| XENOGEN CORP Item 1A Risk Factors In addition to the forward-looking statements discussed in this report, we also provide the following cautionary discussion of risks, uncertainties and possibly inaccurate assumptions relevant to our business |
| These items are factors that we believe could cause our actual results to differ materially from expected and historical results |
| Other factors also could adversely affect us |
| If our proposed merger with Caliper Life Sciences, Inc |
| is not consummated, our stock price, business and operations could be harmed |
| On February 10, 2006, we entered into a definitive Agreement and Plan of Merger with Caliper Life Sciences, Inc |
| and its subsidiary, Caliper Holdings, Inc, pursuant to which we will be merged with and into Caliper Holdings and become a wholly-owned subsidiary of Caliper |
| A copy of the merger agreement and other documents relating to the merger are attached as exhibits to the Current Report on Form 8-K that we 17 ______________________________________________________________________ [43]Table of Contents filed with the Securities and Exchange Commission on February 16, 2006 |
| Our Board of Directors has approved the merger and the merger agreement |
| In March 2006, Caliper and Xenogen will file a registration statement on Form S-4 and a notice of special meeting of stockholders and definitive proxy statement for the special meeting of stockholders pursuant to which we will ask our stockholders to adopt and approve the merger agreement and the merger |
| The obligations of Caliper and Xenogen to effect the merger are subject to a number of conditions, including approval by the Xenogen and Caliper stockholders, and the merger may not occur |
| If the merger is not consummated for any reason, we may be subject to a number of material risks, including the following: • we may be required to pay Caliper a termination fee of dlra3dtta1 million; • the price of our common stock may decline to the extent that the current market price of our common stock reflects an assumption that the merger will be completed; and • we must pay our accrued costs related to the merger, such as legal, accounting and certain financial advisory fees, even if the merger is not completed |
| In addition, our customers may, in response to the announcement of the merger, delay or defer purchasing decisions |
| Any delay or deferral in purchasing decisions by our customers would have a material adverse effect on our business, regardless of whether or not the merger is ultimately completed |
| Similarly, our current and prospective employees may experience uncertainty about their future role with Caliper until Caliper’s strategies with regard to us are announced or executed |
| This uncertainty may adversely affect our ability to attract and retain key management, marketing, technical, manufacturing, administrative, sales and other personnel |
| We have a history of losses and an accumulated deficit of dlra186dtta3 million as of December 31, 2005, and we may never achieve profitability |
| We have incurred significant net losses every year since our inception |
| As of December 31, 2005, we had an accumulated deficit of dlra186dtta3 million |
| To achieve profitability, we will need to generate and sustain substantially higher revenue than we have to date, while achieving reasonable costs and expense levels |
| We may not be able to generate enough revenue to achieve profitability |
| We may not achieve or maintain reasonable costs and expense levels |
| Even if we become profitable, we may not be able to sustain or increase profitability on a quarterly or annual basis |
| If we fail to achieve profitability within the timeframe expected by securities analysts or investors, the market price of our common stock will likely decline |
| If our products and services do not become widely used by pharmaceutical, biotechnology, biomedical and chemical researchers, it is unlikely that we will ever become profitable |
| Pharmaceutical, biotechnology, biomedical and chemical researchers have historically conducted in vivo biological assessment using a variety of technologies, including a variety of animal models |
| Compared to these technologies, our technology is relatively new, and the number of companies and institutions using our technology is relatively limited |
| The commercial success of our products will depend upon the widespread adoption of our technology as a preferred method to perform in vivo biological assessment |
| In order to be successful, our products must meet the technical and cost requirements for in vivo biological assessment within the life sciences industry |
| Widespread market acceptance will depend on many factors, including: • the willingness and ability of researchers and prospective customers to adopt new technologies; 18 ______________________________________________________________________ [44]Table of Contents • our ability to convince prospective strategic partners and customers that our technology is an attractive alternative to other methods of in vivo biological assessment; • our customers’ perception that our products can help accelerate efforts and reduce costs in drug development; and • our ability to sell and service sufficient quantities of our products |
| Additionally, to our knowledge, only one of our drug development customers has used our imaging technology to submit an investigational new drug application, or IND, to the Food and Drug Administration, or FDA, and no drugs have been approved to date using our imaging technology |
| As a result, our ability to assist the drug development process in leading to the approval of drugs with commercial potential has yet to be fully proven |
| If commercial advantages are not realized from the use of in vivo biophotonic imaging, our existing customers could stop using our products, and we could have difficulty attracting new customers |
| Because of these and other factors, our products may not gain widespread market acceptance or become the industry standard for in vivo biological assessment |
| As a company in the early stage of commercialization, our limited history of operations makes evaluation of our business and future growth prospects difficult |
| We have had a limited operating history and are at an early stage of commercialization |
| While we sold our first IVIS^® Imaging Systems and entered into our first commercial license in 2000, we did not begin to sell our products and services in commercial quantities until 2002 |
| Our in vivo biophotonic imaging technology is a relatively new technology that has not yet achieved widespread adoption |
| To date, we have generated revenues of dlra16dtta0 million in 2002, dlra20dtta1 million in 2003, dlra30dtta9 million in 2004 and dlra39dtta7 million in 2005 |
| We do not have enough experience in selling our products at a level consistent with broad market acceptance and to know whether we can do so and generate a profit |
| As a result of these factors, it is difficult to evaluate our prospects, and our future success is more uncertain than if we had a longer or more proven history of operations |
| Our future revenue is unpredictable and could cause our operating results to fluctuate significantly from quarter to quarter |
| In particular, our operating results in the first and third quarters have historically been lower than those in the second and fourth quarters due to the decision-making process of our customer base |
| The sale of many of our products, including our IVIS Imaging Systems and related Bioware, typically involve a significant scientific evaluation and commitment of capital by customers |
| Accordingly, the initial sales cycles of many of our products are lengthy and subject to a number of significant risks that are beyond our control, including customers’ budgetary constraints and internal acceptance reviews |
| As a result of this lengthy and unpredictable sales cycle, our operating results have historically fluctuated significantly from quarter to quarter, and we expect this trend to continue |
| In addition, a large portion of our expenses, including expenses for our Alameda, California and Cranbury, New Jersey facilities, equipment and personnel, are relatively fixed |
| Historically, customer buying patterns and our revenue growth have caused a substantial portion of our revenues to occur in the last month of the quarter |
| Delays in the receipt of orders, our recognition of product 19 ______________________________________________________________________ [45]Table of Contents or service revenue or the manufacture of product near the end of the quarter could cause quarterly revenues to fall short of anticipated levels |
| Because our operating expenses are based on anticipated revenue levels and a high percentage of our expenses are relatively fixed, less than anticipated revenues for a quarter could have a significant adverse impact on our operating results |
| Accordingly, if our revenue declines or does not increase as we anticipate, we might not be able to correspondingly reduce our operating expenses in a timely enough manner to avoid incurring additional losses |
| Our failure to achieve our anticipated level of revenue could significantly harm our operating results for a particular fiscal period |
| The following are among additional factors that could cause our operating results to fluctuate significantly from period to period: • changes in the demand for, and pricing of, our products and services; • the length of our sales cycles and buying patterns of our customers, which may cause a decrease in our operating results for a quarterly period; • the nature, pricing and timing of other products and services provided by us or our competitors; • changes in our long term custom animal production contracts and other renewable contracts, including licenses; • our ability to obtain key components for our imaging systems and manufacture and install them on a timely basis to meet demand; • changes in the research and development budgets of our customers; • acquisition, licensing and other costs related to the expansion of our operations; • the timing of milestones, licensing and other payments under the terms of our license agreements, commercial agreements and agreements pursuant to which others license technology to us; • expenses related to our commercial and patent infringement litigation with AntiCancer and other litigation in which we may become involved; and • expenses related to, and the results of, patent filings and other proceedings relating to intellectual property rights |
| Due to the possibility of fluctuations in our revenue and expenses, we believe that quarter to quarter or annual comparisons of our operating results are not a good indication of our future performance |
| The termination or non-renewal of a large contract or the loss of, or a significant reduction in, sales to any of our significant customers could harm our operating results |
| We generally sell our products and often provide our services pursuant to agreements that are renewable on an annual basis |
| Failure to renew or the cancellation of these agreements by any one of our significant customers, which include Pfizer Inc |
| and affiliates of Novartis, could result in a significant loss of revenue |
| We currently derive, and we expect to continue to derive, a large percentage of our total revenue from a relatively small number of customers |
| If any of these customers terminates or substantially diminishes 20 ______________________________________________________________________ [46]Table of Contents its relationship with us, our revenue could decline significantly |
| Revenue concentration among our largest customers is as follows: • our ten largest customers accounted for approximately 32dtta8prca, 41prca and 53prca of our revenue for the years ended December 31, 2005, 2004 and 2003, respectively; and • our largest and second largest customers accounted for approximately 12prca and 5prca of our revenue for the year ended December 31, 2005, 16prca and 7prca of our revenue for the year ended December 31, 2004, and 21prca and 11prca of our revenue for the year ended December 31, 2003 |
| The loss of significant revenue from any of our significant customers could negatively impact our results of operations or limit our ability to execute our strategy |
| We may not fully realize our revenue under long-term contracts, which could harm our business and result in higher losses than anticipated |
| We have long-term contracts for custom animal production and/or phenotyping services with two customers that are renewed annually and are expected to generate future revenues |
| These two long-term contracts may not be renewed annually and may be terminated at any time during their terms |
| In addition, we may not be able to maintain our sublicensed rights under certain patents relating to these contracts |
| If we are unable to meet customer demand, it would adversely impact our financial results and restrict our sales growth |
| To be successful, we must manufacture our IVIS Imaging Systems in substantial quantities at acceptable costs |
| If we do not succeed in manufacturing sufficient quantities of our imaging systems to meet customer demand, we could lose customers and fail to acquire new customers, if they choose a competitor’s product because our imaging system is not available |
| Increasing demand since the launch of our IVIS Imaging System has necessitated an increase in our manufacturing capacity |
| We believe our current manufacturing capacity in Alameda, California is sufficient to meet our current and forecasted demand through 2006, and we are in the planning stages for managing this capacity |
| We have also experienced a shift in customer demand towards our IVIS 200 systems and, more recently, IVIS 50 systems, and we have altered our planned manufacturing to increase IVIS system output in an effort to meet this demand |
| Certain components of our IVIS 200 systems and IVIS 50 systems are specially manufactured by our single-source suppliers and supply of these parts to us requires adequate lead time that can result in production delays |
| If we experience unexpected shifts in customer demand that requires alterations to planned manufacturing, we may experience production delays that could restrict our sales growth |
| If, following the closing of the merger with Caliper, manufacturing of our IVIS systems is relocated away from our Alameda, California facility, any manufacturing delays or disruptions relating to the relocation could negatively impact our ability to meet customer demand |
| If we are unable to meet customer demand for IVIS Imaging Systems, it would adversely affect our financial results and restrict our sales growth |
| We depend on a limited number of suppliers, and we will be unable to manufacture or deliver our products if shipments from these suppliers are interrupted or are not supplied on a timely basis |
| We use original equipment manufacturers, or OEMs, for various parts of our IVIS Imaging Systems, including the cameras, boxes, certain subassemblies, filters and lenses |
| We obtain these key components from a small number of sources |
| For example, the lens for our IVIS 200 system is obtained from a single source on a purchase order basis from Coastal Optical Systems Inc, and the CCD cameras for all of our IVIS Imaging 21 ______________________________________________________________________ [47]Table of Contents Systems are obtained from two sources, Spectral Instruments, Inc |
| We have binding supply agreements with Spectral and Andor |
| From time to time, we have experienced delays in obtaining components from certain of our suppliers, which have had an impact on our production schedule for imaging systems |
| We believe that alternative sources for these components in the event of a disruption or discontinuation in supply would not be available on a timely basis, which would disrupt our operations and impair our ability to manufacture and sell our products |
| Our dependence upon outside suppliers and OEMs exposes us to risks, including: • the possibility that one or more of our suppliers could terminate their services at any time; • the potential inability of our suppliers to obtain required components or products; • reduced control over pricing, quality and timely delivery, due to the difficulties in switching to alternative suppliers; • the potential delays and expense of seeking alternative suppliers; and • increases in prices of raw materials, products and key components |
| Because we receive revenue principally from biomedical research institutions and pharmaceutical, biotechnology and chemical companies, the industry conditions faced by those companies and their capital spending policies may have a significant effect on the demand for our products |
| We market our products to pharmaceutical, biotechnology and chemical companies and biomedical research institutions, and the capital spending policies of these entities can have a significant effect on the demand for our products |
| These policies vary significantly between different customers and are based on a wide variety of factors, including the resources available for purchasing research equipment, the spending priorities among various types of research companies and the policies regarding capital expenditures |
| In particular, the volatility of the public stock market for biotechnology companies has at certain times significantly impacted the ability of these companies to raise capital, which has directly affected their capital spending budgets |
| In addition, continued consolidation within the pharmaceutical industry will likely delay and may potentially reduce capital spending by pharmaceutical companies involved in such consolidations |
| During the past several years, many of our customers and potential customers, particularly in the biopharmaceutical industry, have reduced their capital spending budgets because of these generally adverse prevailing economic conditions, consolidation in the industry and increased pressure on the profitability of such companies, due in part to competition from generic drugs |
| If our customers and potential customers do not increase their capital spending budgets, because of continuing adverse economic conditions or further consolidation in the industry, we could face weak demand for our products |
| Similarly, changes in availability of grant moneys may impact our sales to academic customers |
| Recent developments regarding safety issues for widely used drugs, including actual and/or threatened litigation, also may affect capital spending by pharmaceutical companies |
| Any decrease or delay in capital spending by life sciences or chemical companies or biomedical researchers could cause our revenue to decline and harm our profitability |
| In addition, consolidation within the pharmaceutical industry may not only affect demand for our products, but also existing business relationships |
| If two or more of our present or future customers merge, we may not receive the same fees under agreements with the combined entities that we received under agreements with these customers prior to their merger |
| Moreover, if one of our customers merges with an entity that is not a customer, the new combined entity may prematurely terminate our agreement |
| Any of these developments could materially harm our business or financial condition |
| 22 ______________________________________________________________________ [48]Table of Contents If we fail to properly manage our growth, our business could be adversely affected |
| We have substantially increased the scale of our operations since our initial public offering in 2004 |
| If we are unable to manage our growth effectively, our losses could increase |
| The management of our growth will depend, among other things, upon our ability to improve our operational, financial and management controls, reporting systems and procedures |
| In addition, we will have to invest in additional customer support resources, hire and train additional personnel for manufacturing, installation and field support, and expand our inventory of instrumentation parts and components, which will result in additional burdens on our systems and resources and require additional capital expenditures |
| We have a limited sales and marketing organization, and although we intend to increase our sales and marketing organization, we may be unable to build an organization to meet demand for our products and services |
| We currently have a limited number of people in our sales force engaged in the direct sale of our products, many of whom were added in 2004 |
| Because our products are technical in nature, we believe that our sales and marketing staff must have scientific or technical expertise and experience and require they be trained in the instrumentation and reagents that they sell |
| Although we expanded our sales and marketing organization in 2004 and continued our expansion efforts in 2005, the number of employees with these skills is relatively small |
| Competition is intense and we may not be able to continue to attract and retain sufficient qualified people or grow and maintain an efficient and effective sales and marketing department |
| In several foreign countries and regions outside the US, including several countries in Europe and Asia, we sell our products and services primarily through third-party distributors |
| We are dependent upon the sales and marketing efforts of our third-party distributors in these international markets |
| These distributors may not commit the necessary resources to effectively market and sell our products and services |
| Our financial condition would be harmed if we fail to build an adequate direct and indirect sales and marketing organization and our marketing and sales efforts are unsuccessful |
| We depend on key employees in a competitive market for skilled personnel, and without additional employees, we cannot grow or achieve profitability |
| We are highly dependent on the principal members of our management team, including David W Carter, chairman of our board and chief executive officer, and Pamela R Contag, Ph |
| Carter and Dr |
| Contag, we do not have any key person life insurance on such individuals |
| Additionally, while we have change of control severance arrangements in place for the principal members of our management team, as a practical matter, such arrangements may not ensure the employee’s retention |
| Our future success also will depend in part on the continued service of our key scientific, consulting and management personnel and our ability to identify hire and retain additional personnel |
| We experience intense competition for qualified personnel |
| We may be unable to attract and retain personnel necessary for the development of our business |
| Moreover, a significant portion of our work force is located in the San Francisco Bay Area of California, where demand for personnel with the scientific and technical skills we seek is extremely high and is likely to remain high |
| 23 ______________________________________________________________________ [49]Table of Contents Our intellectual property rights, including one patent that is due to expire in 2006, may not provide meaningful commercial protection for our products, which could enable third parties to use our technology, or very similar technology, and could reduce our ability to compete in the market |
| We rely on patent, copyright, trade secret and trademark laws to limit the ability of others to compete with us using the same or similar technology in the US and other countries |
| However, these laws afford only limited protection and may not adequately protect our rights to the extent necessary to sustain any competitive advantage we may have |
| The laws of some foreign countries do not protect proprietary rights to the same extent as the laws of the US, and many companies have encountered significant problems in protecting their proprietary rights abroad |
| These problems can be caused by the absence of adequate rules and methods for defending and enforcing intellectual property rights |
| We will be able to protect our technology from unauthorized use by third parties only to the extent that they are covered by valid and enforceable patents or are effectively maintained as trade secrets |
| The patent positions of companies developing tools for pharmaceutical, biotechnology, biomedical and chemical industries, including our patent position, generally are uncertain and involve complex legal and factual questions, particularly as to questions concerning the enforceability of such patents against alleged infringement |
| The biotechnology patent situation outside the US is even more uncertain, particularly with respect to the patentability of transgenic animals |
| Changes in either the patent laws or in interpretations of patent laws in the US and other countries may therefore diminish the value of our intellectual property |
| Moreover, our patents and patent applications may not be sufficiently broad to prevent others from practicing our technologies or from developing competing products |
| We also face the risk that others may independently develop similar or alternative technologies or design around our patented technologies |
| We own, or control through licenses, a variety of issued patents and pending patent applications |
| However, the patents on which we rely may be challenged and invalidated, and our patent applications may not result in issued patents |
| AntiCancer, a party with whom we have been engaged in ongoing commercial litigation, filed a lawsuit against us alleging infringement of five patents and requesting that the court declare invalid one of our primary patents covering methods of in vivo biophotonic imaging |