over 90% of the spots;

 

  §  

reaction flow slide suitable for gravity loading sequencing chemistry by direct pipetting without using pressure or tubing that enables the processing of up to 18 slides per run on one instrument;

 

  §  

unchained DNA sequencing chemistry using cPAL technology that allows reading 10 bases from each adapter end, or up to 80 bases per DNA spot, using a 4-adapter library;

 

  §  

high-throughput, two-camera DNA sequencing instrument that processes 18 flow slides in parallel by robotic transfer of slides from biochemistry station to imaging station that employs TDI imaging at 30 frames per second; and

 

  §  

probability-based primary DNA base calling, read mapping and genome sequence and sequence variants determination algorithms and software for fast and accurate sequence analysis of a large number of human genomes using up to 200 gigabases of unchained base reads per genome.

In addition, our research and development teams are engaged in developing new applications for our technologies, including:

 

  §  

Cancer Genomes. We are developing new methods for sequencing the complex structural variations found in cancer genomes, such as duplications, deletions and translocations in tumor genomes. We believe these methods will enable the research community to better understand the genetic basis for cancer.

 

  §  

Diploid Sequencing. We have invented and are developing a method for independently sequencing the maternal and paternal chromosomes. We believe this independent chromosome sequencing will be required for many molecular diagnostics, because multiple variants within a gene may or may not affect both copies of the gene.

 

  §  

Human Methylomes. We are researching possible methods of sequencing the human methylome, which we believe will be important in understanding cancer genomes.

 

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  §  

Human Transcriptomes. We are researching possible methods of sequencing the human transcriptome, which, when combined with complete human genomes, we believe will shed light on the genetic basis of human disease and drug response.

In the years ended December 31, 2007, 2008 and 2009, we spent $10.3 million, $23.6 million and $22.4 million, respectively, on company-sponsored research and development activities.

Intellectual Property

Our success depends in part upon our ability to obtain and maintain intellectual property rights with respect to our products, technology and know-how, to prevent others from infringing these intellectual property rights and to operate without infringing the proprietary rights of others. Our policy is to seek to protect our proprietary position by, among other methods, filing patent applications related to our proprietary technology, inventions and improvements that are important to the development and conduct of our business. We also rely on trade secrets and know-how to develop and maintain our proprietary position.

Our patent strategy is to seek broad patent protection on new developments in genome sequencing technology, and also file patent applications covering new implementations of our technology. Additionally, we file new patent applications directed at equipment and software that are used in conjunction with our genome sequencing technology.

Our core genome sequencing technology originated at Callida Genomics, Inc., or Callida, in the laboratory of Radoje (Rade) Drmanac, Ph.D., our Chief Scientific Officer and one of our co-founders. Dr. Drmanac played an important role in high-throughput sequencing of whole genomes using ligation-based sequencing reactions performed on microarrays. In March 2006, we entered into a license agreement with Callida pursuant to which we exclusively licensed from Callida the relevant patent filings relating to the use of the technology in random arrays and probe anchor ligation, and we also non-exclusively licensed the use of this technology on non-random arrays. In exchange for the licenses, we issued to Callida 13,333 shares of our common stock, paid $1.0 million in cash for repayment of certain promissory notes held by Callida and agreed to pay $250,000 each year until the earlier of (a) March 28, 2012 and (b) such time as our common stock is traded on a national exchange and the shares issued to Callida are freely tradeable and have a minimum fair market value of $2.0 million. The license agreement remains in effect until each of the licensed patents has either expired or has been abandoned or ruled invalid. Either party may terminate the agreement for a material breach upon 120 days’ notice (or 30 days’ notice if the breach is due to failure to make a payment under the license agreement). Pursuant to the license agreement, Callida retains the rights to use the exclusively licensed technology for research purposes only. In addition to our in-licensed patent portfolio from Callida, we have also secured other exclusive licenses to patent applications for intellectual property related to our sequencing technology.

As of July 17, 2010, we have licensed from Callida six issued U.S. patents and six issued international patents that will expire between 2014 and 2027. We own or have licensed 97 pending patent applications, including 54 in the United States, 30 international applications and 13 applications filed under the Patent Cooperation Treaty.

In addition to pursuing patents on our technology, we have taken steps to protect our intellectual property and proprietary technology by entering into confidentiality agreements and intellectual property assignment agreements with our employees, consultants, corporate partners and, when needed, our advisors.

The patent positions of companies like ours are generally uncertain, and the validity and breadth of claims in DNA sequencing technology patents may involve complex factual and legal issues for which no consistent policy exists. Our patents and licenses may not enable us to obtain or keep any competitive advantage. Our pending U.S. and foreign patent applications may not issue as patents or may not issue in a form that will be advantageous to us. Patents we have obtained or do obtain in the future may be challenged by re-examination, opposition or other administrative proceeding, or may be challenged in litigation, and such challenges could result in a determination that the patent is invalid.

 

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Our licensed patents may be successfully circumvented by competitors. In addition, the patent laws of foreign countries differ from those in the United States, and the degree of protection afforded by foreign patents may be different from the protection offered by U.S. patents.

Our commercial success depends in part on our non-infringement of the patents or proprietary rights of third parties. For a description of the risks we face relating to intellectual property, please see “Risk Factors—Risks Related to Intellectual Property.”

Competition

Competition among organizations developing or commercializing sequencing instruments and services is intense. The sequencing industry is dominated by large, established companies that provide instruments and reagents, mostly for expression analysis and genotyping. These companies include Illumina, Inc., Life Technologies Corporation and Roche Diagnostics Corporation. These competitors are large and well-established, and each maintains a significant market share. Although historically these companies have sold instruments and reagents, some of these competitors have made recent forays into the sequencing services market. For example, Illumina recently announced that it will be providing individual genome sequencing services for as low as $9,500 per genome, and Life Technologies recently announced a collaboration to build a genome sequencing facility. Illumina also announced that it is pursuing a global program designed to provide researchers with access to academic and commercial institutions that can perform large-scale whole human genome sequencing projects using Illumina’s technology. Additionally, new competitors may enter the whole genome sequencing market, either by providing sequencing services like we do or by selling less expensive and more powerful sequencing instruments. We expect to face more intense competition if our service-based model is successful. In addition, future competitors may include smaller companies, like Ion Torrent Systems, Inc., NABsys, Inc., Oxford Nanopore Technologies, Ltd., Pacific Biosciences, Inc. and Helicos Biosciences Corporation, which have developed or are developing sequencing technologies that may compete with ours in the future. Large, established companies may acquire smaller companies, such as these, with emerging technologies and use their extensive resources to develop and commercialize or incorporate these technologies into their instruments and services.

A number of these and other organizations are developing methods for DNA sequencing using single molecule or long-read sequencing technologies. To date, the developers of single molecule technologies have not demonstrated that single molecule sequencing can achieve the quality required for complete human genome discovery projects at a reasonable cost. While long-reads are critically important for de novo sequencing, or sequencing organisms which have not previously been sequenced, they are not required for sequencing high quality complete human genomes.

In addition to commercial companies, there are large, government-funded or research-sponsored organizations, such as the Broad Institute of MIT and Harvard, the Genome Center at Washington University, the Baylor College of Medicine Human Genome Sequencing Center, the Wellcome Trust Sanger Institute and BGI (formerly known as Beijing Genome Institute), that purchase commercial DNA sequencing instruments and offer DNA sequencing services to academic and commercial customers.

For a description of the risks we face related to competition, please see “Risk Factors—Risks Related to Our Business—We face significant competition. Our failure to compete effectively could adversely affect our sales and results of operations” and “—The emergence of competitive genome sequencing technologies may impact our business.”

Operations

We have established laboratory operations for our first genome center in Mountain View, California, and we have additional laboratory operations in Sunnyvale, California. Our Tier III certified data center is located in Santa Clara, California. We expect to deploy additional sequencing centers in the future, and it is likely that these will be located in other regions, including outside of the United States.

 

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Genomic samples arrive at our facilities by common carrier, such as FedEx or UPS, and are tested for a number of pre-defined quality acceptance criteria. Samples that pass acceptance testing are prepared for sequencing, loaded on a flow slide and sequenced on a sequencing instrument. After the sequencing process, data generated by the sequencing instrument is processed in our high performance computing center to generate the final customer data deliverable. We upload our customers’ finished genomic data to AWS, who copies the data to hard disks and ships the hard disks to our customers. Our customers also can pay AWS to store their data on an ongoing basis.

The time to deliver, from sample receipt to data shipment, typically takes 90 to 120 days. Our genome sequencing center has a finite capacity, and time to delivery will increase if demand exceeds our capacity. In the future, we expect to reduce time to delivery though technical and procedural improvements. Our sequencing capacity is primarily determined by the equipment, automation and personnel we deploy.

Facilities

We lease approximately 67,000 square feet of office and laboratory space at our headquarters in Mountain View, California, under a lease that expires in August 2016. We lease approximately an additional 11,000 square feet of office and laboratory space in Sunnyvale, California, under a lease that expires in December 2010. These facilities contain laboratory and non-laboratory personnel. We believe that our current facilities are adequate for our first genome center over the next two years. We may need to acquire additional space as we deploy additional genome centers, either in Mountain View or in other locales, and we may need to expand our Mountain View non-laboratory space for other uses. We believe additional non-laboratory expansion space near our Mountain View facility is readily available.

We also lease approximately 2,200 square feet of data center space in Santa Clara, California, under a contract that expires in May 2011. Our computing capabilities are principally located in this facility, which is sufficient for our current operations. As our operations expand, we will need to acquire additional data center space, either at this location, or in other regional facilities.

Manufacturing and Supply

We have adopted a manufacturing strategy of purchasing most components we use to conduct our sequencing services, including silicon wafers, optical microscopes and various other imaging components, sophisticated cameras and chemicals and reagents, from third party suppliers. This allows us to maintain a more flexible infrastructure while focusing our expertise on deploying these components and supplies to provide high-quality, lower-cost whole genome sequencing services on a large scale.

We currently rely on single-source suppliers for certain key materials used in our sequencing process. In particular, we rely on SVTC Technologies L.L.C. to provide us with the silicon chips that are the base of the flow slide used in our sequencing process. We also rely on Hamamatsu Corporation for the cameras used in our sequencing instruments. We are in the process of identifying and qualifying additional suppliers, although we cannot predict how long that qualification process will last, and the time needed to establish a relationship can be lengthy.

Delays, quality issues or interruptions by our suppliers may harm our business, and we may be forced to establish relationships with new suppliers. However, because the lead time needed to engage a new supplier can be lengthy, we may experience delays in meeting demand if we must switch to a new supplier. For more information regarding risks related to our supply chain, please see “Risk Factors—Risks Related to Our Business—We depend on a limited number of suppliers, including single-source suppliers, of various critical components for our sequencing process. The loss of these suppliers, or their failure to supply us with the necessary components on a timely basis, could cause delays in our sequencing center and adversely affect our business.”

 

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Government Regulations

We believe our sequencing service is not currently subject to FDA regulation, clearance or approval. However, if we expand our service to encompass products that are intended to be used for the diagnosis of disease, such as molecular diagnostic products, regulation by governmental authorities in the United States and other countries will be a significant factor in the development, testing, production, and marketing of such products.

Our laboratory is subject to federal, state, regional and local regulations relating to the handling and disposal of hazardous materials and biohazardous waste, including chemicals, biological agents and compounds and blood and other human tissue. We utilize qualified third party vendors for waste disposal and handling, and these vendors are contractually obligated to comply with any applicable regulations. Our cost of waste disposal has historically not been material, and we expect this to be true in the future.

Due to the nature of our current operations, we have not sought accreditation for our facilities under the Clinical Laboratory Improvement Amendments, or CLIA. In addition, because the genomic data we provide generally neither identifies nor provides a reasonable basis to identify an individual, we are not currently subject to the Health Insurance Portability and Accountability Act of 1996, or HIPAA. However, once provided to certain of our customers, the genomic data and the activities of those customers may be regulated under both HIPAA and the Genetic Information Nondiscrimination Act of 2008.

Given the evolving nature of this industry, legislative bodies or regulatory authorities may adopt additional regulation or expand existing regulation to include our service. For example, in the future, our service could be subject to FDA regulation or we may be required to seek CLIA accreditation for our facilities. Changes to the current regulatory framework, including the imposition of additional or new regulations, could arise at any time, and we may be unable to obtain or maintain FDA or comparable regulatory approval or clearance of our service, if required. These regulations and restrictions may materially and adversely affect our business, financial condition and results of operations. For more information regarding the risks of future government regulation, please see “Risk Factors—Risks Related to Our Business—Because the market for genome sequencing is relatively new and rapidly evolving, we may become subject to additional future governmental regulation, which may place additional cost and time burdens on our operations.”

Backlog

In this prospectus, we refer to order backlog, which is the number of genomes for which we have executed purchase orders from our customers that we believe are firm and for which we have not yet recognized revenue. Estimating the dollar value of backlog that will be fulfilled within the current fiscal year requires significant judgments and estimates, as the mix of customer orders and pricing terms varies between arrangements depending on the number of genomes covered by the arrangement. It also requires estimating the timing of the receipt of qualified samples and the timing of the sequencing of the genomes. In addition, given the revenue variance resulting from this mix and the rapidly evolving nature of the sequencing industry, we do not believe that backlog as of any particular date is necessarily indicative of future results. However, we do believe that order backlog is an indication of our customers’ willingness to utilize our solution. As of March 31, 2010, our order backlog for which we believe we will sequence, bill and gain customer acceptance within twelve months was $7.0 million. We did not have any commercial operations as of March 31, 2009, and, as a result, we did not have any backlog. See “Risk Factors—Risk Related to Our Business—Our order backlog may never be completed, and we may never earn revenue on backlogged contracts to sequence genomes.”

Segment and Geographical Information

We operate in one reportable business segment, and we have derived a majority of our revenue from customers located in the United States. As of March 31, 2010, we have derived approximately 20% of our revenue since inception from customers located in Canada and Europe. Sales to customers located outside of the United States are denominated in U.S. dollars. We expect that sales to international customers will be an important and growing source of revenue, particularly as we construct additional genome sequencing centers outside of the United States. All of our long-lived assets are located in the United States.

 

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Employees

As of June 30, 2010, we had a total of 159 employees, 40 of whom hold Ph.D. degrees and 75 of whom are engaged in full-time research and development activities. We plan to expand our production, our sales and marketing and our research and development programs, and we plan to hire additional staff as these initiatives are implemented. None of our employees is represented by a labor union, and we consider our employee relations to be in good standing.

Legal Proceedings

From time to time, we may become involved in legal proceedings and claims arising in the ordinary course of our business. We are not currently a party to any legal proceedings the outcome of which, if determined adversely to us, we believe would individually or in the aggregate have a material adverse effect on our business, operating results, financial condition or cash flows.

 

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Management

Executive Officers, Key Employees and Directors

The following table sets forth certain information about our executive officers, key employees and directors, as of July 15, 2010.

 

Name    Age    Position

Executive Officers

     

Clifford A. Reid, Ph.D.

   51    President, Chief Executive Officer and Director

Ajay Bansal

   48    Chief Financial Officer

Radoje Drmanac, Ph.D.

   52    Chief Scientific Officer

Bruce Martin

   45    Senior Vice President of Product Development

Mark J. Sutherland

   53    Senior Vice President of Business Development

Key Employees

     

Dennis Ballinger, Ph.D.

   55    Vice President of Genomics

William Banyai, Ph.D.

   55    Vice President of Hardware

Robert J. Curson

   67    Vice President of Financial Operations

Alan Dow, Ph.D.

   55    Vice President of Intellectual Property and Legal Affairs

Ken Prokuski

   60    Vice President of Operations

Aaron Solomon

   45    Vice President of Sales

Jennifer Turcotte

   40    Vice President of Marketing

Directors

     

Clifford A. Reid, Ph.D.

   51    President, Chief Executive Officer and Director

Alexander E. Barkas, Ph.D.(1)

   63    Director

C. Thomas Caskey, M.D.

   71    Director

Carl L. Gordon, Ph.D., CFA(2)

   45    Director

Andrew E. Senyei, M.D.(2)

   60    Director

Lewis J. Shuster(2)

   55    Director

Charles P. Waite, Jr.(1)

   55    Director

 

(1) Member of the Compensation Committee.
(2) Member of the Audit Committee.

Executive Officers and Key Employees

Clifford A. Reid, Ph.D., is our co-founder and has served as our President and Chief Executive Officer since July 2005 and as a member of our board of directors since July 2005. From March 2003 to September 2005, Dr. Reid was Vice President of Collaborative Solutions at Open Text Corporation, a software company. In 1995, Dr. Reid co-founded Eloquent, Inc., a digital video communications company, and served as its Chief Executive Officer until 1999 and as its Chairman until 2003, when it was acquired by Open Text. In 1988, Dr. Reid co-founded Verity, Inc., an enterprise text search engine company, and served as its Vice President of Engineering from 1988 to 1992 and as its Executive Vice President from 1992 to 1993. Dr. Reid received a B.S. in Physics from the Massachusetts Institute of Technology, an M.B.A. from Harvard University and a Ph.D. in Management Science and Engineering from Stanford University. As our President, Chief Executive Officer and co-founder, Dr. Reid brings expertise and knowledge regarding our business and operations to our board of directors. He also brings to our board of directors an extensive background in the technology industry and in leadership roles, providing both strategic and operational vision and guidance.

Ajay Bansal has served as our Chief Financial Officer since May 2010. From June 2009 to January 2010, Mr. Bansal served as Chief Financial Officer and Executive Vice President of Business Development at Lexicon Pharmaceuticals, Inc., a biopharmaceutical company. From December 2007 to October 2008, Mr. Bansal served as Chief Financial Officer and Executive Vice President of Finance of Tercica, Inc., a biopharmaceutical

 

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company acquired by the Ipsen Group in October 2008. He also served as Chief Financial Officer and Senior Vice President of Finance of Tercica from March 2006 until December 2007. From February 2003 to January 2006, Mr. Bansal served as Vice Present of Finance and Administration and Chief Financial Officer of Nektar Therapeutics, a biopharmaceutical company. From July 2002 to February 2003, Mr. Bansal served as Director of Operations Analysis at Capital One Financial, a bank holding company. From August 1998 to June 2002, Mr. Bansal was at Mehta Partners LLC, a financial advisory firm, where he was named partner in January 2000. Prior to joining Mehta Partners, Mr. Bansal spent more than ten years in management roles at Novartis, a pharmaceuticals company, and in consulting at Arthur D. Little, Inc., McKinsey & Company, Inc. and ZS Associates. Mr. Bansal received a B.S. in Mechanical Engineering from the Indian Institute of Technology (Delhi) and an M.S. in Operations Management and an M.B.A. from Northwestern University.

Radoje Drmanac, Ph.D., is our co-founder and has served as our Chief Scientific Officer since July 2005. In 2001, Dr. Drmanac co-founded Callida Genomics, Inc., a DNA sequencing company, and served as Callida’s Chief Scientific Officer from 2001 to 2004 and has served as its President since 2004. In 1994, Dr. Drmanac co-founded Hyseq, Inc., a DNA array technology company that became Hyseq Pharmaceuticals, Inc. and later merged with Variagenics, Inc. to become Nuvelo, Inc., and served as its Senior Vice President of Research from 1994 to 1998 and as its Chief Scientific Officer from 1998 to 2001. Prior to that, Dr. Drmanac served as a group leader at Argonne National Laboratory. Dr. Drmanac received a B.S., M.S. and Ph.D. in Molecular Biology from the University of Belgrade.

Bruce Martin has served as our Senior Vice President of Product Development since March 2010. From May 2007 to March 2010, Mr. Martin was our Vice President of Product Development. From 2005 to May 2007, Mr. Martin served as Vice President of Product Strategy at PSS Systems, Inc., an internet software company. From 2002 to 2003, Mr. Martin served as Chief Technical Officer of Openwave Systems Inc., a software company. Mr. Martin received a B.S. in Computer Science and Electrical Engineering from the University of California, Davis.

Mark J. Sutherland has served as our Senior Vice President of Business Development since March 2010. From October 2008 to November 2009, Mr. Sutherland served as Senior Vice President of Business Development at GenVault Corporation, a DNA storage company. From November 2005 to September 2007, Mr. Sutherland served as Chief Business Officer for Flashpoint Technology, Inc., a digital content management company. Beginning in August 1988, Mr. Sutherland served for 17 years in roles of increasing responsibility at Molecular Dynamics, a manufacturer of molecular biology and genetic engineering equipment, and its successor companies, Amersham Biosciences and GE Healthcare. Mr. Sutherland served as Vice President of Genomics at Amersham from 1998 to 2001 and as VP, Strategic Alliances, at Amersham and for the Discovery Systems business of GE Healthcare from 2001 to 2005. Mr. Sutherland received a B.S. in Chemistry with Honors from Stanford University.

Dennis Ballinger, Ph.D., has served as our Vice President of Genomics since October 2008. From 2002 to 2008, Dr. Ballinger served as Vice President of Genomics at Perlegen Sciences, Inc., a developer of genetic tests. From 1999 to 2001, he served as Director of Product Development at Ingenuity Systems, Inc., a software company. From 1998 to 1999, he served as Senior Director of Functional Genomics at Hyseq, Inc. From 1994 to 1998, he served as Director of Cardiovascular Disease Research at Myriad Genetics, a developer of molecular diagnostic products. From 1989 to 1994, Dr. Ballinger was an Assistant Professor of molecular biology at the Sloan-Kettering Institute and Cornell University Graduate School. Dr. Ballinger received a B.S. in molecular cell biology from University of Colorado, Boulder and a Ph.D. in cellular and developmental biology from the Massachusetts Institute of Technology and completed his postdoctoral training at the California Institute of Technology.

William Banyai, Ph.D., has served as our Vice President of Hardware since July 2006. From March 2000 to February 2006, Dr. Banyai was a founder and the Chief Technical Officer of Glimmerglass Networks, an optical networking company. From February 1996 to February 2000, Dr. Banyai served as a staff physicist at the Lawrence Livermore National Lab. From November 1994 to November 1995, Dr. Banyai served as the Chief Technologist of Silicon Light Machines, a high-resolution display company. From September 1992 to October

 

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1994, Dr. Banyai served as a research engineer at Stanford University’s Ginzton Laboratory. From January 1991 to August 1992, Dr. Banyai served as a research scientist at the Sandia National Lab’s Compound Semiconductor Research Facility. Dr. Banyai received a B.S. in physics and an M.S. in electrical science from the University of Michigan, an Engineer of Electrical Engineering from the University of Southern California and a Ph.D. in optical sciences from the University of Arizona.

Robert J. Curson is our co-founder and has served as our Vice President of Financial Operations since May 2010. From July 2005 to May 2010, he served as our Chief Financial Officer. From April 2003 to July 2005, Mr. Curson was a partner of Neon Partners, an investment partnership focusing on special turn-around situations. From July 1999 until its acquisition by Open Text Corporation in April 2003, Mr. Curson served as Chief Financial Officer of Eloquent, Inc., a digital video communications company. From July 1993 to July 1999, Mr. Curson served as Chief Financial Officer of RasterOps Inc., a digital imaging and peripherals company which, during Mr. Curson’s tenure, was re-incorporated as Truevision Inc., a digital video company. Mr. Curson received a B.S. in Mechanical Engineering and an M.A. in Operations Research and Economics from the University of Leeds, U.K., and an M.B.A. from the University of California, Los Angeles.

Alan Dow, Ph.D., has served as our Vice President of Intellectual Property and Legal Affairs since September 2008. From September 2004 to September 2008, Dr. Dow worked as an attorney in private practice at BioTechnology Law Group in San Diego, California, specializing in patent prosecution and intellectual property-related transactions. From June 2001 to July 2004, Dr. Dow served as Vice President and General Counsel of Vical Incorporated, a biopharmaceutical company. Dr. Dow received a B.S. in Chemistry from the University of Maine at Orono, a Ph.D. in Genetics from Harvard University and a J.D. from Stanford Law School.

Ken Prokuski has served as our Vice President of Operations since January 2010. From August 2009 to January 2010, Mr. Prokuski served as an independent consultant to us. From October 1993 to January 2009, Mr. Prokuski served as Senior Director of Manufacturing Operations at Applied Biosystems, a life sciences company and a division of Life Technologies. From September 1992 to September 1993, Mr. Prokuski served as Material Manager at Arico Coating Technology, a thin film deposition equipment manufacturer. From September 1991 to September 1992, Mr. Prokuski served as Director of Materials at Toshiba America, Inc., an electronics company. From January 1990 to August 1991, Mr. Prokuski served as Operations Manager at Millipore Corporation, a life sciences company. Mr. Prokuski received a B.A. in Psychology from Northeastern Illinois University and an Executive M.B.A. from Golden Gate University.

Aaron Solomon, has served as our Vice President of Sales since March 2009. From April 2008 to March 2009, Mr. Solomon served as Vice President of Business Development at Tethys Bioscience, a developer of diagnostic tests. From October 2005 to April 2008, Mr. Solomon served as Director of Western Region Industrial Sales and later as Vice President of Industrial Sales at Affymetrix, a leading DNA microarray company. From February 2004 until its acquisition by Affymetrix in October 2005, Mr. Solomon served as Vice President of Business Development at ParAllele, a targeted genotyping company. Mr. Solomon received a B.S. in Biological Sciences from the University of California, Irvine.

Jennifer Turcotte has served as our Vice President of Marketing since September 2008. From November 2007 to August 2008, she served as our Senior Director of Product Marketing. From June 2007 to October 2007, Ms. Turcotte served as Senior Director, Marketing Solutions, at SAP, Inc., a business management software company. From March 2004 to May 2007, Ms. Turcotte served as Senior Director of Product Marketing at Siperian, Inc., a software company acquired by Informatica in March 2010. Prior to joining Siperian, Ms. Turcotte held senior product marketing positions at Rearden Commerce, technology-based personal assistance company, Ariba, Inc., a software and information technology company, Nuance Communications, a software company, and BEA Systems, Inc., a software company that was acquired by Oracle Corporation. Ms. Turcotte received a B.Eng. in mechanical engineering from Carleton University in Ottawa, Canada.

 

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Directors

Alexander E. Barkas, Ph.D., has served as a member of our board of directors since March 2007. In 1997, Dr. Barkas co-founded Prospect Venture Partners, a venture capital firm, and currently serves as a Managing Director at that firm. From 1991 to 1997, Dr. Barkas was a Partner at Kleiner Perkins Caufield & Byers, a venture capital firm. Prior to that, Dr. Barkas was a Founder and Chief Executive Officer of BioBridge Associates, a healthcare industry consulting firm. Dr. Barkas has served as Chairman of Geron Corporation, a biopharmaceutical company, since 1993 and as a member of the board of directors since 1992. Dr. Barkas has also served as a director of Amicus Therapeutics, Inc., a biotechnology company, since 2004. From May 2002 to October 2008, Dr. Barkas served as a director of Tercica, and as its Chairman from August 2003 to October 2008. Dr. Barkas received a Ph.D. in Biology from New York University and a B.A. in Biology from Brandeis University, where he currently is Chairman of the University Science Advisory Council and serves on the Board of Trustees. As a venture capitalist, Dr. Barkas brings to our board of directors broad experience in advising and managing life science and biotechnology companies from early-stage to mature companies, including expertise in capital raising, strategic transactions, financial budgeting and reporting, strategy and operations, recruiting and compensation. In addition, Dr. Barkas brings insight on compensation-related matters to the compensation committee based on his breadth of exposure to life science companies.

C. Thomas Caskey, M.D., has served as a member of our board of directors since August 2009. Since January 2006, Dr. Caskey has served as Director and Chief Executive Officer of the Brown Foundation Institute of Molecular Medicine for the Prevention of Human Diseases, part of the University of Texas Health Science Center at Houston. Since 2003, Dr. Caskey has served as an Adjunct Partner at Essex Woodlands Health Ventures, a venture capital firm. Dr. Caskey served as Managing Director of Cogene Biotech Ventures, Ltd., a venture capital firm, from March 2005 to October 2005 and as President and Chief Executive Officer from April 2000 to March 2005. He served as Senior Vice President, Research, at Merck Research Laboratories, a division of Merck & Co., Inc., a pharmaceutical company, from 1995 to 2000 and as President of the Merck Genome Research Institute from 1996 to 2000. Before joining Merck, Dr. Caskey served 25 years at Baylor College of Medicine in a series of senior positions, including Chairman, Department of Human and Molecular Genetics, and Director, Human Genome Center. He is a member of the National Academy of Sciences. Dr. Caskey served as a director of Lexicon Genetics Incorporated, a biopharmaceutical company, from April 2000 to April 2006 and as Chairman from April 2000 to March 2005. Dr. Caskey served as a director of Luminex Corporation, a developer of biological testing technologies, from January 2001 to May 2005. Dr. Caskey received a B.A. from the University of South Carolina and an M.D. from Duke University. Dr. Caskey brings to the board an extensive scientific and operational background gained as a research scientist, executive and venture capital advisor focused on life science and pharmaceutical companies.

Carl L. Gordon, Ph.D., CFA, has served as a member of our board of directors since August 2009. In 1998, Dr. Gordon co-founded OrbiMed Advisors LLC, an asset management firm, and has served as a General Partner since that time. From 1995 to 1997, Dr. Gordon served as a Senior Biotechnology Analyst at Mehta & Isaly, the predecessor firm to OrbiMed. From 1993 to 1995, Dr. Gordon served as a Fellow at The Rockefeller University. Since May 2008, Dr. Gordon has served as a director of Amarin Corporation, a biopharmaceutical company. From March 2004 to May 2007, Dr. Gordon served as a director of Biocryst Pharmaceuticals, Inc., a pharmaceutical company. Dr. Gordon received an A.B. from Harvard University and a Ph.D. in molecular biology from the Massachusetts Institute of Technology. As a venture capitalist focused on life science companies who sits on numerous boards, Dr. Gordon provides financial and operational expertise regarding our industry. In addition, Dr. Gordon provides substantial expertise in the particularly relevant scientific field of molecular biology.

Andrew E. Senyei, M.D., has served as a member of our board of directors since March 2006. Since 1987, Dr. Senyei has served as a Managing Director and a General Partner of Enterprise Partners, a venture capital firm. In 1989, Dr. Senyei co-founded Molecular Biosystems, Inc., a biotechnology company acquired by Alliance Pharmaceutical Corp. in 2000. Prior to joining Enterprise Partners, Dr. Senyei served as a practicing clinician and Adjunct Associate Professor of Obstetrics and Gynecology at the University of California, Irvine. Dr. Senyei has served as Chairman of Genoptix, Inc., a specialized medical laboratory service provider, since

 

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April 2000. Dr. Senyei served as a director of Adeza Biomedical Corporation, a healthcare products company, from 1987 until Adeza was acquired by Cytyc Corporation in April 2007. Dr. Senyei has served on the Board of Trustees of Northwestern University since 2005 and on the Advisory Council of the Jacobs School of Engineering at the University of California, San Diego, since 2002. Dr. Senyei received a B.S. from Occidental College and an M.D. from Northwestern University Medical School, and he completed his residency training at the University of California, Irvine, Medical Center. Dr. Senyei’s medical and business expertise, including his experience as a venture capitalist building and serving on the board of directors of more than 25 public and private emerging life sciences and healthcare companies, combined with his extensive prior experience as an inventor and practicing clinician, give him valuable insight into our industry. His experience provides the seasoned business judgment and broad strategic vision which enables him to serve as an effective and valuable director and to have the qualifications and leadership and other skills to serve on our board of directors.

Lewis J. Shuster has served as a member of our board of directors since April 2010. In 2002, Mr. Shuster founded Shuster Capital, a strategic and operating advisor to and angel investor in life science companies, and has served as its Chief Executive Officer since that time. From June 2003 to November 2007, Mr. Shuster served as Chief Executive Officer of Kemia, Inc., a drug discovery and development company. From February 2000 to December 2001, Mr. Shuster held various operating executive positions at Invitrogen Corporation, a biotechnology company that merged with Applied Biosystems Inc. and became Life Technologies Corporation. From 1994 to 1999, Mr. Shuster served as Chief Financial Officer of Pharmacopeia, Inc., a drug discovery product and service company, and later as Chief Operating Officer of Pharmacopeia Labs, a division of Pharmacopeia, Inc. Mr. Shuster joined Human Genome Sciences as its first employee in September 1992 and as Executive Vice President of Operations and Finance and helped guide the development and operation of what was the world’s leading gene sequencing operation in 1994. Mr. Shuster served as a director of Epitomics, Inc., a private monoclonal antibody firm, from 2002 until May 2010, and a director of Sorrento Therapeutics, Inc., a biopharmaceutical company, from September 2009 to February 2010 and has served as a director of Retrotope, a privately held biotechnology company, since April 2008. Mr. Shuster received a B.A. in Economics from Swarthmore College and an M.B.A. from Stanford University. Mr. Shuster provides the board with an extensive background in financial and strategic planning, auditing and accounting and financial leadership expertise. As Chairman of the Audit Committee, Mr. Shuster also keeps the board abreast of current audit issues and collaborates with our independent registered public accounting firm and senior management team.

Charles P. Waite, Jr., has served as a member of our board of directors since March 2006. Mr. Waite has been a General Partner of OVP Venture Partners II and a Vice President of Northwest Venture Services Corp. since 1987, a General Partner of OVP Venture Partners III since 1994, a General Partner of OVP Venture Partners IV since 1997, a General Partner of OVP Venture Partners V since 2000 and a General Partner of OVP Venture Partners VI since 2001, all of which are venture capital firms. He currently serves on the board of directors of eight private companies. Mr. Waite received an A.B. in History from Kenyon College and an M.B.A. from Harvard University. Mr. Waite brings to the board significant operational and leadership experience as a venture capital investor who sits on a number of boards. Mr. Waite’s investment focus on life science companies also provides substantial expertise in our industry.

Scientific Advisory Board

We maintain a scientific advisory board consisting of members with experience and expertise in the field of genomics and genetics who provide us with consulting services. Our scientific advisory board consists of the following members:

Mark Chee, Ph.D., is an internationally recognized expert in genomics. He presently serves as Chief Executive Officer and Chief Scientific Officer of Prognosys Biosciences, Inc. Previously, he co-founded Illumina, Inc., and was Director of Genetics Research at Affymetrix, Inc. He has published scientific papers on microarray technology and applications and is an inventor on over 40 issued patents. He also serves on the External Scientific Committee of The Cancer Genome Atlas project. Dr. Chee received his B.Sc. in Biochemistry from the University of New South Wales and his Ph.D. in Molecular Biology from the University of Cambridge.

 

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George Church, Ph.D., is Professor of Genetics at Harvard Medical School and Director of the Center for Computational Genetics. With degrees from Duke University in Chemistry and Zoology, he co-authored research on 3D-software & RNA structure with Sung-Hou Kim. His 1984 Ph.D. from Harvard in Biochemistry & Molecular Biology with Wally Gilbert included the first direct genomic sequencing method. He co-initiated the Human Genome Project a few months later as a Research Scientist at newly formed Biogen Inc. and was a Monsanto Life Sciences Research Fellow at UCSF. He invented the broadly applied concepts of molecular multiplexing and tags, homologous recombination methods and array DNA synthesizers. Technology transfer of automated sequencing and software to Genome Therapeutics Corp. resulted in the first commercial genome sequence (the human pathogen, H. pylori, 1994). He has served in advisory roles for 12 journals, five granting agencies and 22 biotechnology companies. His current research focuses on integrating biosystems-modeling with personal genomics and synthetic biology.

Leroy Hood, M.D., Ph.D., is currently President of the Institute for Systems Biology. His research has focused on the study of molecular immunology, biotechnology and genomics. His professional career began at the California Institute of Technology where he and his colleagues pioneered four instruments, the DNA gene sequencer and synthesizer and the protein synthesizer and sequencer, which comprise the technological foundation for contemporary molecular biology. In particular, the DNA sequencer has revolutionized genomics by allowing the rapid, automated sequencing of DNA, which played a crucial role in contributing to the successful mapping of the human genome during the 1990s. In 1992, he moved to the University of Washington as founder and Chairman of the cross-disciplinary Department of Molecular Biotechnology. In 2000, he co-founded the Institute for Systems Biology in Seattle, Washington to pioneer systems approaches to biology and medicine. He is a member of the National Academy of Sciences, the American Philosophical Society, the American Association of Arts and Sciences and the Institute of Medicine. He has also played a role in founding numerous biotechnology companies, including Amgen, Inc., Applied Biosystems, Inc., Systemix Institute, Darwin Molecular Corp. and Rosetta Inpharmatics LLC. Dr. Hood received an M.D. from Johns Hopkins School of Medicine and a Ph.D. in Biochemistry from the California Institute of Technology. He has published more than 600 peer-reviewed papers, is listed as an inventor on 14 issued patents and has co-authored textbooks in biochemistry, immunology, molecular biology and genetics.

Douglas A. Lauffenburger, Ph.D., is the Uncas & Helen Whitaker Professor of Bioengineering and Director of the Biological Engineering Division at the Massachusetts Institute of Technology and also holds appointments in the Department of Biology and the Department of Chemical Engineering. Dr. Lauffenburger received B.S. and Ph.D. degrees in chemical engineering from the University of Illinois in 1975 and the University of Minnesota in 1979, respectively. His major research interests are in cell engineering, the fusion of engineering with molecular cell biology. A central focus of his research program is in receptor-mediated cell communication and intracellular signal transduction, with emphasis on development of predictive computational models derived from quantitative experimental studies, on cell cue/signal/response relationships. These models have applications in drug discovery and development.

Leadership Structure of the Board

The board appointed              as the lead independent director in              to help reinforce the independence of the board as a whole. The lead independent director is empowered to, among other duties and responsibilities, provide general leadership of the affairs of the independent directors, preside over board meetings in the absence of the Chief Executive Officer and during independent director closed session portions of the meetings, preside over and establish the agendas for meetings of the independent directors and act as liaison between the Chief Executive Officer and the independent directors. The board believes that the lead independent director can help ensure the effective independent functioning of the board in its oversight responsibilities.

 

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Board Composition

Independent Directors

Our board of directors consists of seven members. Our board of directors has determined that all of our directors, other than Dr. Reid, qualify as “independent” directors in accordance with the NASDAQ listing requirements. Dr. Reid is not considered independent because he is an employee of Complete Genomics. The NASDAQ independence definition includes a series of objective tests, such as that the director is not, and has not been for at least three years, one of our employees and that neither the director nor any of his family members has engaged in various types of business dealings with us. In addition, as required by NASDAQ rules, our board of directors has made a subjective determination as to each independent director that no relationships exist, which, in the opinion of our board of directors, would interfere with the exercise of independent judgment in carrying out the responsibilities of a director. In making these determinations, our board of directors reviewed and discussed information provided by the directors and us with regard to each director’s business and personal activities and relationships as they may relate to us and our management.

Classified Board of Directors

In accordance with our amended and restated certificate of incorporation to be in effect immediately prior to the consummation of this offering, our board of directors will be divided into three classes with staggered, three-year terms. At each annual meeting of stockholders, the successors to directors whose terms then expire will be elected to serve from the time of election and qualification until the third annual meeting following election. Effective upon the completion of this offering, our directors will be divided among the three classes as follows:

 

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the Class I directors will be             ,              and             , and their terms will expire at the annual meeting of stockholders to be held in 2011;

 

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the Class II directors will be             ,              and             , and their terms will expire at the annual meeting of stockholders to be held in 2012; and

 

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the Class III directors will be             ,              and             , and their terms will expire at the annual meeting of stockholders to be held in 2013.

Our amended and restated certificate of incorporation will provide that the authorized number of directors may be changed only by resolution of the board of directors. Any additional directorships resulting from an increase in the number of directors will be distributed among the three classes so that, as nearly as possible, each class will consist of one-third of the directors. The division of our board of directors into three classes with staggered three-year terms may delay or prevent a change of our management or a change-in-control of our company.

Voting Arrangements

The election of the members of our board of directors is governed by the amended and restated voting agreement that we entered into with certain holders of our common stock and certain holders of our convertible preferred stock and the related provisions of our amended and restated certificate of incorporation. Pursuant to the voting agreement and these provisions:

 

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the holders of our Series A Preferred Stock, voting separately as a single class, have the right to elect two directors to our board of directors, one of whom is designated by OVP Venture Partners VI, L.P. and its affiliates, for which Mr. Waite has been designated, and one of whom is designated by Enterprise Partners VI, L.P. and its affiliates, for which Dr. Senyei has been designated;

 

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the holders of our Series B Preferred Stock, voting separately as a single class, have the right to elect one director to our board of directors, who is designated by Prospect Venture Partners III, L.P., for which Dr. Barkas has been designated;

 

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the holders of our Series C Preferred Stock, voting separately as a single class, have the right to elect one director to our board of directors, who is designated by Highland Capital Management, L.P., for which Mr. Shuster has been designated;

 

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  §  

the holders of our Series D Preferred Stock, voting separately as a single class, have the right to elect two directors to our board of directors, one of whom is designated by Essex Woodlands Health Ventures Fund VIII, L.P., for which Dr. Caskey has been designated, and one of whom is designated by OrbiMed Associates III, LP and its affiliates, for which Dr. Gordon has been designated;

 

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the holders of our common stock, voting separately as a single class, have the right to elect one director to our board of directors, who is the then-current chief executive officer, currently Dr. Reid; and

 

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the holders of our preferred stock and common stock, voting together as a single class, have the right to elect the remaining director, if any.

The holders of our common stock and preferred stock who are parties to our voting agreement are obligated to vote for such designees indicated