ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following information should be read in conjunction with the condensed consolidated financial statements and the accompanying notes included in Part I, Item 1 of this Report, and the “Risk Factors” included in Part I, Item 1A of the
2015
10-K.
SAFE HARBOR CAUTIONARY STATEMENT
This quarterly report on Form 10-Q contains statements that are forward-looking statements under the Private Securities Litigation Reform Act of 1995. Forward-looking statements provide our current expectations of forecasts of future events. All statements other than statements of current or historical fact contained in this quarterly report, including statements regarding our future financial position, business strategy, impact of the reimbursement landscape, the acquisition impact and integration of Nanosphere, new products including ARIES
®
and NxTAG
®
, assay sales, consumables sales patterns and bulk purchases, budgets, system sales, anticipated gross margins, liquidity, cash flows, projected costs and expenses, taxes, deferred tax assets, litigation costs, including the costs or impact of any litigation settlements or orders, regulatory approvals or the impact of any laws or regulations applicable to us, plans and objectives of management for future operations, and acquisition impact and integration and the expected benefit of our future acquisitions are forward-looking statements. The words “anticipate,” “believe,” “continue,” “should,” “estimate,” “expect,” “intend,” “may,” “plan,” “project,” “will” and similar expressions as they relate to us, are intended to identify forward-looking statements. These statements are based on our current plans and actual future activities, and our financial condition and results of operations may be materially different from those set forth in the forward-looking statements as a result of known or unknown risks and uncertainties, including, among other things:
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risks and uncertainties associated with the integration of Nanosphere and implementing our acquisition strategy, our ability to identify suitable acquisition targets including our ability to obtain financing on acceptable terms, our ability to integrate acquired companies, or selected assets into our consolidated business operations, and the ability to fully realize the benefits of our acquisitions;
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concentration of our revenue in a limited number of direct customers and strategic partners, some of which may experience decreased demand for their products utilizing or incorporating our technology, budget or finance constraints in the current economic environment, or periodic variability in their purchasing patterns or practices as a result of material resource planning challenges;
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•
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risks and uncertainties relating to market demand and acceptance of our products and technology, including ARIES
®
, MultiCode
®
, NxTAG
®
, xMAP
®
and Verigene
®
;
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•
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our ability to successfully launch new products in a timely manner;
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the uncertainty relating to increased focus on direct sales to the end user;
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dependence on strategic partners for development, commercialization and distribution of products;
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the timing of and process for regulatory approvals;
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competition and competitive technologies utilized by our competitors;
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fluctuations in quarterly results due to a lengthy and unpredictable sales cycle, fluctuations in bulk purchases of consumables, fluctuations in product mix, and the seasonal nature of some of our assay products;
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our ability to obtain and enforce intellectual property protections on our products and technologies;
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our ability to scale manufacturing operations and manage operating expenses, gross margins and inventory levels;
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the impact of the ongoing uncertainty in global finance markets and changes in government and government agency funding, including its effects on the capital spending policies of our partners and end users and their ability to finance purchases of our products;
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changes in principal members of our management staff;
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potential shortages, or increases in costs, of components or other disruptions to our manufacturing operations;
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our increasing dependency on information technology to enable us to improve the effectiveness of our operations and to monitor financial accuracy and efficiency;
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the implementation, including any modification, of our strategic operating plans;
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•
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the uncertainty regarding the outcome or expense of any litigation brought against or initiated by us; and
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risks relating to our foreign operations, including fluctuations in exchange rates, tariffs, customs and other barriers to importing/exporting materials and products in a cost effective and timely manner; difficulties in accounts receivable collections; the burden of monitoring and complying with foreign and international laws and treaties; and the burden of complying with and change in international taxation policies.
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Many of these risks, uncertainties and other factors are beyond our control and are difficult to predict. Any or all of our forward-looking statements in this quarterly report may turn out to be inaccurate. We have based these forward-looking statements largely on our current expectations and projections about future events and financial trends that we believe may affect our financial condition, results of operations, business strategy and financial needs. New factors could also emerge from time to time that could adversely affect our business. The forward-looking statements herein can be affected by inaccurate assumptions we might make or by known or unknown risks, uncertainties and assumptions, including the risks, uncertainties and assumptions outlined above and described in the
2015
10-K. In light of these risks, uncertainties and assumptions, the forward-looking events and circumstances discussed in this quarterly report may not occur and actual results could differ materially from those anticipated or implied in the forward-looking statements. When you consider these forward-looking statements, you should keep in mind these risk factors and other cautionary statements in this quarterly report, including in this "Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations” and in our other annual and periodic reports.
Our forward-looking statements speak only as of the date made. We undertake no obligation to publicly update or revise forward-looking statements whether as a result of new information, future events or otherwise. All subsequent written and oral forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by the cautionary statements contained in this quarterly report.
Unless the context requires otherwise, references in this Quarterly Report on Form 10-Q to “Luminex,” the “Company,” “we,” “us” and “our” refer to Luminex Corporation and its subsidiaries.
OVERVIEW
We develop, manufacture and sell proprietary biological testing technologies and products with applications throughout the diagnostics, pharmaceutical and life sciences industries. These industries depend on a broad range of tests, called assays, to perform diagnostic testing and conduct life science research.
We have established a position in several segments of the life sciences industry by developing and delivering products that meet a variety of customer needs in specific market segments, including multiplexing, accuracy, precision, sensitivity, specificity, reduction of labor and ability to test for proteins and nucleic acids. These needs are addressed by our proprietary technology, which allows the end user in a laboratory to perform biological testing in a multiplexed format. Multiplexing allows for many different laboratory results to be generated from one sample with a single assay. This is important because our end user customers, which include laboratory professionals performing research and clinical laboratories performing tests on patients as ordered by physicians and other laboratories, have a fundamental need to perform high quality testing as efficiently as possible. Until the availability of multiplexing technology such as our xMAP
®
(Multi-Analyte-Profiling) technology, the laboratory professional had to perform one assay at a time in a sequential manner, and if additional testing was required on a sample, a second assay would be performed to generate the second result, and so on until all the necessary tests were performed.
We have a full range of instruments using our xMAP technology: our LUMINEX 100/200™ systems offer 100-plex testing; our FLEXMAP 3D
®
system is our high-throughput, 500-plex testing system; and our MAGPIX
®
system provides 50-plex testing at a lower cost using imaging rather than flow cytometry. By using our xMAP technology, the end users are able to be more efficient by generating multiple simultaneous results per sample. We believe that this technology may also offer advantages in other industries, such as in food safety/animal health and bio-defense/bio-threat markets. Using the products Luminex has available today, up to 500 simultaneous analyte results can be determined from a single sample.
We primarily serve the diagnostics, pharmaceutical and life sciences industries by marketing products, including our testing equipment and assays, to various types of testing laboratories. We have a large installed base of systems that has grown primarily from the following:
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placements made by partners who either:
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license our xMAP technology and develop products that incorporate our xMAP technology into products that they then sell to end users, or
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purchase our proprietary xMAP laboratory instrumentation and our proprietary xMAP microspheres and sell xMAP-based assay products and/or xMAP-based testing services, which run on the xMAP instrumentation, and pay a royalty to us; and
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our direct sales force that focuses on the sale of molecular diagnostic assays that run on our systems.
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As of
September 30, 2016
, Luminex had
73
strategic partners, of which
52
have released commercialized reagent-based products utilizing our technology. Our remaining partners are in various stages of development and commercialization of products that incorporate our technology.
Our acquisition of Nanosphere on June 30, 2016 expands our offering in the molecular diagnostic market segment with Nanosphere's proprietary diagnostic tools that enable rapid and accurate detection of respiratory, gastrointestinal and bloodstream infections. Nanosphere is a leader in the high-growth bloodstream infection testing segment with its U.S. Food and Drug Administration (FDA) cleared Verigene Gram-Positive and Gram-Negative Blood Culture test panels, for the early detection of pathogens associated with bloodstream infections. In addition to detecting bacteria, these panels also detect yeast and identify antibiotic resistance markers. In contrast to traditional methodologies, which can take several days, these assays enable physicians to identify the pathogen, including associated resistance markers, and thus prescribe the most appropriate antibiotic regimen within 2.5 hours after positive blood culture. The ability for clinicians to make earlier, better informed therapeutic decisions results in improved patient outcomes and lower healthcare costs. In addition, Nanosphere has FDA-cleared products for the detection of gastrointestinal and respiratory infections. These include a targeted product for the detection of
C. difficile
, as well as highly multiplexed molecular enteric and respiratory pathogen panels which tests for a wide spectrum of microorganisms often associated with these types of infections. With the addition of the Verigene platform, Luminex offers customers automated molecular platforms for both syndromic and targeted molecular diagnostic testing.
In addition to our menu of infectious disease tests, we are currently developing a next generation Verigene system that will deliver improved user experience. This system is designed to provide reduced time to result, improved user interface, including a room temperature cartridge all in a fully automated sample to result system with an optimized footprint.
A primary focus for our growth is the development and sale of molecular diagnostic assays utilizing our proprietary MultiCode
®
and Verigene technologies for use on our installed base of systems. We utilize a direct sales model for sales of these products, which is intended to take advantage of our increasing installed base of instruments. Our assays are primarily focused on multiplexed applications for the human molecular clinical diagnostics market. Our assay products are currently focused on three segments of the molecular diagnostic testing market: human genetics, personalized medicine and infectious disease.
In addition to the sales to this installed base, in the fourth quarter of 2015 we received FDA clearance for our ARIES
®
system. The ARIES
®
system is a sample to answer clinical test system that automates and integrates extraction of nucleic acid from a clinical sample, performs real-time polymerase chain reaction, and detects multiple signals generated by target specific probes. The ARIES
®
system is used with specific assays to measure multiple analytes indicative of infectious disease. The ARIES
®
system uses internal barcode scanning and other advanced features to minimize operator errors. Two independent modules each support from one to six cassettes, allowing both STAT and Batch testing. The ARIES
®
system can run both In Vitro Diagnostics (IVD) and MultiCode
®
Analyte Specific Reagents simultaneously with a common Universal Assay Protocol. The ARIES
®
system was commercially launched in the fourth quarter of 2015. We also received FDA clearance for the ARIES
®
HSV (herpes simplex virus) 1&2 Assay in the fourth quarter of 2015; CE-IVD Mark in Europe for the ARIES
®
System and ARIES
®
HSV 1&2 Assay in the first quarter of 2016; CE-IVD Mark in Europe for the ARIES
®
Flu A/B & RSV Assay in the second quarter of 2016; and FDA Clearance and CE-IVD Mark for the ARIES
®
M1 System and FDA clearance for the ARIES® Flu A/B & RSV Assay in the third quarter of 2016.
Third Quarter 2016
Highlights
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Consolidated revenue was
$71.2 million
for the quarter ended
September 30, 2016
, representing an
18%
increase over revenue for the
third
quarter of
2015
.
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•
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System revenue was
$10.5 million
for the quarter ended
September 30, 2016
, representing a
9%
increase over system revenue for the
third
quarter of
2015
.
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•
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Consumable revenue was
$12.3 million
for the quarter ended
September 30, 2016
, representing a
12%
increase over consumable revenue for the
third
quarter of
2015
.
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•
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Assay revenue was
$32.4 million
for the quarter ended
September 30, 2016
, representing a
32%
increase over assay revenue for the
third
quarter of
2015
.
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•
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Royalty revenue was
$11.1 million
for the quarter ended
September 30, 2016
, representing an
8%
increase over royalty revenue for the
third
quarter of
2015
.
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•
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Received U.S. FDA clearance for the ARIES
®
Flu A/B & RSV Assay.
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Received U.S. FDA clearance and CE-IVD Mark for the Company's ARIES M1 System.
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Received FDA Emergency Use Authorization for Zika Virus Molecular Detection Assay.
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•
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Shipments of
294
multiplexing analyzers, which include Luminex
®
100/200
TM
systems, MAGPIX
®
systems and FLEXMAP 3D
®
systems.
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Recent Acquisition of Nanosphere
As previously discussed in Note 2 - Business Combinations, on June 30, 2016, we completed our acquisition of Nanosphere, Inc. (Nanosphere), a publicly-held molecular diagnostic company based in Northbrook, Illinois. The Acquisition was an all cash transaction that was undertaken to expand the Company's access to the high-growth molecular microbiology market and to Nanosphere's portfolio of molecular testing solutions. In connection with closing the Acquisition, we retired Nanosphere's
$25.4 million
of debt and paid transaction and debt prepayment expenses of approximately
$4.0 million
. As a result of the Acquisition and the debt payoff, our cash, cash equivalents and investments were reduced by approximately
$93.1 million
during the
nine
months ended
September 30, 2016
, partially offset by operating cash flows of
$35.8 million
. The results of operations for Nanosphere are included in the Company’s consolidated financial statements beginning July 1, 2016.
As a result of the dilutive nature of the Acquisition, we believe both profitability and operating cash flows over the next eighteen months, approximately, will be lower than our recent historical results; however, we expect to maintain profitability and positive operating cash flows. We currently anticipate that the Acquisition and its related integration will be accretive to the Company's consolidated revenue, profitability, and cash flow by the end of 2017.
Growth in Inventory
Our inventory has increased from
$31.3 million
as of
December 31, 2015
to
$41.5 million
as of
September 30, 2016
primarily due to increases in systems inventory and the inclusion of the acquired Nanosphere inventory. Based upon the increased demand for our systems that we have experienced over the past twelve months, we are building both our finished good system inventory and parts and supplies inventory related to our systems to be able to meet both expected and unanticipated demand.
Material Partner Activity
As previously disclosed, the cystic fibrosis (CF) assay revenue from the Company's largest customer, LabCorp, will wind down in 2017 while LabCorp transfers its CF business to an alternative technology. Also, LabCorp recently informed us following a request for proposal process that they have elected to develop the next iteration of one of their women's health products with another party. The transition time is significant and, as a result, the parties have negotiated significant minimum women's health purchases for 2017 and the first half of 2018, pursuant to an amendment to the Party’s existing supply agreement. LabCorp historically had the right to terminate the supply agreement with Luminex on 90 days’ notice. Going forward, through June 30, 2018, LabCorp will acquire no less than
$63.1 million
in additional women's health products during 2017 and the first six months of 2018. This is in comparison to anticipated 2016 purchases of approximately
$36.0 million
.
Consumables Sales and Royalty Revenue Trends
We have experienced significant fluctuations in consumable revenue over the past three years. Overall, the fluctuations manifested themselves through periodic changes in volume from our largest purchasing customers. On a quarterly basis, our largest customers account for approximately
70%
of our total consumable sales volume. We expect these fluctuations to continue as the ordering patterns and inventory levels of our largest bulk purchasing partners remain variable. Additionally, even though we experience variability in consumable revenue, the key indicator of the success of our partners’ commercialization efforts is the rising level of royalties and reported royalty bearing sales.
Future Operations
We expect our areas of focus over the next twelve months to be:
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accelerating development and commercialization of the assays on our automated diagnostics systems;
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increasing the growth of our partner business through enrichment of our existing partner relationships and the addition of new partners;
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developing and commercializing the next generation system for Verigene;
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•
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placement of our ARIES
®
system, our sample to answer platform for our MultiCode
®
-RTx technology, including IVD assays;
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•
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realizing the anticipated synergies of the Nanosphere acquisition and associated integration, including the effective incorporation of our combined salesforce in the marketplace;
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•
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development and commercialization of a pipeline of assays for the ARIES
®
system;
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•
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market acceptance of our recently launched Respiratory Viral Panel line of IVD assays;
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continued execution of our direct sales strategy, including developing the infrastructure necessary to support our sales force and decreasing reliance on our distributors;
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commercialization, regulatory clearance and market adoption of products, including commercialization of MultiCode
®
assays outside of the United States;
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maintenance and improvement of our existing products and the timely development, completion and successful commercial launch of our pipeline products;
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adoption and use of our platforms and consumables by our customers for their testing services;
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expansion and enhancement of our installed base of systems and our market position within our identified target market segments;
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•
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monitoring and mitigating the effect of the ongoing uncertainty in global finance markets and changes in government funding on planned purchases by end users; and
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continued adoption and development of partner products incorporating Luminex technology through effective partner management.
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We anticipate continued revenue concentration in our higher margin items (assays, consumables and royalties) contributing to favorable, but variable, gross margin percentages. Additionally, we believe that a sustained investment in research and development is necessary in order to meet the needs of our marketplace and provide a sustainable new product pipeline. We may experience volatility in research and development expenses as a percentage of revenue on a quarterly basis as a result of the timing of development expenses, clinical validation and clinical trials in advance of the commercial launch of our new products.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The discussion and analysis of our financial condition and results of operations are based upon our condensed consolidated financial statements, which have been prepared in accordance with U.S. GAAP for interim financial statements. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Estimates and assumptions are reviewed periodically. Actual results may differ from these estimates under different assumptions or conditions.
Management believes there have been no significant changes during the quarter ended
September 30, 2016
to the items that we disclosed as our critical accounting policies and estimates in Management’s Discussion and Analysis of Financial Condition and Results of Operations in the
2015
10-K.
RESULTS OF OPERATIONS
THREE MONTHS ENDED
SEPTEMBER 30
,
2016
COMPARED TO THREE MONTHS ENDED
SEPTEMBER 30
,
2015
Selected consolidated financial data for the three months ended
September 30
,
2016
and
2015
is as follows (dollars in thousands):
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Three Months Ended September 30,
|
|
|
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2016
|
|
2015
|
|
Variance
|
|
Variance (%)
|
Revenue
|
$
|
71,221
|
|
|
$
|
60,601
|
|
|
$
|
10,620
|
|
|
18
|
%
|
Gross profit
|
$
|
45,665
|
|
|
$
|
41,812
|
|
|
3,853
|
|
|
9
|
%
|
Gross margin percentage
|
64
|
%
|
|
69
|
%
|
|
(5
|
)%
|
|
N/A
|
|
Operating expenses
|
$
|
41,637
|
|
|
$
|
32,106
|
|
|
9,531
|
|
|
30
|
%
|
Income from operations
|
$
|
4,028
|
|
|
$
|
9,706
|
|
|
(5,678
|
)
|
|
(58
|
)%
|
Total revenue increased by
18%
to
$71.2 million
for the
three
months ended
September 30, 2016
from
$60.6 million
for the comparable period in
2015
, driven primarily by the Acquisition on June 30, 2016, which contributed approximately
13%
of the
18%
increase. Nanosphere's most notable impact is expected to be in the assay revenue component of our business.
A breakdown of revenue for the
three
months ended
September 30, 2016
and
2015
is as follows (dollars in thousands):
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|
|
|
|
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Three Months Ended September 30,
|
|
|
|
|
|
2016
|
|
2015
|
|
Variance
|
|
Variance (%)
|
System sales
|
$
|
10,494
|
|
|
$
|
9,622
|
|
|
$
|
872
|
|
|
9
|
%
|
Consumable sales
|
12,305
|
|
|
10,940
|
|
|
1,365
|
|
|
12
|
%
|
Royalty revenue
|
11,068
|
|
|
10,249
|
|
|
819
|
|
|
8
|
%
|
Assay revenue
|
32,443
|
|
|
24,639
|
|
|
7,804
|
|
|
32
|
%
|
Service revenue
|
2,934
|
|
|
2,386
|
|
|
548
|
|
|
23
|
%
|
Other revenue
|
1,977
|
|
|
2,765
|
|
|
(788
|
)
|
|
(28
|
)%
|
|
$
|
71,221
|
|
|
$
|
60,601
|
|
|
$
|
10,620
|
|
|
18
|
%
|
We continue to experience revenue concentration in a limited number of customers. Five customers accounted for
47%
(
20%
,
11%
,
7%
,
5%
and
4%
, respectively) of consolidated total revenue in the
third
quarter of
2016
. For comparative purposes, these top five customers accounted for
52%
(
23%
,
13%
,
9%
,
5%
and
2%
, respectively) of total revenue in the
third
quarter of
2015
. No other customer accounted for more than 10% of consolidated total revenue during those periods.
Revenue from the sale of systems and peripheral components increased
9%
to
$10.5 million
for the
three
months ended
September 30, 2016
from
$9.6 million
for the
three
months ended
September 30, 2015
, resulting in part to the Acquisition, placement of additional ARIES
®
systems, as well as favorable mix in sales of multiplexing analyzers with lower sales of MAGPIX systems, partially offset by more sales of LX and FLEXMAP 3D systems. We sold
294
multiplexing analyzers in the
third
quarter of
2016
, as compared to
307
multiplexing analyzers sold for the corresponding prior year period. For the
three
months ended
September 30, 2016
, five of our partners accounted for
211
multiplexing analyzers, or
72%
, of total multiplexing analyzers sold, as compared to five of our partners accounting for
229
multiplexing analyzers, or
75%
, of total multiplexing analyzers sold for the
three
months ended
September 30, 2015
.
Consumable sales, comprised of microspheres and sheath fluid, increased
12%
to
$12.3 million
for the
three
months ended
September 30, 2016
from
$10.9 million
for the
three
months ended
September 30, 2015
. During the
three
months ended
September 30, 2016
, we had
22
bulk purchases of consumables totaling approximately
$9.6 million
(
78%
of total consumable revenue), ranging from
$0.1 million
to
$1.8 million
, as compared with
21
bulk purchases totaling approximately
$8.3 million
(
75%
of total consumable revenue), ranging from $0.1 million to $1.8 million, for the
three
months ended
September 30, 2015
. The increase in revenue from bulk purchases in the
third
quarter of
2016
is the primary driver to the increase in consumable revenue from the prior year quarter. We expect fluctuations in consumable sales on an ongoing basis. Partners who reported royalty bearing sales accounted for
$9.0 million
, or
73%
, of consumable sales for the
three
months ended
September 30, 2016
compared to
$7.7 million
, or
70%
, of the total consumable sales for the
three
months ended
September 30, 2015
.
Royalty revenue, which results when our partners sell products or testing services incorporating our technology, increased by
8%
to
$11.1 million
for the
three
months ended
September 30, 2016
from
$10.2 million
for the
three
months ended
September 30, 2015
. This increase is the result of an increase in base royalties of
$0.5 million
and an increase in minimum royalty payments and royalty audit findings and other adjustments of approximately
$0.3 million
. We expect modest fluctuations in the royalties submitted quarter to quarter based upon the varying contractual terms, differing reporting and payment requirements, and the addition of new partners. Our partners’ end user sales may reflect volatility from quarter to quarter and therefore, that same volatility is reflected in our reported royalty revenues on a quarterly basis.
Assay revenue increased
32%
to
$32.4 million
for the
three
months ended
September 30, 2016
from
$24.6 million
for the
three
months ended
September 30, 2015
, driven primarily by the Acquisition, which accounted for 26% of the 32% increase, in addition to increased sales of infectious disease testing assays. Revenue for our primary assay portfolios increased in infectious disease testing products by
53%
while our genetic testing assay products decreased by 13% for the
three
months ended
September 30, 2016
from the
third
quarter of
2015
. This decrease was attributable to pricing and reimbursement challenges within the pharmacogenetic market segment, causing us to shift some focus away from these opportunities. Additionally, infectious disease testing assay products and genetic testing assay products represented
78%
and
22%
, respectively, of total assay revenue in the
third
quarter of
2016
, compared to
68%
and
32%
, respectively, in the
third
quarter of
2015
. The acquired assay revenue for Nanosphere represents approximately 20% of total assay revenue for the
three
months ended
September 30, 2016
, and consisted primarily of infectious disease testing assay products. Our largest customer, by revenue, accounted for
41%
of total assay revenue for the
three
months ended
September 30, 2016
compared to
53%
for the
three
months ended
September 30, 2015
. No other customer accounted for more than 10% of total assay revenue during those periods. As disclosed previously, cystic fibrosis revenue from our largest assay customer is expected to transition to a competing technology and, although timing is uncertain, the loss of a significant portion of that revenue is expected by the first half of 2017. As discussed in the Overview section above, the same assay customer has recently informed us that they plan on developing the next iteration of their women's health portfolio with another party, which could negatively impact assay revenue in 2018.
Service revenue, comprised of extended warranty contracts earned ratably over the term of a contract and time and materials for billable service work not under an extended warranty contract, increased
$0.5 million
, or
23%
, to
$2.9 million
for the
third
quarter of
2016
compared to the
third
quarter of
2015
. As of
September 30, 2016
, we had
1,981
Luminex systems covered under extended service agreements and
$4.8 million
in deferred revenue related to those contracts. As of
September 30, 2015
, we had
1,682
Luminex systems covered under extended service agreements and
$4.3 million
in deferred revenue related to those contracts.
Other revenue, which includes training revenue, shipping revenue, miscellaneous part sales, amortized license fees, 2015 milestone payments from our development agreement with Merck and revenue from agreements with U.S. government agencies, decreased
28%
to
$2.0 million
for the
three
months ended
September 30, 2016
compared to
$2.8 million
for the
three
months ended
September 30, 2015
, primarily driven by a reduction in government contract revenue. We expect this trend to continue in the near term as our focus has shifted away from these government contract opportunities.
Gross Profit
. Gross profit increased to
$45.7 million
for the
three
months ended
September 30, 2016
, as compared to
$41.8 million
for the
three
months ended
September 30, 2015
. However, gross margin (gross profit as a percentage of total revenue) was
64%
for the
three
months ended
September 30, 2016
, lower than the prior year quarter of
69%
. The decrease in gross margin percentage is attributable to the Acquisition. The acquired Nanosphere portfolio has meaningfully lower gross margins than the pre-existing Luminex business, including the impact of a $0.5 million incremental expense resulting from recording Nanosphere's inventory acquired at fair value on the date of the Acquisition. We expect the gross margins on the acquired portfolio to continue to negatively impact our consolidated gross margins in the near term; however, we expect synergies realized from the acquisition, increased sales volumes and the commercialization of the next generation Verigene system to increase these gross margins in the longer term. We anticipate continued fluctuation in gross margin and related gross profit primarily as a result of variability in consumable and system purchases and seasonality effects inherent in our assay revenue.
Research and Development Expense.
Research and development expense increased to
$12.8 million
, or
18%
of total revenue, for the
three
months ended
September 30, 2016
from
$10.1 million
, or
17%
of total revenue, for the
three
months ended
September 30, 2015
. The increase in research and development expense was primarily a result of the addition of Nanosphere's expenses, as well as higher costs for clinical trials of ARIES assays. Research and development headcount as of
September 30, 2016
was
229
, including
33
Nanosphere employees, as compared to
199
as of
September 30, 2015
. The focus of our research and development activities is the development and commercialization of a pipeline of assays for the ARIES
®
system and the development of the next generation Verigene system and assays.
Selling, General and Administrative Expense
. Selling, general and administrative expenses, excluding the amortization of acquired intangible assets, increased to
$26.4 million
for the
three
months ended
September 30, 2016
from
$21.2 million
for the
three
months ended
September 30, 2015
. The increase was primarily attributable to the addition of Nanosphere's expenses and transaction costs of $0.5 million incurred during the quarter. Selling, general and administrative headcount as of
September 30, 2016
was
371
, including
47
Nanosphere employees, as compared to
312
as of
September 30, 2015
. As a percentage of revenue, selling, general and administrative expense, excluding the amortization of acquired intangible assets, was
37%
in the
third
quarter of
2016
, up from
35%
in the
third
quarter of
2015
.
Amortization of Acquired Intangible Assets.
Amortization of acquired intangible assets increased to $2.5 million for the
three
months ended
September 30, 2016
from $0.8 million for the
three
months ended
September 30, 2015
. The increase was primarily driven by the completion of the in-process research and development project related to our ARIES
®
System which began amortizing in November 2015, as well as due to acquired intangible assets from the Acquisition which began amortizing in July 2016.
Income taxes
. Our effective tax rate for the
three
months ended
September 30, 2016
was
32%
, reflecting a
$1.3 million
expense, as compared to
34%
, or a
$3.3 million
expense, for the
three
months ended
September 30, 2015
primarily resulting from the impact of projected income tax benefits related to Nanosphere in our provisional tax rates. We expect our consolidated effective tax rate to be in the 25% to 35% range over the next several years, absent any other significant discrete items. We continue to assess our business model and its impact in various tax jurisdictions.
NINE
MONTHS ENDED
SEPTEMBER 30
,
2016
COMPARED TO
NINE
MONTHS ENDED
SEPTEMBER 30
,
2015
Selected consolidated financial data for the
nine
months ended
September 30
,
2016
and
2015
is as follows (dollars in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30,
|
|
|
|
|
|
2016
|
|
2015
|
|
Variance
|
|
Variance (%)
|
Revenue
|
$
|
198,368
|
|
|
$
|
177,259
|
|
|
$
|
21,109
|
|
|
12
|
%
|
Gross profit
|
$
|
135,392
|
|
|
$
|
125,301
|
|
|
10,091
|
|
|
8
|
%
|
Gross margin percentage
|
68
|
%
|
|
71
|
%
|
|
(3
|
)%
|
|
N/A
|
|
Operating expenses
|
$
|
112,063
|
|
|
$
|
95,943
|
|
|
16,120
|
|
|
17
|
%
|
Income from operations
|
$
|
23,329
|
|
|
$
|
29,358
|
|
|
(6,029
|
)
|
|
(21
|
)%
|
Total revenue increased by
12%
to
$198.4 million
for the
nine
months ended
September 30, 2016
from
$177.3 million
for the comparable period in
2015
. The increase was primarily attributable to increases in assay, system, and consumable sales, driven in part by the Acquisition on June 30, 2016 which contributed approximately 4% of the 12% growth in total revenue.
A breakdown of revenue for the
nine
months ended
September 30, 2016
and
2015
is as follows (dollars in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30,
|
|
|
|
|
|
2016
|
|
2015
|
|
Variance
|
|
Variance (%)
|
System sales
|
$
|
27,805
|
|
|
$
|
22,129
|
|
|
$
|
5,676
|
|
|
26
|
%
|
Consumable sales
|
37,489
|
|
|
32,714
|
|
|
4,775
|
|
|
15
|
%
|
Royalty revenue
|
33,888
|
|
|
32,024
|
|
|
1,864
|
|
|
6
|
%
|
Assay revenue
|
85,367
|
|
|
74,323
|
|
|
11,044
|
|
|
15
|
%
|
Service revenue
|
7,892
|
|
|
7,108
|
|
|
784
|
|
|
11
|
%
|
Other revenue
|
5,927
|
|
|
8,961
|
|
|
(3,034
|
)
|
|
(34
|
)%
|
|
$
|
198,368
|
|
|
$
|
177,259
|
|
|
$
|
21,109
|
|
|
12
|
%
|
We continue to experience revenue concentration in a limited number of customers. Five customers accounted for
50%
(
21%
,
13%
,
7%
, 6% and
3%
, respectively) of consolidated total revenue in the
nine
months ended
September 30, 2016
. For comparative purposes, these top five customers accounted for
53%
(
23%
,
13%
,
8%
, 6% and
3%
, respectively) of total revenue in the
nine
months ended
September 30, 2015
. No other customer accounted for more than 10% of consolidated total revenue during those periods.
Revenue from the sale of systems and peripheral components increased
26%
to
$27.8 million
for the
nine
months ended
September 30, 2016
from
$22.1 million
for the
nine
months ended
September 30, 2015
, primarily due to the increase in the total multiplexing analyzer placements. We sold
826
multiplexing analyzers in the
nine
months ended
September 30, 2016
, as compared to
734
multiplexing analyzers sold for the corresponding prior year period. For the
nine
months ended
September 30, 2016
, five of our partners accounted for
592
, or
72%
, of total multiplexing analyzers sold. Five of our partners accounted for
559
, or
76%
, of total multiplexing analyzers sold for the
nine
months ended
September 30, 2015
.
Consumable sales increased
15%
to
$37.5 million
for the
nine
months ended
September 30, 2016
compared to
$32.7 million
for the
nine
months ended
September 30, 2015
. We had
64
bulk purchases of consumables totaling approximately
$29.4 million
(
78%
of total consumable revenue), ranging from
$0.1 million
to
$3.4 million
, during the
nine
months ended
September 30, 2016
, as compared with
52
bulk purchases totaling approximately
$24.4 million
(
75%
of total consumable revenue), ranging from $0.1 million to $6.9 million, for the
nine
months ended
September 30, 2015
. The increase in revenue from bulk purchases in the
nine
months ended
September 30, 2016
is the main driver to the increase in consumable revenue from the prior year period and is primarily due to overall growth across our partners. We anticipate a modest decline in our consumable sales in the fourth quarter of 2016 primarily attributable to the timing of purchases by our largest purchaser of consumables. However, excluding purchases from our largest purchaser of consumables for the
nine
months ended
September 30, 2016
and
2015
, consumables from our remaining customers grew by
16%
for the
nine
months ended
September 30, 2016
as compared to the prior year period. We expect fluctuations in consumable sales on an ongoing basis. Partners who reported royalty bearing sales accounted for
$25.0 million
, or
67%
, of consumable sales for the
nine
months ended
September 30, 2016
compared to
$22.4 million
, or
69%
, of the total consumable sales for the
nine
months ended
September 30, 2015
.
Royalty revenue increased
6%
to
$33.9 million
for the
nine
months ended
September 30, 2016
from
$32.0 million
for the
nine
months ended
September 30, 2015
. This increase is primarily attributable to an increase in base royalties of approximately
$1.4 million
as a result of continued menu expansion and increased utilization of our partners’ assays on our technology. We expect modest fluctuations in the royalties submitted quarter to quarter based upon the varying contractual terms, differing reporting and payment requirements, and the addition of new partners. Our partners’ end user sales may reflect volatility from quarter to quarter and therefore, that same volatility is reflected in our reported royalty revenues on a quarterly basis.
Assay revenue increased
15%
to
$85.4 million
for the
nine
months ended
September 30, 2016
from
$74.3 million
for the
nine
months ended
September 30, 2015
, driven primarily by the Acquisition, which contributed 9% of the 15% increase. The remaining 6% of growth is attributable to increased sales in infectious disease testing assays. Our infectious disease testing assay portfolio increased
27%
from the first
nine
months of
2015
while our genetic testing assay portfolio decreased
9%
over the comparable time period. Additionally, infectious disease testing and genetic testing assay products represented
73%
and
27%
, respectively, of total assay revenue in the
nine
months ended
September 30, 2016
, compared to
66%
and
34%
, respectively, in the
nine
months ended
September 30, 2015
. Our largest customer, by revenue, accounted for
45%
of total assay revenue for the
nine
months ended
September 30, 2016
compared to
51%
for the
nine
months ended
September 30, 2015
. No other customer accounted for more than 10% of total assay revenue during those periods. As disclosed previously, cystic fibrosis revenue from our largest assay customer is expected to transition to a competing technology and, although timing is uncertain, the loss of a significant portion of that revenue is expected by the first half of 2017.
Service revenue, comprised of extended warranty contracts earned ratably over the term of a contract and time and materials for billable service work not under an extended warranty contract, increased
11%
to
$7.9 million
for the
nine
months ended
September 30, 2016
compared to
$7.1 million
for the
nine
months ended
September 30, 2015
.
Other revenue, which includes training revenue, shipping revenue, miscellaneous part sales, amortized license fees, 2015 milestone payments from our development agreement with Merck and revenue from agreements with U.S. government agencies, decreased to
$5.9 million
for the
nine
months ended
September 30, 2016
compared to
$9.0 million
for the
nine
months ended
September 30, 2015
, primarily driven by a decrease in revenue from U.S. government contracts, in addition to a Merck milestone payment in 2015, which did not recur in 2016.
Gross Profit
. Gross profit increased to
$135.4 million
for the
nine
months ended
September 30, 2016
, as compared to
$125.3 million
for the
nine
months ended
September 30, 2015
. Gross margin (gross profit as a percentage of total revenue) was
68%
for the
nine
months ended
September 30, 2016
, a decrease from
71%
for the
nine
months ended
September 30, 2015
, was attributable to the Acquisition. The acquired Nanosphere portfolio currently has meaningfully lower gross margins than the pre-existing Luminex business, including the impact of a $0.5 million incremental expense resulting from recording Nanosphere's inventory acquired at fair value on the date of the Acquisition. The acquired Nanosphere portfolio has significantly lower gross margins than the pre-existing Luminex business. We expect the gross margins on the acquired portfolio to continue to negatively impact our consolidated gross margins in the near term; however, we expect synergies realized from the acquisition, increased sales volumes and the commercialization of the next generation Verigene system to increase these gross margins in the longer term. We anticipate continued fluctuation in gross margin and related gross profit primarily as a result of variability in consumable and system purchases and seasonality effects inherent in our assay revenue.
Research and Development Expense.
Research and development expense increased to
$35.3 million
, or
18%
of total revenue, for the
nine
months ended
September 30, 2016
from
$31.7 million
, or
18%
of total revenue, for the
nine
months ended
September 30, 2015
. The
$3.6 million
increase in research and development expense was primarily the result of the addition of Nanosphere's expenses and higher material and expenses driven by the expansion of assay research and clinical trials. Research and development headcount as of
September 30, 2016
was
229
, including
33
Nanosphere employees, as compared to
199
as of
September 30, 2015
. The focus of our research and development activities has been the development and clinical validation of our next generation sample to answer platform for our ARIES
®
system.
Selling, General and Administrative Expense
. Selling, general and administrative expenses, excluding the amortization of acquired intangible assets, increased to
$70.9 million
for the
nine
months ended
September 30, 2016
from
$61.7 million
for the
nine
months ended
September 30, 2015
, primarily resulting from the addition of Nanosphere and the Acquisition transaction costs of $2.5 million, in addition to higher sales and marketing expenses driven by increased headcount and marketing activities. Selling, general and administrative headcount as of
September 30, 2016
was
371
, including
47
Nanosphere employees, as compared to
312
as of
September 30, 2015
. As a percentage of revenue, selling, general and administrative expense, excluding the amortization of acquired intangible assets, was
36%
in the first
nine
months of
2016
, compared to
35%
in the first
nine
months of
2015
.
Amortization of Acquired Intangible Assets.
Amortization of acquired intangible assets increased to $5.8 million for the
nine
months ended
September 30, 2016
from $2.5 million for the
nine
months ended
September 30, 2015
. The increase was primarily driven by the completion of the in-process research and development project related to our ARIES
®
System which began amortizing in November 2015, as well as due to acquired intangible assets from the acquisition of Nanosphere which began amortizing in July 2016.
Other Income, net.
Other income, net decreased to a loss of
$1.4 million
for the
nine
months ended
September 30, 2016
from income of
$1.0 million
for the
nine
months ended
September 30, 2015
. The decrease was primarily the result of the $1.5 million debt retirement fees in connection with the payoff of Nanosphere's debt.
Settlement of litigation
. An expense of $7.1 million was recorded in the second quarter of 2015 related to the settlement of litigation with ENZO. The expense associated with the settlement was for partial consideration of a license, dismissal of litigation, releases, and covenants granted by ENZO. See Note 12 - Commitments and Contingencies to our condensed consolidated financial statements for further discussion.
Income taxes
. Our effective tax rate for the
nine
months ended
September 30, 2016
was
22%
, reflecting a
$4.8 million
expense, as compared to
28%
, or a
$6.5 million
expense, for the
nine
months ended
September 30, 2015
primarily the result of the impact of the Acquisition and the inclusion of projected income tax benefits related to Nanosphere in our provisional tax rates in 2016. We expect our consolidated effective tax rate to be in the 25% to 35% range over the next several years, absent any other significant discrete items. We continue to assess our business model and its impact in various tax jurisdictions.
LIQUIDITY AND CAPITAL RESOURCES
|
|
|
|
|
|
|
|
|
|
September 30, 2016
|
|
December 31, 2015
|
|
(in thousands)
|
Cash and cash equivalents
|
$
|
84,145
|
|
|
$
|
128,546
|
|
Short-term investments
|
—
|
|
|
11,988
|
|
Long-term investments
|
—
|
|
|
7,459
|
|
|
$
|
84,145
|
|
|
$
|
147,993
|
|
As of
September 30, 2016
, we held cash and cash equivalents, short-term investments and long-term investments of
$84.1 million
and had working capital of
$133.3 million
. At
December 31, 2015
, we held cash and cash equivalents, short-term investments and long-term investments of
$148.0 million
and had working capital of
$182.3 million
. The
$63.8 million
decrease in cash, cash equivalents and investments is primarily attributable to the cash payment of approximately
$92.4 million
in connection with the acquisition of Nanosphere, and the subsequent retirement of approximately
$25.4 million
of Nanosphere's debt. These payments were partially offset by the cash acquired from Nanosphere of
$24.3 million
and operating cash flows of the Company in the amount of
$35.8 million
for the
nine
months ended
September 30, 2016
. Our capital expenditures were
$8.4 million
during the first
nine
months of 2016, which were partially funded by
$3.6 million
in proceeds from our employee stock purchase plan.
As a result of the dilutive nature of the Acquisition, we believe both profitability and operating cash flows over the next eighteen months, approximately, will be lower than our recent historical results; however, we expect to maintain profitability and positive operating cash flows. We currently anticipate that the Acquisition and its related integration will be accretive to the Company's consolidated revenue, profitability, and cash flow by the end of 2017.
We have funded our operations to date primarily through the issuance of equity securities (in conjunction with an initial public offering in 2000, subsequent option exercises, and our secondary public offering in 2008) and cash generated from operations. Our cash reserves are typically held directly or indirectly in a variety of short-term, interest-bearing instruments, including non-government sponsored debt securities. We do not have any investments in asset-backed commercial paper, auction rate securities, or mortgage backed or sub-prime style investments.
Our future capital requirements will depend on a number of factors, including our success in developing and expanding markets for our products, payments under possible future strategic arrangements, continued progress of our research and development of potential products, the timing and outcome of regulatory approvals, the need to acquire licenses to new technology, costs associated with strategic acquisitions including integration costs and assumed liabilities, the status of competitive products and potential cost associated with both protecting and defending our intellectual property. We believe that our existing cash and cash equivalents are sufficient to fund our operating expenses, capital equipment requirements and other expected liquidity requirements for the coming twelve months. Factors that could affect our capital requirements, in addition to those listed above, include, without limitation: (i) continued collections of accounts receivable consistent with our historical experience; (ii) our ability to manage our inventory levels consistent with past practices; (iii) volatility in our key partners' consumable purchasing patterns; (iv) execution of partnership agreements that include significant up front license fees; (v) our stock repurchase programs from time to time and (vi) executing strategic investment or acquisition agreements requiring significant cash consideration. See also the "Safe Harbor Cautionary Statement" of this report and the risk factors in the
2015
10-K and our other filings with the SEC.
To the extent our capital resources are insufficient to meet future capital requirements we will have to raise additional funds to continue the development and deployment of our technologies, or to supplement our position through strategic acquisitions. There can be no assurance that debt or equity funds will be available on favorable terms, if at all. Any downgrade in our credit rating could adversely affect our ability to raise debt capital on favorable terms, or at all. To the extent that additional capital is raised through the sale of equity or convertible debt securities, the issuance of those securities could result in dilution to our stockholders. Moreover, incurring debt financing could result in a substantial portion of our operating cash flow being dedicated to the payment of principal and interest on such indebtedness, could render us more vulnerable to competitive pressures and economic downturns and could impose restrictions on our operations. If adequate funds are not available, we may be required to curtail operations significantly or to obtain funds through entering into agreements on unattractive terms.