GPRO - 3.31.2012 - 10-Q

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
____________________________________ 
FORM 10-Q
____________________________________ 
(Mark One)
x Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the quarterly period ended March 31, 2012
OR
 o Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the transition period from _________to ________           
Commission File Number: 000-49834
____________________________________ 
GEN-PROBE INCORPORATED
(Exact Name of Registrant as Specified in Its Charter)
 ____________________________________ 
Delaware
 
33-0044608
(State or other jurisdiction of
 
(I.R.S. Employer
incorporation or organization)
 
Identification Number)
 
 
 
10210 Genetic Center Drive, San Diego, CA
 
92121-4362
(Address of Principal Executive Office)
 
(Zip Code)
(858) 410-8000
(Registrant’s telephone number, including area code)
____________________________________  
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding twelve months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past ninety days.    Yes   x   No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨
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. (Check one):
 
Large accelerated filer
x
 
 
Accelerated filer
¨
Non-accelerated filer
¨
(Do not check if a smaller reporting company)
 
Smaller Reporting Company
¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x
As of April 25, 2012, 45,386,659 shares of the registrant’s common stock, $0.0001 par value per share, were outstanding.



GEN-PROBE INCORPORATED
TABLE OF CONTENTS
FORM 10-Q
 
 
Page
PART I — FINANCIAL INFORMATION
 
 
 
Item 1. Financial Statements
 
 
 
PART II — OTHER INFORMATION
 
 
 
Item 1A. Risk Factors
Item 6. Exhibits
 


i


GEN-PROBE INCORPORATED
CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share data)




 
 
March 31,
2012
 
December 31,
2011
 
 
(Unaudited)
 
 
ASSETS
 
 
 
 
Current assets
 
 
 
 
Cash and cash equivalents
 
$
138,774

 
$
87,021

Marketable securities
 
174,409

 
218,789

Trade accounts receivable, net of allowance for doubtful accounts of $293 and $320 as of March 31, 2012 and December 31, 2011, respectively
 
67,199

 
57,767

Accounts receivable—other
 
2,317

 
3,446

Inventories
 
81,331

 
77,886

Deferred income tax
 
8,707

 
8,188

Prepaid expenses
 
15,792

 
11,555

Other current assets
 
3,732

 
4,967

Total current assets
 
492,261

 
469,619

Marketable securities, net of current portion
 
88,101

 
62,237

Property, plant and equipment, net
 
180,270

 
176,081

Capitalized software, net
 
17,961

 
16,992

Patents, net
 
11,486

 
11,758

Goodwill
 
140,385

 
140,404

Purchased intangibles, net
 
104,553

 
106,619

License, manufacturing access fees and other assets, net
 
61,246

 
61,738

Total assets
 
$
1,096,263

 
$
1,045,448

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
 
Current liabilities
 
 
 
 
Accounts payable
 
$
14,260

 
$
12,000

Accrued salaries and employee benefits
 
21,533

 
28,795

Other accrued expenses
 
17,584

 
12,846

Income tax payable
 
6,428

 
1,857

Short-term borrowings
 
248,000

 
248,000

Deferred revenue
 
1,413

 
1,238

Total current liabilities
 
309,218

 
304,736

Non-current income tax payable
 
10,044

 
10,019

Deferred income tax
 
19,283

 
19,283

Deferred revenue, net of current portion
 
3,644

 
3,237

Other long-term liabilities
 
7,910

 
7,831

Commitments and contingencies
 

 

Stockholders’ equity
 
 
 
 
Preferred stock, $0.0001 par value per share; 20,000,000 shares authorized, none issued and outstanding
 

 

Common stock, $0.0001 par value per share; 200,000,000 shares authorized, 45,342,898 and 45,008,879 shares issued and outstanding as of March 31, 2012 and December 31, 2011, respectively
 
5

 
5

Additional paid-in capital
 
43,954

 
23,650

Accumulated other comprehensive income (loss)
 
2,745

 
(313
)
Retained earnings
 
699,460

 
677,000

Total stockholders’ equity
 
746,164

 
700,342

Total liabilities and stockholders’ equity
 
$
1,096,263

 
$
1,045,448

See accompanying notes to consolidated financial statements


1

                    
GEN-PROBE INCORPORATED
CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share data)
(Unaudited)

 
 
 
Three Months Ended March 31,
 
 
2012
 
2011
Revenues
 
 
 
 
Product sales
 
$
150,117

 
$
138,112

Collaborative research revenue
 
1,351

 
3,568

Royalty and license revenue
 
1,914

 
1,358

Total revenues
 
153,382

 
143,038

Operating expenses
 
 
 
 
Cost of product sales (excluding acquisition-related intangible amortization)
 
52,371

 
41,943

Acquisition-related intangible amortization
 
2,759

 
2,805

Research and development
 
28,586

 
28,963

Marketing and sales
 
19,045

 
16,522

General and administrative
 
18,954

 
18,153

Total operating expenses
 
121,715

 
108,386

Income from operations
 
31,667

 
34,652

Other income (expense)
 
 
 
 
Investment and interest income
 
2,538

 
735

Interest expense
 
(543
)
 
(503
)
Other income, net
 
128

 
177

Total other income, net
 
2,123

 
409

Income before income tax
 
33,790

 
35,061

Income tax expense
 
11,330

 
11,784

Net income
 
$
22,460

 
$
23,277

Net income per share
 
 
 
 
Basic
 
$
0.50

 
$
0.49

Diluted
 
$
0.49

 
$
0.48

Weighted average shares outstanding
 
 
 
 
Basic
 
45,124

 
47,861

Diluted
 
46,204

 
49,004

See accompanying notes to consolidated financial statements


2


GEN-PROBE INCORPORATED
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(In thousands)
(Unaudited)



 
 
Three Months Ended March 31,
 
 
2012
 
2011
Comprehensive income
 
$
25,518

 
$
22,422

See accompanying notes to consolidated financial statements


3


GEN-PROBE INCORPORATED
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
 


 
 
 
Three Months Ended March 31,
 
 
2012
 
2011
Operating activities
 
 
 
 
Net income
 
$
22,460

 
$
23,277

Adjustments to reconcile net income to net cash provided by operating activities
 
 
 
 
Depreciation and amortization
 
11,448

 
11,345

Amortization of premiums on investments, net of accretion of discounts
 
2,037

 
2,673

Stock-based compensation
 
6,152

 
6,036

Excess tax benefit from employee stock-based compensation
 
(1,246
)
 
(1,425
)
Deferred revenue
 
477

 
97

Deferred income tax
 
(245
)
 
(615
)
Loss on disposal of property and equipment
 
52

 
24

Changes in assets and liabilities
 
 
 
 
Trade and other accounts receivable
 
(8,117
)
 
(2,816
)
Inventories
 
(3,506
)
 
3,420

Prepaid expenses
 
(4,062
)
 
(2,116
)
Other current assets
 
1,161

 
(536
)
Other long-term assets
 
199

 
(132
)
Accounts payable
 
2,228

 
(3,196
)
Accrued salaries and employee benefits
 
(7,725
)
 
(7,847
)
Other accrued expenses
 
4,566

 
(40
)
Income tax payable
 
5,902

 
11,500

Other long-term liabilities
 
(49
)
 
456

Net cash provided by operating activities
 
31,732

 
40,105

Investing activities
 
 
 
 
Proceeds from sales and maturities of marketable securities
 
144,227

 
30,460

Purchases of marketable securities
 
(127,119
)
 
(5,731
)
Purchases of property, plant and equipment
 
(9,265
)
 
(10,762
)
Purchases of capitalized software
 
(1,738
)
 
(780
)
Purchases of intangible assets, including licenses and manufacturing access fees
 
(825
)
 
(923
)
Other
 
408

 
501

Net cash provided by investing activities
 
5,688

 
12,765

Financing activities
 
 
 
 
Repurchase and retirement of common stock
 

 
(47,972
)
Proceeds from issuance of common stock and employee stock purchase plan shares
 
14,232

 
17,390

Repurchase and retirement of restricted stock for payment of taxes
 
(1,124
)
 
(358
)
Excess tax benefit from employee stock-based compensation
 
1,246

 
1,425

Borrowings
 

 
10,000

Net cash provided by (used in) financing activities
 
14,354

 
(19,515
)
Effect of exchange rate changes on cash and cash equivalents
 
(21
)
 
518

Net increase in cash and cash equivalents
 
51,753

 
33,873

Cash and cash equivalents at the beginning of period
 
87,021

 
59,690

Cash and cash equivalents at the end of period
 
$
138,774

 
$
93,563

See accompanying notes to consolidated financial statements

4


GEN-PROBE INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



Notes to Consolidated Financial Statements (unaudited)

Note 1.     Summary of Significant Accounting Policies

Basis of Presentation

The accompanying interim consolidated financial statements of Gen-Probe Incorporated (“Gen-Probe” or the “Company”) as of March 31, 2012, and for the three month periods ended March 31, 2012 and 2011, are unaudited and have been prepared in accordance with United States generally accepted accounting principles (“U.S. GAAP”) for interim financial information. Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. In management’s opinion, the unaudited interim consolidated financial statements include all adjustments, consisting only of normal recurring accruals, necessary to state fairly the financial information therein in accordance with U.S. GAAP. Interim results are not necessarily indicative of the results that may be reported for any other interim period or for the year ending December 31, 2012.

These unaudited interim consolidated financial statements and related footnotes should be read in conjunction with the audited consolidated financial statements and related footnotes contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011.

Principles of Consolidation
    
These unaudited interim consolidated financial statements include the accounts of Gen-Probe as well as its wholly owned subsidiaries. All material intercompany transactions and balances have been eliminated in consolidation. The Company has not identified any interests in variable interest entities that require consolidation.

The Company translates the financial statements of its non-U.S. operations using the end-of-period exchange rates for assets and liabilities and the average exchange rates for each reporting period for results of operations. Net gains and losses resulting from the translation of foreign financial statements and the effect of exchange rates on intercompany receivables and payables of a long-term investment nature are recorded as a separate component of stockholders’ equity under the caption “Accumulated other comprehensive income (loss).” These adjustments will affect net income upon the sale or liquidation of the underlying investment.
    
Use of Estimates

The preparation of financial statements in conformity with U.S. GAAP requires management to make certain estimates and assumptions that affect the amounts reported in the consolidated financial statements. These estimates include assessing the collectability of accounts receivable, the recognition of revenues, and the valuation of the following: stock-based compensation; marketable securities; equity investments in publicly and privately held companies; income tax; accrued liabilities; inventories; and goodwill and long-lived assets, including patent costs, capitalized software, purchased intangibles and licenses and manufacturing access fees. Actual results could differ from those estimates.
Segment Information

The Company currently operates in one business segment: the development, manufacturing, marketing, sales and support of molecular diagnostic products primarily to diagnose human diseases, screen donated human blood and ensure transplant compatibility. Although the Company’s products comprise distinct product lines to serve different end markets within molecular diagnostics, the Company does not operate its business in operating segments. The Company is managed by a single functionally- based management team that manages all aspects of the Company’s business and reports directly to the Chief Executive Officer. For all periods presented, the Company operated in a single business segment. Product sales by product line are presented in Note 10 of these Notes to Consolidated Financial Statements.
Revenue Recognition

The Company records shipments of its clinical diagnostic products as product sales when the product is shipped, title and risk of loss have passed to the customer, the consideration is fixed and determinable, and collection of the resulting receivable is reasonably assured.


5

GEN-PROBE INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)





The Company manufactures blood screening products according to demand schedules provided by its collaboration partner, Novartis Vaccines and Diagnostics, Inc. (“Novartis”). Upon shipment to Novartis, the Company recognizes blood screening product sales at an agreed upon transfer price and records the related cost of products sold. Based on the terms of the Company’s collaboration agreement with Novartis, the Company’s ultimate share of the net revenue from sales to the end user is not known until reported to the Company by Novartis. The Company then adjusts blood screening product sales upon receipt of customer revenue reports and a net payment from Novartis of amounts reflecting the Company’s ultimate share of net sales by Novartis for these products, less the transfer price revenues previously recognized.

In most cases, the Company provides its instrumentation to its clinical diagnostics customers without requiring them to purchase the equipment or enter into an equipment lease. Instead, the Company recovers the cost of providing the instrumentation in the amount it charges for its diagnostic assays. The depreciation costs associated with an instrument are charged to cost of product sales on a straight-line basis over the estimated life of the instrument. The costs to maintain these instruments in the field are charged to cost of product sales as incurred.

The Company sells its instruments to Novartis for use in blood screening and records these instrument sales upon delivery since Novartis is responsible for the placement, maintenance and repair of the units with its customers. The Company also sells instruments to its clinical diagnostics customers and records sales of these instruments upon delivery and customer acceptance. For certain customers with non-standard payment terms, instrument sales are recorded based upon expected cash collection. Prior to delivery, each instrument is tested to meet Gen-Probe’s specifications and the specifications of the United States Food and Drug Administration (the “FDA”), and is shipped fully assembled. Customer acceptance of the Company’s clinical diagnostic instrument systems requires installation and training by the Company’s technical service personnel. Installation is a standard process consisting principally of uncrating, calibrating and testing the instrumentation.

The Company records revenue for its research products and services in the period during which the related costs are incurred or the services are provided. This revenue consists of outsourcing services for the pharmaceutical, biotechnology and healthcare industries, including nucleic acid purification and analysis services, as well as the sale of monoclonal antibodies.

Revenue arrangements with multiple deliverables are evaluated for proper accounting treatment. In these arrangements, the Company records revenue as separate units of accounting if the delivered items have value to the customer on a stand-alone basis, if the arrangement includes a general right of return relative to the delivered items, and if delivery or performance of the undelivered items is considered probable and substantially within the Company’s control. Beginning in 2011, arrangement consideration is allocated at the inception of the arrangement to all deliverables using the relative selling price method that is based on a three-tier hierarchy. The relative selling price method requires that the estimated selling price for each deliverable be based on vendor-specific objective evidence (“VSOE”) of fair value, which represents the price charged for each deliverable when it is sold separately or, for a deliverable not yet being sold separately, the price established by management. When VSOE of fair value is not available, third-party evidence (“TPE”) of fair value is acceptable, or a best estimate of the selling price if neither VSOE nor TPE is available. A best estimate of the selling price should be consistent with the objective of determining the price at which the Company would transact if the deliverable were sold regularly on a stand-alone basis and should also take into account market conditions and company-specific factors.

The Company recognizes collaborative research revenue over the term of various collaboration agreements, as negotiated monthly contracted amounts are earned or reimbursable costs are incurred related to those agreements. Negotiated monthly contracted amounts are earned in relative proportion to the performance required under the applicable contracts. Non-refundable license fees with stand-alone value are recognized at the time that the Company has satisfied all performance obligations. License fees without stand-alone value are recognized in combination with any undelivered performance obligations. Milestone consideration that is contingent upon achievement of a milestone in its entirety is recorded as revenue in the period in which the milestone is achieved only if the milestone meets all criteria to be considered substantive. These criteria include: (i) the consideration being earned should be commensurate with either the Company’s performance to achieve the milestone or the enhancement of the value of the item delivered as a result of a specific outcome resulting from the Company’s performance to achieve the milestone; (ii) the consideration being earned should relate solely to past performance; (iii) the consideration being earned should be reasonable relative to all deliverables and payment terms in the arrangement; and (iv) the milestone should be considered in its entirety and cannot be bifurcated into substantive and non-substantive components. Any amounts received prior to satisfying the Company’s revenue recognition criteria are recorded as deferred revenue on the Company’s consolidated balance sheets.

Royalty and license revenue is recognized in connection with the sale or use of the Company’s products or technologies under license agreements with third parties. For those arrangements where royalties are reasonably estimable, the Company

6

GEN-PROBE INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)





recognizes revenue based on estimates of royalties earned during the applicable period and adjusts for differences between the estimated and actual royalties in the following period. Historically, these adjustments have not been material. For those arrangements where royalties are not reasonably estimable, the Company recognizes revenue upon receipt of royalty statements from the applicable licensee.
Stock-based Compensation

Stock-based compensation expense is recognized for restricted stock, deferred issuance restricted stock, performance stock awards, which include awards subject to performance conditions and/or market conditions, stock options, and shares purchasable under the Company’s Employee Stock Purchase Plan (“ESPP”). Certain of these costs are capitalized into inventory on the Company’s consolidated balance sheets, and are recognized as an expense when the related products are sold.

The Company uses the Black-Scholes-Merton option pricing model to value stock options granted. The determination of the fair value of stock option awards on the date of grant using the Black-Scholes-Merton model is affected by the Company’s stock price and the implied volatility on its traded options, as well as the input of other subjective assumptions. These assumptions include, but are not limited to, the expected term of stock options and the Company’s expected stock price volatility over the term of the awards.

Stock-based compensation expense for restricted stock, deferred issuance restricted stock, and performance condition stock awards is measured based on the closing fair market value of the Company’s common stock on the date of grant. Stock-based compensation expense for market condition stock awards is measured based on the fair value of the award on the date of grant using a Monte Carlo simulation model. The Monte Carlo simulation model utilizes multiple point variables that determine the probability of satisfying the market condition stipulated in the grant and calculates the fair value of the award.

The following table presents the weighted average assumptions used by the Company to estimate the fair value of stock options and performance stock awards granted under the Company’s equity incentive plans and the shares purchasable under the Company’s ESPP, as well as the resulting average fair values:

 
 
Three Months Ended March 31,
 
 
2012
 
2011
Stock options
 
 
 
 
Risk-free interest rate
 
0.7
%
 
1.7
%
Volatility
 
34.5
%
 
31.0
%
Dividend yield
 

 

Expected term (years)
 
4.3

 
4.3

Resulting average fair value
 
$
19.57

 
$
17.46

Performance stock awards 
 
 
 
 
Risk-free interest rate
 
0.4
%
 
1.3
%
Volatility
 
30.1
%
 
33.4
%
Dividend yield
 

 

Resulting average fair value
 
$
81.96

 
$
82.58

Employee stock purchase plan shares
 
 
 
 
Risk-free interest rate
 
0.1
%
 
0.2
%
Volatility
 
38.7
%
 
21.5
%
Dividend yield
 

 

Expected term (years)
 
0.5

 
0.5

Resulting average fair value
 
$
15.27

 
$
12.27

 






7

GEN-PROBE INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)






The Company’s unrecognized stock-based compensation expense as of March 31, 2012, before income taxes and adjusted for estimated forfeitures, related to outstanding unvested share-based payment awards was as follows (in thousands, except number of years):

 
Weighted Average
Remaining Expense Life (Years)
 
Unrecognized
Expense
Stock options
 
3.0

 
$
36,530

Performance stock awards
 
2.6

 
10,871

Restricted stock
 
1.8

 
1,907

Deferred issuance restricted stock
 
1.2

 
247

Employee stock purchase plan shares
 
0.2

 
118

Total
 
 
 
$
49,673


The following table summarizes the stock-based compensation expense that the Company recorded in its consolidated statements of income for the three month periods ended March 31, 2012 and 2011 (in thousands):
 
 
Three Months Ended March 31,
 
 
2012
 
2011
Cost of product sales
 
$
850

 
$
788

Research and development
 
1,724

 
1,792

Marketing and sales
 
731

 
612

General and administrative
 
2,847

 
2,844

Total
 
$
6,152

 
$
6,036


Net Income Per Share

Diluted net income per share is reported based on the more dilutive of the treasury stock or the two-class method. Under the two-class method, net income is allocated to common stock and participating securities. The Company’s restricted stock, deferred issuance restricted stock and performance stock awards meet the definition of participating securities. Basic net income per share under the two-class method is computed by dividing net income, adjusted for earnings allocated to unvested stockholders for the period, by the weighted average number of common shares outstanding during the period. Diluted net income per share under the two-class method is computed by dividing net income, adjusted for earnings allocated to unvested stockholders for the period, by the weighted average number of common and common equivalent shares outstanding during the period. The Company excludes stock options from the calculation of diluted net income per share when the combined exercise price, unrecognized stock-based compensation expense and assumed tax benefits upon exercise are greater than the average market price for the Company’s common stock because their effect is anti-dilutive. Potentially dilutive securities totaling approximately 1.4 million and 0.7 million shares for the three month periods ended March 31, 2012 and 2011, respectively, were excluded from the calculations of diluted earnings per share (“EPS”) below because of their anti-dilutive effect.

The following table sets forth the computation of basic and diluted EPS for the three month periods ended March 31, 2012 and 2011 (in thousands, except per share amounts):
 
 
Three Months Ended March 31,
 
 
2012
 
2011
Basic net income per share
 
 
 
 
Net income
 
$
22,460

 
$
23,277

Less income allocated to participating securities
 
(30
)
 
(35
)
Net income allocated to common stockholders
 
$
22,430

 
$
23,242

 
 
 
 
 
Weighted average common shares outstanding - basic
 
45,124

 
47,861

Net income per share - basic
 
$
0.50

 
$
0.49


8

GEN-PROBE INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)





 
 
Three Months Ended March 31,
 
 
2012
 
2011
Diluted net income per share
 
 
 
 
Net income
 
$
22,460

 
$
23,277

Less income allocated to participating securities
 
(29
)
 

Net income allocated to common stockholders
 
$
22,431

 
$
23,277

 
 
 
 
 
Weighted average common shares outstanding - basic
 
45,124

 
47,861

Dilutive securities
 
1,080

 
1,143

Weighted average common shares outstanding - diluted
 
46,204

 
49,004

Net income per share - diluted
 
$
0.49

 
$
0.48


Adoption of Recent Accounting Pronouncements

Accounting Standards Update 2011-04

In May 2011, the Financial Accounting Standards Board (“FASB”) issued an Accounting Standards Update (“ASU”) on fair value measurement. The ASU expands the disclosure requirements of Accounting Standards Codification (“ASC”) Topic 820, Fair Value Measurement (“ASC Topic 820”), for fair value measurements and makes other amendments. Specifically, the ASU clarifies the accounting guidance for highest-and-best-use and valuation-premise concepts for non-financial assets, application to financial assets and financial liabilities with offsetting positions in market risks or counterparty credit risk, premiums or discounts in fair value measurement, and fair value of an instrument classified in an entity’s stockholders’ equity. Additionally, the ASU expands the disclosure requirements under ASC Topic 820, particularly for Level 3 inputs. The ASU was effective for interim and annual reporting periods of the Company beginning January 1, 2012. Upon adoption, the guidance did not have a material impact on the Company’s consolidated financial statements and is not expected to have a material impact on its future operating results.

Accounting Standards Update 2011-05 and 2011-12

In June 2011, the FASB issued ASU 2011-05 on the presentation of comprehensive income. The ASU removes the presentation options in ASC Topic 220, Comprehensive Income, and requires entities to report components of comprehensive income in either (1) a continuous statement of comprehensive income or (2) two separate but consecutive statements. The ASU does not change the items that must be reported in other comprehensive income (loss) and does not require any incremental disclosures in addition to those already required under existing accounting guidance. The ASU was effective for interim and annual reporting periods of the Company beginning January 1, 2012. For the three months ended March 31, 2012, the Company has applied the provisions of ASU 2011-05 by presenting comprehensive income in a statement separate from the consolidated statements of income.

In December 2011, the FASB issued ASU 2011-12, deferring certain provisions of ASU 2011-05. One of the provisions of ASU 2011-05 required entities to present reclassification adjustments out of accumulated other comprehensive income (loss) by component in both the statement in which net income is presented and the statement in which other comprehensive income (loss) is presented (for both interim and annual financial statements). This requirement is indefinitely deferred by ASU 2011-12 and will be further deliberated by the FASB at a future date. The effective date of ASU 2011-12 is the same as that for the unaffected provisions of ASU 2011-05.

Accounting Standards Update 2011-08

In September 2011, the FASB issued an ASU on performing goodwill impairment testing. The ASU amends the guidance in ASU Topic 350-20, Goodwill. Under the revised guidance, entities testing goodwill for impairment have the option of performing a qualitative assessment before calculating the fair value of the reporting unit (step 1 of the goodwill impairment test). If entities determine, on the basis of qualitative factors, that the fair value of the reporting unit is more likely than not less than the carrying amount, the two-step impairment test would be required. The ASU does not change how goodwill is calculated or assigned to reporting units, does not revise the requirement to test goodwill annually for impairment, and does not amend the requirement to test goodwill for impairment between annual tests if events and circumstances warrant. The ASU provides examples of events and circumstances to consider for qualitative assessment. The amendments were effective for annual and interim goodwill impairment tests performed by the Company beginning January 1, 2012. The Company adopted this guidance in the first quarter

9

GEN-PROBE INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)





of 2012 for its goodwill impairment testing. The Company does not believe the adoption of this guidance will have a material impact on its consolidated financial statements.

Note 2.     Restructuring Activities

Following its acquisition of Tepnel Life Sciences plc (“Tepnel”) in April 2009, the Company had four locations in the United Kingdom (“UK”): Manchester, Cardiff, Livingston, and Abingdon. In order to accommodate the anticipated growth in the business and to optimize expenses, the Company decided to consolidate its UK operations to Manchester and Livingston. This consolidation was communicated internally in May 2010. The Company estimates that expenses related to this consolidation will total approximately $4.7 million and will be incurred in phases over a two-year period ending in the second quarter of 2012. These expenses will include termination costs, including severance costs related to the elimination of certain redundant positions and relocation costs for certain key employees, and site closure costs.

During the first quarter of 2012, the Company decided to restructure certain of its business activities relating to its acquired Genetic Testing Institute, Inc. (“GTI Diagnostics”) business and the customer service functions for the U.S. portion of its Tepnel business. The restructuring is intended to optimize the operational efficiency and cost structure of the Company. The Company estimates that expenses relating to this restructuring will total $0.5 million and will be incurred within the first half of 2012. These expenses will include severance costs related to the elimination of certain positions and site closure costs relating to a facility outside of the U.S.

During the three months ended March 31, 2012, the Company recorded approximately $1.1 million of termination and site closure costs. These amounts are included in general and administrative expenses in the Company’s consolidated statements of income. Through March 31, 2012, the Company has recorded approximately $4.9 million of cumulative termination and site closure costs related to these restructuring activities.

The following table summarizes the restructuring activities accounted for under ASC Topic 420 for the three months ended March 31, 2012, as well as the remaining restructuring accrual on the Company’s consolidated balance sheets as of March 31, 2012 (in thousands):
 
 
Termination
Costs
 
Site Closure
Costs
 
Total
 
 
 
 
 
 
 
Restructuring reserves as of December 31, 2011
 
$
267

 
$
440

 
$
707

Charged to expenses
 
657

 
448

 
1,105

Amounts paid
 
(460
)
 
(425
)
 
(885
)
Foreign currency translation
 
10

 
14

 
24

Restructuring reserves as of March 31, 2012
 
$
474

 
$
477

 
$
951


Note 3.     Balance Sheet Information

The following tables provide details of selected balance sheet line items as of March 31, 2012 and December 31, 2011 (in thousands):

Inventories
 
 
March 31,
2012
 
December 31,
2011
Raw materials and supplies
 
$
18,170

 
$
19,429

Work in process
 
28,192

 
27,464

Finished goods
 
34,969

 
30,993

Inventories
 
$
81,331

 
$
77,886






10

GEN-PROBE INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)






Property, Plant and Equipment, Net
 
 
March 31,
2012
 
December 31,
2011
Land
 
$
19,369

 
$
19,355

Building
 
79,809

 
80,005

Machinery and equipment
 
219,786

 
213,729

Building improvements
 
64,956

 
60,628

Furniture and fixtures
 
22,270

 
21,790

Construction in-progress
 
1,199

 
2,789

Property, plant and equipment, at cost
 
407,389

 
398,296

Less: accumulated depreciation and amortization
 
(227,119
)
 
(222,215
)
Property, plant and equipment, net
 
$
180,270

 
$
176,081


Purchased Intangibles
 
 
March 31, 2012
 
December 31, 2011

 
Gross
 
Accumulated Amortization
 
Gross
 
Accumulated Amortization
Customer relationships
 
$
77,720

 
$
(17,447
)
 
$
77,326

 
$
(15,723
)
Developed technology
 
59,206

 
(38,855
)
 
59,206

 
(38,292
)
Trademarks
 
10,879

 
(1,631
)
 
10,817

 
(1,487
)
Trade names
 
7,300

 
(526
)
 
7,300

 
(435
)
In-process research and development
 
7,907

 

 
7,907

 

Total purchased intangibles
 
$
163,012

 
$
(58,459
)
 
$
162,556

 
$
(55,937
)

License, Manufacturing Access Fees and Other Assets, Net
 
 
March 31,
2012
 
December 31,
2011
License and manufacturing access fees
 
$
68,488

 
$
67,906

Investment in Qualigen, Inc.
 
5,404

 
5,404

Investment in DiagnoCure, Inc.
 
5,000

 
5,000

Investment in Roka Bioscience, Inc.
 
4,705

 
4,705

Other assets
 
11,909

 
11,257

License, manufacturing access fees and other assets, at cost
 
95,506

 
94,272

Less: accumulated amortization
 
(34,260
)
 
(32,534
)
License, manufacturing access fees and other assets, net
 
$
61,246

 
$
61,738


Other Accrued Expenses
 
 
March 31,
2012
 
December 31,
2011
 
 
 
 
 
Research and development
 
$
5,431

 
$
3,554

Professional fees
 
3,471

 
1,148

Royalties
 
2,778

 
3,047

Marketing and sales
 
1,754

 
1,261

Other
 
4,150

 
3,836

Other accrued expenses
 
$
17,584

 
$
12,846


11

GEN-PROBE INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)






Note 4.     Marketable Securities

The Company’s marketable securities include equity securities, mutual funds, treasury securities and tax advantaged municipal securities. The equity securities consist of investments in common stock. The deferred compensation plan assets are invested in mutual funds with quoted market prices. The Company’s investment policy limits the effective maturity on individual securities to six years and an average portfolio maturity to three years with a minimum Moody’s credit rating of A3 or a Standard & Poor’s credit rating of A-. As of March 31, 2012, the Company’s portfolio had an average maturity of three years and an average credit quality of AA1 as defined by Moody’s.

The following is a summary of marketable securities as of March 31, 2012 and December 31, 2011 (in thousands):

 
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Estimated
Fair Value
March 31, 2012
 
 
 
 
 
 
 
 
Debt securities
 
$
251,494

 
$
487

 
$
(677
)
 
$
251,304

Equity securities
 
10,518

 
688

 

 
11,206

Mutual funds
 
6,233

 
408

 

 
6,641

Total marketable securities
 
$
268,245

 
$
1,583

 
$
(677
)
 
$
269,151

December 31, 2011
 
 
 
 
 
 
 
 
Debt securities
 
$
270,745

 
$
1,298

 
$
(191
)
 
$
271,852

Equity securities
 
10,518

 

 
(1,344
)
 
9,174

Mutual funds
 
6,127

 
16

 
(88
)
 
6,055

Total marketable securities
 
$
287,390

 
$
1,314

 
$
(1,623
)
 
$
287,081


The following table shows the estimated fair values and gross unrealized losses as of March 31, 2012 for the Company’s investments in individual debt securities that have been in a continuous unrealized loss position deemed to be temporary for less than 12 months and for more than 12 months (in thousands):

Less than 12 Months
 
More than 12 Months
Estimated Fair
Value        
 
Unrealized
Losses
 
Estimated Fair
Value
 
Unrealized
Losses
$
76,895

 
$
(677
)
 
$

 
$


As of March 31, 2012 and December 31, 2011, the Company had 22 and 18 marketable debt securities, respectively, in an unrealized loss position. Of the 22 debt securities in an unrealized loss position as of March 31, 2012, the average estimated fair value and average unrealized loss was $3.5 million and $31,000, respectively. Of the 18 debt securities in an unrealized loss position at December 31, 2011, the average estimated fair value and average unrealized loss was $2.9 million and $11,000, respectively.

The contractual terms of the debt securities held by the Company do not permit the issuer to settle the securities at a price less than the amortized cost of the investments. The Company does not consider its investments in debt securities with a current unrealized loss position to be other-than-temporarily impaired as of March 31, 2012 because the Company does not intend to sell the investments and it is not more likely than not that the Company will be required to sell the investments before recovery of their amortized cost.

The Company periodically reviews its marketable equity securities for other-than-temporary declines in fair value below their cost basis, or whenever events or circumstances indicate that the carrying amount of an asset may not be recoverable. The determination that a decline is other-than-temporary is, in part, subjective and influenced by many factors. When assessing marketable equity securities for other-than-temporary declines in value, the Company considers factors including: the significance of the decline in value compared to the cost basis; the underlying factors contributing to a decline in the prices of securities in a single asset class; how long the market value of the investment has been less than its cost basis; any market conditions that impact liquidity; the views of external investment analysts; the financial condition and near-term prospects of the investee; any news or

12

GEN-PROBE INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)





financial information that has been released specific to the investee; and the outlook for the overall industry in which the investee operates.

The following table shows the current and non-current classification of the Company’s marketable securities as of March 31, 2012 and December 31, 2011 (in thousands):
 
 
March 31, 2012
 
December 31, 2011
Current
 
$
174,409

 
$
218,789

Non-current (1)
 
94,742

 
68,292

Total marketable securities
 
$
269,151

 
$
287,081

____________
(1)
Deferred compensation plan assets invested in mutual funds are included under the caption “License, manufacturing access fees and other assets, net” on the Company’s consolidated balance sheets.

As of March 31, 2012, the Company held non-current marketable debt and equity securities of $76.9 million and $11.2 million, respectively, and non-current deferred compensation plan assets invested in mutual funds of $6.6 million. As of December 31, 2011, the Company held non-current marketable debt and equity securities of $53.0 million and $9.2 million, respectively, and non-current deferred compensation plan assets invested in mutual funds of $6.1 million. Investments in an unrealized loss position deemed to be temporary as of March 31, 2012 and December 31, 2011 that have a contractual maturity of greater than 12 months have been classified on the Company’s consolidated balance sheets as non-current marketable securities under the caption “Marketable securities, net of current portion,” reflecting the Company’s current intent and ability to hold such investments to maturity. The Company’s investments in marketable debt and equity securities, other than mutual funds, are classified as available-for-sale.

The following table shows the gross realized gains and losses from the sale of marketable securities, based on the specific identification method during the three month periods ended March 31, 2012 and 2011 (in thousands):
 
 
Three Months Ended March 31,
 
 
2012
 
2011
Proceeds from sale of marketable securities
 
$
146,184

 
$
30,153

Gross realized gains
 
$
1,957

 
$
2

Gross realized losses
 

 
(356
)
Net realized gain (loss)
 
$
1,957

 
$
(354
)

Note 5.     Fair Value Measurements

The Company determines the fair value of its assets and liabilities based on the exchange price that would be received for an asset or paid to transfer a liability (exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants as of the measurement date. There is an established hierarchy for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that the most observable inputs be used when available. Observable inputs are inputs market participants would use in valuing the asset or liability and are developed based on market data obtained from sources independent of the Company. Unobservable inputs are inputs that reflect the Company’s assumptions about the factors market participants would use in valuing the asset or liability. Applicable accounting guidance under ASC Topic 820 establishes three levels of inputs that may be used to measure fair value:

Level 1 - Quoted prices for identical instruments in active markets.
 
Level 2 - Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations in which all significant inputs and significant value drivers are observable in active markets.
 
Level 3 - Valuations derived from valuation techniques in which one or more significant inputs or significant value drivers are unobservable.
 
Assets and liabilities are classified based upon the lowest level of input that is significant to the fair value measurement.

13

GEN-PROBE INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)





The carrying amounts of financial instruments such as cash equivalents, accounts receivable, prepaid and other current assets, accounts payable and other current liabilities approximate the related fair values due to the short-term maturities of these instruments. The Company reviews the fair value hierarchy on a quarterly basis. Changes in the observations or valuation inputs may result in a reclassification of levels for certain securities within the fair value hierarchy.

Set forth below is a description of the Company’s valuation methodologies used for assets and liabilities measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy. Where appropriate, the description includes details of the valuation models, the key inputs to those models, as well as any significant assumptions.

Assets and Liabilities Measured at Fair Value on a Recurring Basis
 
The Company’s cash equivalents and marketable securities include equity securities, mutual funds, treasury securities, tax advantaged municipal securities, and money market funds. When available, the Company uses quoted market prices to determine fair value and classifies such items as Level 1. The Company’s Level 1 financial instruments include equity securities and mutual funds. The Company obtains the fair value of its Level 2 financial instruments from a professional pricing service, which may determine the fair value using quoted prices for recently traded financial instruments with similar underlying terms as well as directly or indirectly observable inputs, such as interest rates and yield curves that are observable at commonly quoted intervals. The Company validates the fair value of its Level 2 marketable debt securities provided by its professional pricing service by evaluating the reasonableness of the methods and assumptions used by the professional pricing service, and by comparing their assessment of the fair value of the Company’s investment portfolio against the fair value of the Company’s investment portfolio from an independent professional pricing source and with publicly available data for actual transactions.

The following tables present the Company’s fair value hierarchy for assets and liabilities measured at fair value on a recurring basis (as described above) as of March 31, 2012 and December 31, 2011 (in thousands):
 
 
March 31, 2012
 
 
Quoted Prices
in Active
Markets for
Identical 
Assets
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
 
Total Carrying
Value in the
Consolidated
Balance Sheets
Assets
 
 
 
 
 
 
 
 
Cash equivalents
 
$

 
$
82,762

 
$

 
$
82,762

Marketable securities
 
 
 
 
 
 
 
 
Equity securities
 
11,206

 

 

 
11,206

Municipal securities
 

 
251,304

 

 
251,304

Mutual funds
 
6,641

 

 

 
6,641

Total marketable securities
 
17,847

 
251,304

 

 
269,151

Total assets at fair value
 
$
17,847

 
$
334,066

 
$

 
$
351,913

Liabilities
 
 
 
 
 
 
 
 
Deferred compensation plan liabilities
 
$
6,641

 
$

 
$

 
$
6,641

Total liabilities at fair value
 
$
6,641

 
$

 
$

 
$
6,641

 
 
 
 
 
 
 
 
 


14

GEN-PROBE INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)





 
 
December 31, 2011
 
 
Quoted Prices
in Active
Markets for
Identical 
Assets
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
 
Total Carrying
Value in the
Consolidated
Balance Sheets
Assets
 
 
 
 
 
 
 
 
Cash equivalents
 
$

 
$
28,364

 
$

 
$
28,364

Marketable securities
 
 
 
 
 
 
 
 
Equity securities
 
9,174

 

 

 
9,174

Municipal securities
 

 
271,852

 

 
271,852

Mutual funds
 
6,055

 

 

 
6,055

Total marketable securities
 
15,229

 
271,852

 

 
287,081

Total assets at fair value
 
$
15,229

 
$
300,216

 
$

 
$
315,445

Liabilities
 
 
 
 
 
 
 
 
Deferred compensation plan liabilities
 
$
6,055

 
$

 
$

 
$
6,055

Total liabilities at fair value
 
$
6,055

 
$

 
$

 
$
6,055


Activity Between and Within Levels of the Fair Value Hierarchy

The Company’s policy is to record transfers of assets and liabilities between Level 1 and Level 2 at their fair values as of the end of each reporting period, consistent with the date of the determination of fair value. There were no transfers between levels during the first quarter of 2012. In the fourth quarter of 2011, the Company converted its deferred compensation plan assets into mutual funds traded in active markets with quoted market prices. Similarly, in the fourth quarter of 2011, the participants’ selected investments were converted to investments based on mutual funds traded in active markets with quoted market prices. Liabilities under the deferred compensation plan are recorded at amounts due to participants, based on the fair value of the participants’ selected investments. Therefore, for the year ended December 31, 2011, the Company transferred $6.1 million of both deferred compensation plan assets and deferred compensation plan liabilities, respectively, from Level 2 to Level 1.

For those financial instruments measured at fair value on a recurring and non-recurring basis with significant Level 3 inputs, there was no activity for the three months ended March 31, 2012.

Assets and Liabilities Measured at Fair Value on a Non-recurring Basis
 
Certain assets and liabilities, including cost method investments, are measured at fair value on a non-recurring basis and therefore are not included in the tables above. Such instruments are not measured at fair value on an ongoing basis but are subject to fair value adjustments in certain circumstances (for example, when there is evidence of impairment).

Equity Investment in Public Company

In April 2009, the Company made a $5.0 million preferred stock investment in DiagnoCure, Inc. (“DiagnoCure”), a publicly-held company traded on the Toronto Stock Exchange. The Company’s equity investment was initially valued based on the transaction price under the cost method of accounting. The market value of the underlying common stock is the most observable value of the preferred stock, but because there is no active market for DiagnoCure’s preferred shares the Company has classified its equity investment in DiagnoCure as Level 2 in the fair value hierarchy. The Company's investment in DiagnoCure, which had a value of $5.0 million as of March 31, 2012, is included in “Licenses, manufacturing access fees and other assets, net” on the Company’s consolidated balance sheets.

Equity Investments in Private Companies

The valuation of investments in non-public companies requires significant management judgment due to the absence of quoted market prices, inherent lack of liquidity and the long-term nature of such assets. The Company’s equity investments in private companies are initially valued based upon the transaction price under the cost method of accounting. Equity investments

15

GEN-PROBE INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)





in non-public companies are classified as Level 3 in the fair value hierarchy.

The Company records impairment charges when an investment has experienced a decline that is deemed to be other-than-temporary. The determination that a decline is other-than-temporary is, in part, subjective and influenced by many factors. Future adverse changes in market conditions or poor operating results of investees could result in losses or an inability to recover the carrying value of the investments, thereby possibly requiring impairment charges in the future. When assessing investments in private companies for an other-than-temporary decline in value, the Company considers many factors, including, but not limited to, the following: the share price from the investee’s latest financing round; the performance of the investee in relation to its own operating targets and its business plan; the investee’s revenue and cost trends; the investee’s liquidity and cash position, including its cash burn rate; and market acceptance of the investee’s products and services. From time to time, the Company may consider third party evaluations or valuation reports. The Company also considers new products and/or services that the investee may have forthcoming, any significant news specific to the investee, the investee’s competitors and the outlook of the overall industry in which the investee operates. In the event the Company’s judgments change as to other-than-temporary declines in value, the Company may record an impairment loss, which could have an adverse effect on its results of operations.

Roka Bioscience, Inc.

In September 2009, the Company spun-off its industrial testing assets to Roka Bioscience, Inc. (“Roka”), a newly formed private company. In consideration for the contribution of assets, the Company received shares of preferred stock representing 19.9% of Roka’s capital stock on a fully diluted basis. The Company considers Roka to be a variable interest entity in accordance with ASC Topic 810, Consolidation. However, the Company is not the primary beneficiary of Roka and therefore has not consolidated Roka’s financial position or results of operations in the Company’s consolidated financial statements.

In April 2011, the Company purchased approximately $4.0 million of Roka’s Series C preferred stock as a participant in Roka’s Series C preferred stock round of financing that raised a total of approximately $20.0 million. As of March 31, 2012, the Company owns shares of preferred stock representing approximately 14.7% of Roka’s capital stock on a fully diluted basis. The Company’s investment has been valued based on the transaction price under the cost basis of accounting. The Company’s overall investment in Roka had a value of approximately $4.7 million as of March 31, 2012, and is included in “Licenses, manufacturing access fees and other assets, net” on the Company’s consolidated balance sheets.

Qualigen, Inc.

The Company invested in Qualigen, Inc. (“Qualigen”), a private company, in 2006. The Company’s investment in Qualigen, which had a value of approximately $5.4 million as of March 31, 2012, has been valued based upon several factors, including a market approach and an income (discounted cash flow) approach. This investment is also included in “Licenses, manufacturing access fees and other assets, net” on the Company’s consolidated balance sheets.

Note 6.     Borrowings

In February 2009, the Company entered into a credit agreement with Bank of America, N.A. (“Bank of America”), which provided for a one-year senior secured revolving credit facility in an amount of up to $180.0 million that is subject to a borrowing base formula. Subject to the terms of the credit agreement, including the amount of funds that the Company is permitted to borrow from time to time under the credit agreement, the revolving credit facility has a sub-limit for the issuance of letters of credit in a face amount of up to $10.0 million. Advances under the revolving credit facility were used to consummate the Company’s acquisition of Tepnel and are also available for other general corporate purposes. At the Company’s option, loans accrue interest at a per annum rate based on, either: the base rate (the base rate is defined as the greatest of (i) the federal funds rate plus a margin equal to 0.50%, (ii) Bank of America’s prime rate and (iii) the London Interbank Offered Rate (“LIBOR”) plus a margin equal to 1.00%); or LIBOR plus a margin equal to 0.60%, in each case for interest periods of 1, 2, 3 or 6 months as selected by the Company. In connection with the credit agreement, the Company also entered into a security agreement, pursuant to which the Company secured its obligations under the credit agreement with a first priority security interest in the securities, cash and other investment property held in specified accounts maintained by Merrill Lynch, Pierce, Fenner & Smith Incorporated, an affiliate of Bank of America.

In March 2009, the Company and Bank of America amended the credit agreement to increase the amount that the Company may borrow from time to time under the credit agreement from $180.0 million to $250.0 million. The term of the credit facility with Bank of America has been extended three times and currently expires in February 2013. In June 2011, Bank of America issued a £1.2 million standby letter of credit on behalf of the Company, thereby reducing the amount the Company can borrow under the credit facility by the face amount of the letter of credit. The total principal amount outstanding under the revolving credit

16

GEN-PROBE INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)





facility as of March 31, 2012 was $248.0 million, the interest rate payable on such outstanding amount was approximately 0.84% and no further borrowings are currently available under the credit facility.
 
Note 7.     Income Tax

As of March 31, 2012, the Company had total gross unrecognized tax benefits of $13.0 million. The amount of unrecognized tax benefits (net of the federal benefit for state taxes) that would favorably affect the Company’s effective income tax rate, if recognized, was $10.0 million. The Company’s federal tax returns for the 2008 through 2010 tax years, California tax returns for the 2005 through 2010 tax years, and UK tax returns for the 2008 through 2010 tax years are subject to future examination.

Note 8.     Contingencies

Litigation
 
The Company is a party to the following litigation and may also be involved in other litigation arising in the ordinary course of business from time to time. The Company intends to vigorously defend its interests in these matters. The Company expects that the resolution of these matters will not have a material adverse effect on its business, financial condition or results of operations. However, due to the uncertainties inherent in litigation, no assurance can be given as to the outcome of these proceedings.

Becton, Dickinson and Company

In October 2009, the Company filed a patent infringement action against Becton, Dickinson and Company (“BD”) in the U.S. District Court for the Southern District of California. The complaint alleges that BD’s Viper™ XTR™ testing system infringes five of the Company’s U.S. patents covering automated processes for preparing, amplifying and detecting nucleic acid targets. The complaint also alleges that BD’s ProbeTec™ Female Endocervical and Male Urethral Specimen Collection Kits for Amplified Chlamydia trachomatis/Neisseria gonorrhoeae (CT/GC) DNA assays used with the Viper XTR testing system infringe two of the Company’s U.S. patents covering penetrable caps for specimen collection tubes. The complaint seeks monetary damages and injunctive relief. In March 2010, the Company filed a second complaint for patent infringement against BD in the U.S. District Court for the Southern District of California alleging that BD’s BD MAX System™ (formerly known as the HandyLab Jaguar system) infringes four of the Company’s U.S. patents covering automated processes for preparing, amplifying and detecting nucleic acid targets. The second complaint also seeks monetary damages and injunctive relief. In June 2010, these two actions were consolidated into a single legal proceeding. There can be no assurances as to the final outcome of this litigation.

Enzo Life Sciences, Inc.

In January 2012, Enzo Life Sciences, Inc. (“Enzo”) filed a patent infringement action against the Company in the United States District Court for the District of Delaware. The complaint alleges that the Company’s manufacture and sale of certain molecular diagnostic assays, including the APTIMA Combo 2 and APTIMA HPV assays, that incorporate the Company’s patented hybridization protection assay technology infringe Enzo’s U.S. patent number 6,992,180. The complaint seeks monetary damages and injunctive relief. The Company intends to vigorously defend the lawsuit. There can be no assurances as to the final outcome of this litigation. The Company has not recorded an accrual as of March 31, 2012 for a contingent liability associated with this legal proceeding based on the Company’s belief that any liability is neither probable nor reasonably possible. In addition, any possible loss or range of loss cannot be reasonably estimated at this time.















17

GEN-PROBE INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)





Note 9.    Stockholders’ Equity

Changes in stockholders’ equity for the three months ended March 31, 2012 were as follows (in thousands):

Balance as of December 31, 2011
 
$
700,342

Net income
 
22,460

Other comprehensive income, net
 
3,058

Proceeds from the issuance of common stock and ESPP shares
 
14,232

Issuance of common stock to board members
 
71

Repurchase and retirement of restricted stock for payment of taxes
 
(1,124
)
Stock-based compensation
 
6,104

Stock-based compensation income tax benefits
 
1,021

Balance as of March 31, 2012
 
$
746,164


Comprehensive Income

All components of comprehensive income, including net income, are reported in the consolidated financial statements in the period in which they are recognized. Comprehensive income is defined as the change in equity during a period from transactions and other events and circumstances from non-owner sources. Net income and other comprehensive income (loss), which includes certain changes in stockholders’ equity, such as foreign currency translation of the Company’s wholly owned subsidiaries’ financial statements and unrealized gains and losses on the Company’s available-for-sale securities, are reported, net of their related tax effect, to arrive at comprehensive income.

Components of comprehensive income, net of income tax, for the three month periods ended March 31, 2012 and 2011 were as follows (in thousands):
 
 
Three Months Ended March 31,
 
 
2012
 
2011
Net income, as reported
 
$
22,460

 
$
23,277

Other comprehensive income (loss)
 
 
 
 
Foreign currency translation adjustment
 
1,788

 
2,328

Unrealized gains (losses)
 
 
 
 
Change in net unrealized gain (loss) on available-for-sale securities during the period
 
2,542

 
(3,413
)
Realized (gain) loss on available-for-sale securities, net of tax
 
(1,272
)
 
230

Total unrealized gains (losses)
 
1,270

 
(3,183
)
Total other comprehensive income (loss), net
 
3,058

 
(855
)
Comprehensive income
 
$
25,518

 
$
22,422

















18

GEN-PROBE INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)





Stock Options

A summary of the Company’s stock option activity for all equity incentive plans for the three months ended March 31, 2012 is as follows (in thousands, except per share data and number of years):
 
 
Number of
Shares
 
Weighted
Average
Exercise
Price
 
Weighted
Average
Remaining
Contractual
Life (Years)
 
Aggregate
Intrinsic
Value
Outstanding as of December 31, 2011
 
5,513

 
$
50.80

 
 
 
 
Granted
 
767

 
68.39

 
 
 
 
Exercised
 
(316
)
 
45.09

 
 
 
 
Cancelled
 
(35
)
 
59.00

 
 
 
 
Outstanding as of March 31, 2012
 
5,929

 
$
53.33

 
4.1

 
$
80,823

Exercisable as of March 31, 2012
 
3,737

 
$
49.97

 
3.1

 
$
62,235


Restricted Stock and Deferred Issuance Restricted Stock

A summary of the Company’s restricted stock and deferred issuance restricted stock award activity for the three months ended March 31, 2012 is as follows (in thousands, except per share data):
 
 
Number of
Shares
 
Weighted
Average
Grant Date
Fair Value
Unvested as of December 31, 2011
 
62

 
$
54.35

Granted
 
3

 
61.86

Vested
 
(3
)
 
51.17

Forfeited
 
(1
)
 
53.26

Unvested as of March 31, 2012
 
61

 
$
54.82


Performance Stock Awards

A summary of the Company’s performance stock award activity for the three months ended March 31, 2012 is as follows (in thousands, except per share data):
 
 
Number of
Shares
 
Weighted Average
Grant Date
Fair Value
Unvested as of December 31, 2011
 
109

 
$
73.92

Awarded
 
108

 
82.00

Vested and issued
 
(46
)
 
72.33

Cancelled
 
(1
)
 
72.63

Unvested as of March 31, 2012
 
170

 
$
79.46

Beginning in 2010, the Company transitioned from its historical practice of granting certain senior Company employees annual restricted stock awards with time-based vesting provisions only, to granting these employees the right to receive a designated number of shares of Company common stock based on the achievement of specific performance criteria over a defined performance period (the “Performance Stock Awards”). All Performance Stock Awards have been granted under the Company’s 2003 Incentive Award Plan and are intended to qualify as performance-based compensation under Section 162(m) of the Internal Revenue Code of 1986, as amended.





19

GEN-PROBE INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)






Note 10.     Product Line and Significant Customer Information

The Company currently operates in one business segment: the development, manufacturing, marketing, sales and support of molecular diagnostic products primarily to diagnose human diseases, screen donated human blood and ensure transplant compatibility.

Product sales by product line for the three month periods ended March 31, 2012 and 2011 were as follows (in thousands):
 
 
Three Months Ended March 31,
 
 
2012
 
2011
 
 
$
 
%
 
$
 
%
Clinical diagnostics
 
$
94,919

 
63
%
 
$
88,290

 
64
%
Blood screening
 
52,543

 
35
%
 
46,705

 
34
%
Research products and services
 
2,655

 
2
%
 
3,117

 
2
%
Total product sales
 
$
150,117

 
100
%
 
$
138,112

 
100
%

During the three month periods ended March 31, 2012 and 2011, 36% and 35%, respectively, of the Company’s total revenues were from Novartis. No other customer accounted for more than 10% of the Company’s revenues during the three month periods ended March 31, 2012 and 2011.

Note 11. Subsequent Event

Entry into Agreement and Plan of Merger with Hologic, Inc.

On April 29, 2012, the Company entered into an Agreement and Plan of Merger (the “Merger Agreement”) with Hologic, Inc. (“Hologic”) and Gold Acquisition Corp., a wholly owned subsidiary of Hologic (“Merger Sub”), pursuant to which Merger Sub will merge with and into the Company, with the Company continuing as the surviving corporation and as a wholly owned subsidiary of Hologic (the “Merger”). Upon the effective time of the Merger, each outstanding share of the Company’s common stock (other than shares held by any stockholders who are entitled to and who properly exercise appraisal rights under Delaware law, treasury shares, and shares held by the Company, Hologic, Merger Sub or any of their respective subsidiaries) will be canceled and converted into the right to receive $82.75 in cash, without interest, on the terms and subject to the conditions set forth in the Merger Agreement. Consummation of the Merger is subject to various conditions, including, among others, adoption of the Merger Agreement by the stockholders of the Company, and the termination or expiration of all applicable waiting periods under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended, and under any similar foreign statutes and regulations applicable to the Merger. The Company expects the Merger to close in the second half of 2012.

The Merger Agreement contains certain termination rights for each of Hologic and the Company, and if the Merger Agreement is terminated under certain circumstances, the Company may be required to pay Hologic a termination fee of $128.0 million or reimburse Hologic for its reasonable and documented out-of-pocket transaction-related expenses in an amount up to $20.0 million. Under certain circumstances specified in the Merger Agreement relating to Hologic’s failure to secure adequate financing for the Merger, Hologic is required to pay the Company a financing failure fee of $200.0 million.


20


Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations

This report contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, which provides a “safe harbor” for these types of statements. Forward-looking statements can be identified by the use of forward-looking words such as “believes,” “expects,” “hopes,” “may,” “will,” “plans,” “intends,” “estimates,” “could,” “should,” “would,” “continue,” “seeks” or “anticipates,” or other similar words (including their use in the negative), or by discussions of future matters, such as our ability to complete the proposed merger transaction with Hologic, Inc. pursuant to the definitive agreement and plan of merger between the parties, the ability to satisfy the conditions to closing the merger transaction, including obtaining the required approval of our stockholders and necessary regulatory clearances or approvals, and the ability to recognize the anticipated benefits of the merger transaction, the development and commercialization of new products, technology enhancements, regulatory approvals or clearance, possible changes in legislation, expectations for future growth, estimates of future revenues, expenses, profits, cash flows or balance sheet items, or other financial guidance and other statements that are not historical. Forward-looking statements are not guarantees of performance. They involve known and unknown risks, uncertainties and assumptions that may cause actual results, levels of activity, performance or achievements to differ materially from any results, level of activity, performance or achievements expressed or implied by any forward-looking statement. We assume no obligation to update any forward-looking statements.

The following information should be read in conjunction with our March 31, 2012 unaudited interim consolidated financial statements and related notes included elsewhere in this Quarterly Report and with our audited consolidated financial statements and related notes for the year ended December 31, 2011 and the related “Management’s Discussion and Analysis of Financial Condition and Results of Operations” section contained in our Annual Report on Form 10-K for the year ended December 31, 2011. We also urge you to review and consider our disclosures describing various risks that may affect our business, which are set forth under the heading “Risk Factors” in this Quarterly Report and in our Annual Report on Form 10-K for the year ended December 31, 2011.

Some totals included in this “Management’s Discussion and Analysis of Financial Condition and Results of Operations” section and elsewhere in this Quarterly Report may not foot due to rounding.

Overview

Gen-Probe Incorporated (NASDAQ: GPRO) is a global leader in the development, manufacture and marketing of rapid, accurate and cost-effective molecular diagnostic products and services that are used primarily to diagnose human diseases, screen donated human blood, and ensure transplant compatibility. Our molecular diagnostic products are designed to detect diseases more rapidly and/or accurately than older tests, and are among the fastest-growing categories of the in vitro diagnostics, or IVD, industry.

We market a broad portfolio of nucleic acid tests, or NATs, to detect infectious microorganisms, including those causing sexually transmitted diseases, or STDs, tuberculosis, strep throat and other infections. Our leading clinical diagnostics products include our APTIMA family of assays that are used to detect the common STDs chlamydia and gonorrhea, certain high-risk strains of the human papillomavirus, or HPV, and Trichomonas vaginalis, the parasite that causes trichomoniasis.

In recent years, we have expanded our portfolio of products with acquisitions focused on transplant-related and respiratory diagnostics. Our transplant diagnostics business, which we obtained as part of our acquisition of Tepnel Life Sciences plc, or Tepnel, in April 2009, offers diagnostics to help determine the compatibility between donors and recipients in tissue and organ transplants. Our acquisition of Prodesse, Inc., or Prodesse, in October 2009 added a portfolio of real-time polymerase chain reaction, or PCR, products for detecting influenza and other infectious organisms. In addition, in December 2010 we acquired Genetic Testing Institute, Inc., or GTI Diagnostics, a manufacturer of certain of our transplant diagnostic products, as well as specialty coagulation and transfusion-related blood bank products.

In blood screening, we developed and manufacture the PROCLEIX family of assays, which are used to detect human immunodeficiency virus (type 1), or HIV-1, the hepatitis C virus, or HCV, the hepatitis B virus, or HBV, and the West Nile virus, or WNV, in donated human blood. These blood screening products are marketed worldwide by our blood screening collaborator, Novartis Vaccines and Diagnostics, Inc., or Novartis, under Novartis’ trademarks. We were awarded a 2004 National Medal of Technology, the nation’s highest honor for technological innovation, in recognition of our pioneering work in developing NAT systems to safeguard the blood supply in the United States.

Several of our current and future molecular tests can be performed on our TIGRIS instrument, a fully automated, high-throughput NAT system for diagnostics and blood screening. We are building on the success of our TIGRIS instrument system by commercializing our next-generation PANTHER instrument, which is a versatile, fully automated NAT system for low- to mid-volume laboratories. The PANTHER instrument was CE-marked and launched in Europe for diagnostic use in the fourth quarter

21


of 2010. In addition, in May 2011 we filed a 510(k) application with the United States Food and Drug Administration, or FDA, for clearance of our PANTHER system to run our APTIMA Combo 2 assay for the detection of chlamydia and gonorrhea. In August 2011, Health Canada granted us a medical device license to use the PANTHER system to run our APTIMA Combo 2 assay in Canada. We are also developing the PANTHER system for use in the blood screening market as part of our blood screening collaboration with Novartis.

Our development pipeline includes products to detect:
certain genotypes of HPV, which can cause cervical cancer;
gene-based markers for prostate cancer;
the quantity of certain viruses, often referred to as the “viral load”;
certain gastrointestinal pathogens;
antigens and antibodies that are used to determine transplant and transfusion compatibility; and
coagulation disorders.
Recent Events

Entry into Agreement and Plan of Merger with Hologic

On April 29, 2012, we entered into an Agreement and Plan of Merger, or the Merger Agreement, with Hologic, Inc., or Hologic, and Gold Acquisition Corp., a wholly-owned subsidiary of Hologic, or Merger Sub, pursuant to which Merger Sub will merge with and into us, and we will continue as the surviving corporation in the merger and as a wholly owned subsidiary of Hologic, which we refer to as the Merger.

At the effective time of the Merger, each outstanding share of our common stock (other than shares held by any stockholders who are entitled to and who properly exercise appraisal rights under Delaware law, treasury shares, and shares of common stock held by us, Hologic, Merger Sub or any of their respective subsidiaries) will be canceled and converted into the right to receive $82.75 in cash, without interest, on the terms and subject to the conditions set forth in the Merger Agreement.

We made customary representations and warranties and covenants in the Merger Agreement, including, among others, to cause a meeting of our stockholders to be held to consider the adoption of the Merger Agreement, and to observe certain limits on the conduct of our business between the date of the Merger Agreement and the consummation of the Merger. Consummation of the Merger is subject to customary closing conditions, including adoption of the Merger Agreement by our stockholders, and the termination or expiration of all applicable waiting periods under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended, and under any similar foreign statutes and regulations applicable to the Merger. We expect the Merger to close in the second half of 2012.

The Merger Agreement contains certain termination rights in favor of each of Hologic and us. Upon the termination of the Merger Agreement under certain circumstances, we are required to pay Hologic a termination fee of $128.0 million or reimburse Hologic for its reasonable and documented out-of-pocket transaction-related expenses in an amount up to $20.0 million.

To support its obligations under the Merger Agreement, Hologic has obtained debt financing commitments from Goldman Sachs Bank USA and Goldman Sachs Lending Partners LLC. Under certain circumstances specified in the Merger Agreement relating to Hologic’s failure to secure adequate financing for the Merger, Hologic is required to pay us a financing failure fee of $200.0 million.

Our board of directors unanimously approved the Merger Agreement following the unanimous recommendation of a strategic transaction committee of our board of directors.

Certain terms of the Merger Agreement and the Merger are summarized in, and the Merger Agreement has been filed as an exhibit to, the Current Report on Form 8-K we filed with the Securities and Exchange Commission on May 1, 2012.

Financial Results

Product sales for the first quarter of 2012 were $150.1 million, compared to $138.1 million in the same period of the prior year, an increase of 9%. Total revenues for the first quarter of 2012 were $153.4 million, compared to $143.0 million in the same

22


period of the prior year, an increase of 7%. Net income for the first quarter of 2012 was $22.5 million ($0.49 per diluted share), compared to net income of $23.3 million ($0.48 per diluted share) in the same period of the prior year, an increase of 2% on a per diluted share basis.

FDA Clearance of APTIMA Trichomonas Assay

In April 2011, the FDA cleared our APTIMA Trichomonas vaginalis assay for sale and marketing in the United States. The APTIMA Trichomonas assay is an amplified NAT that detects Trichomonas vaginalis, the most common curable sexually transmitted infection in the United States. The APTIMA Trichomonas assay has been approved for use on our fully automated, high-throughput TIGRIS instrument system.

FDA Approval of APTIMA HPV Assay

In October 2011, the FDA approved our APTIMA HPV assay, an amplified NAT that detects high-risk strains of HPV that are associated with cervical cancer and precancerous lesions, for sale and marketing in the United States. The APTIMA HPV assay has been approved to run on our TIGRIS instrument system.

FDA Approval of PROGENSA PCA3 Assay

In February 2012, the FDA approved our PROGENSA PCA3 assay, a prostate-cancer specific molecular diagnostic test, for sale and marketing in the United States. The PROGENSA PCA3 assay has been approved for use on our semi-automated Direct Tube Sampling, or DTS, instrument systems.

Stock Repurchase Programs

In February 2011, our Board of Directors authorized the repurchase of up to $150.0 million of our common stock until December 31, 2011, through negotiated or open market transactions. There was no minimum or maximum number of shares to be repurchased under the program. We completed the program in August 2011, repurchasing and retiring approximately 2.5 million shares at an average price of $60.00 per share, or approximately $150.0 million in total.

In September 2011, our Board of Directors authorized the repurchase of up to an additional $100.0 million of our common stock from November 2011 through June 2012, through negotiated or open market transactions. There was no minimum or maximum number of shares to be repurchased under the program. We completed the program in December 2011, repurchasing and retiring approximately 1.7 million shares at an average price of $58.83 per share, or approximately $100.0 million in total.

The Merger Agreement we entered into with Hologic on April 29, 2012 does not allow us to repurchase additional shares of our common stock, subject to certain limited exceptions set forth in the Merger Agreement.

Critical Accounting Policies and Estimates

Our discussion and analysis of our financial condition and results of operations is based on our consolidated financial statements, which have been prepared in accordance with United States generally accepted accounting principles, or U.S. GAAP. The preparation of these consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and the related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates, including those related to revenue recognition, the collectability of accounts receivable, valuation of inventories and long-lived assets, including license and manufacturing access fees, patent costs and capitalized software, equity investments in publicly and privately held companies, accrued liabilities, income tax and the valuation of stock-based compensation. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, which form the basis for making judgments about the carrying values of our assets and liabilities. Senior management has discussed the development, selection and disclosure of these estimates with the Audit Committee of our Board of Directors. Actual results may differ from these estimates.

We believe there have been no significant changes during the first quarter of 2012 to the items that we disclosed as our critical accounting policies and estimates in the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” section of our Annual Report on Form 10-K for the year ended December 31, 2011.





23


Recent Accounting Pronouncements

For information on the recent accounting pronouncements impacting our business, see Note 1 of the Notes to Consolidated Financial Statements included elsewhere in this Quarterly Report.

Results of Operations

Product Sales

(Dollars in millions)
 
Three Months Ended March 31,
 
 
2012
 
2011
 
$ Change
 
% Change
Clinical diagnostics
 
$
94.9

 
$
88.3

 
$
6.6

 
7
 %
Blood screening
 
52.5

 
46.7

 
5.8

 
12
 %
Research products and services
 
2.7

 
3.1

 
(0.4
)
 
(13
)%
Total product sales
 
$
150.1

 
$
138.1

 
$
12.0

 
9
 %
As a percent of total revenues
 
98
%
 
97
%
 
 
 
 

Our primary source of revenue comes from product sales, which consist primarily of the sale of clinical diagnostics and blood screening products. Our clinical diagnostic product sales consist primarily of the sale of our women’s health, other infectious disease, transplant diagnostics, and genetic testing products. The principal customers for our clinical diagnostics products include reference laboratories, public health institutions and hospitals. The blood screening assays and instruments we manufacture are marketed and distributed worldwide through our collaboration with Novartis under Novartis’ Procleix and Ultrio trademarks.

We recognize product sales from the manufacture and shipment of tests for screening donated blood at the contractual transfer prices specified in our collaboration agreement with Novartis for sales to end-user blood bank facilities located in countries where our products have obtained governmental approvals. Blood screening product sales are then adjusted monthly corresponding to Novartis’ payment to us of amounts reflecting our ultimate share of net revenue from sales by Novartis to end users, less the transfer price revenues previously recorded. Net sales are ultimately equal to the sales of the assays by Novartis to third parties, less freight, duty and certain other adjustments specified in our collaboration agreement with Novartis, multiplied by our share of the net revenue.

Product sales increased by 9% during the first quarter of 2012 as compared to the same period in the prior year. The increase was primarily attributed to higher sales from APTIMA assays and instrumentation, and higher blood screening revenues.

Clinical Diagnostic Product Sales

Clinical diagnostic product sales, including assay, instrument, and ancillary sales, represented $94.9 million, or 63% of product sales during the first quarter of 2012, compared to $88.3 million, or 64% of product sales during the same period of the prior year. The $6.6 million increase was primarily attributed to increased sales of APTIMA assays and instruments. The increase was partially offset by lower sales of other infectious disease products.

During the first quarter of 2012, clinical diagnostic product sales were negatively affected by unfavorable estimated exchange rate impacts of $0.5 million as compared to the prior year, primarily due to a stronger U.S. dollar versus the Euro.

Blood Screening Product Sales

Blood screening product sales, including assay, instrument, and ancillary sales, represented $52.5 million, or 35% of product sales during the first quarter of 2012, compared to $46.7 million, or 34% of product sales during the same period of the prior year. The $5.8 million increase was attributed to increased sales of blood screening-related instrumentation and assays to Novartis.

During the first quarter of 2012, blood screening product sales were negatively affected by unfavorable estimated exchange rate impacts of $0.1 million as compared to the prior year, primarily due to a stronger U.S. dollar versus the Euro.

Research Products and Services

As a result of our acquisition of Tepnel in April 2009, we have established an additional category of product sales, which we refer to as “Research products and services.” These sales represent outsourcing services for the pharmaceutical, biotechnology

24


and healthcare industries, including nucleic acid purification and analysis services, as well as the sale of monoclonal antibodies. Research products and services revenues were $2.7 million during the first quarter of 2012 compared to $3.1 million during the same period of the prior year. The $0.4 million decrease was primarily due to continued market weakness affecting contract research organizations.

Collaborative Research Revenue
 
(Dollars in millions)
 
Three Months Ended March 31,
 
 
2012
 
2011
 
$ Change
 
% Change
Collaborative research revenue
 
$
1.4

 
$
3.6

 
$
(2.2
)
 
(61
)%
As a percent of total revenues
 
1
%
 
3
%
 
 
 
 

We recognize collaborative research revenue over the term of various collaboration agreements, as negotiated monthly contracted amounts are earned, in relative proportion to the performance required under the contracts, or as reimbursable costs are incurred related to those agreements. Milestone consideration that is contingent upon achievement of a milestone in its entirety is recorded as revenue in the period in which the milestone is achieved only if the milestone meets all criteria to be considered substantive.

The costs associated with collaborative research revenue are based on fully burdened full-time equivalent rates and are reflected in our consolidated statements of income under the captions “Research and development,” “Marketing and sales” and “General and administrative,” based on the nature of the costs. We do not separately track all of the costs applicable to our collaborations and, therefore, are not able to quantify all of the costs associated with collaborative research revenue.

Collaborative research revenue decreased 61% during the first quarter of 2012 compared to the same period of the prior year. The $2.2 million decrease was primarily due to decreased reimbursements received from Novartis for shared development expenses attributable to the development of the PANTHER instrument and related product enhancements for use in the blood screening market.

Collaborative research revenue tends to fluctuate based on the type and amount of research services performed, the status of projects under collaboration and the achievement of milestones. Due to the nature of our collaborative research revenue, results in any one period are not necessarily indicative of the results that will be achieved in the future. Our ability to generate additional collaborative research revenue depends, in part, on our ability to initiate and maintain relationships with potential and current collaborative partners and the advancement of related collaborative research and development activities.

Royalty and License Revenue
 
(Dollars in millions)
 
Three Months Ended March 31,
 
 
2012
 
2011
 
$ Change
 
% Change
Royalty and license revenue
 
$
1.9

 
$
1.4

 
$
0.5

 
36
%
As a percent of total revenues
 
1
%
 
1
%
 
 
 
 
We recognize revenue for royalties due to us under license agreements with third parties upon the manufacture, sale or use of our products or technologies. For those arrangements where royalties are reasonably estimable, we recognize revenue based on estimates of royalties earned during the applicable period and adjust for differences between the estimated and actual royalties. Historically, these adjustments have not been material. For those arrangements where royalties are not reasonably estimable, we recognize revenue upon receipt of royalty statements from the applicable licensee. Non-refundable license fees with stand-alone value are recognized at the time that we have satisfied all performance obligations. License fees without stand-alone value are recognized in combination with any undelivered performance obligations.

Royalty and license revenue increased by 36% during the first quarter of 2012 compared to the same period of the prior year. The $0.5 million increase was primarily attributable to an increase in collaboration royalties received from Novartis related to the plasma testing market.

Royalty and license revenue may fluctuate based on the nature of the related agreements and the timing of receipt of license fees. Results in any one period are not necessarily indicative of results to be achieved in the future. In addition, our ability to generate additional royalty and license revenue will depend, in part, on our ability to market and commercialize our technologies.

25


Cost of Product Sales
 
(Dollars in millions)
 
Three Months Ended March 31,
 
 
2012
 
2011
 
$ Change
 
% Change
Cost of product sales
 
$
52.4

 
$
41.9

 
$
10.5

 
25
%
Gross profit margin as a percent of product sales
 
65
%
 
70
%
 
 
 
 

Cost of product sales includes direct material, direct labor and manufacturing overhead associated with the production of inventories. Cost of product sales may fluctuate significantly in different periods based on changes in production volumes for both commercially approved products and products under development or in clinical trials. Cost of product sales is also affected by manufacturing efficiencies, allowances for scrap or expired material, additional costs related to initial production quantities of new products after achieving FDA approval, instrument and software amortization, and contractual adjustments, such as instrumentation costs, instrument service costs, warranty costs and royalties. Cost of product sales excludes the amortization of acquisition-related intangibles.

In addition, we manufacture significant quantities of materials, development lots, and clinical trial lots of product prior to receiving approval from the FDA for commercial sale. The majority of costs associated with development lots are classified as research and development, or R&D, expense. The portion of a development lot that is manufactured for commercial sale is capitalized to inventory and classified as cost of product sales upon shipment.

Cost of product sales increased 25% during the first quarter of 2012 compared to the same period of the prior year. The $10.5 million increase was primarily due to additional cost of sales related to higher sales from our APTIMA products, instruments and blood screening shipments to Novartis.

Our gross profit margin as a percentage of product sales decreased to 65% during the first quarter of 2012 from 70% during the same period of the prior year. The decrease in gross profit margin as a percentage of product sales was principally attributed to increased sales of lower margin instrumentation and lower sales of higher margin infectious disease products.

A portion of our blood screening revenues is attributable to sales of TIGRIS and PANTHER instruments to Novartis, which totaled $3.3 million and $2.0 million during the first quarter of 2012 and 2011, respectively. Under our collaboration agreement with Novartis, we sell instruments to Novartis at prices that approximate cost and share in profits of end-user sales in the United States. These instrument sales, therefore, negatively impact our gross margin percentage in the periods during which they occur, but are a necessary precursor to increased sales of blood screening assays in the future.

Acquisition-related Intangible Amortization
 
(Dollars in millions)
 
Three Months Ended March 31,
 
 
2012
 
2011
 
$ Change
 
% Change
Acquisition-related intangible amortization
 
$
2.8

 
$
2.8

 
$

 
%
As a percent of total revenues
 
2
%
 
2
%
 
 
 
 

Amortization expense related to our acquired intangible assets during the first quarter of 2012 was consistent with the same period of the prior year. Our acquired intangible assets are amortized using the straight-line method over their estimated useful lives, which range from 5 to 20 years.

Research and Development
 
(Dollars in millions)
 
Three Months Ended March 31,
 
 
2012
 
2011
 
$ Change
 
% Change
Research and development
 
$
28.6

 
$
29.0

 
$
(0.4
)
 
(1
)%
As a percent of total revenues
 
19
%
 
20
%
 
 
 
 

We invest significantly in R&D as part of our ongoing efforts to develop new products and technologies. Our R&D expenses include the development of proprietary products and instrument platforms, as well as expenses related to the development of new

26


products and technologies in collaboration with our partners. R&D spending is dependent on the status of projects under development and may vary substantially between quarterly or annual reporting periods.

R&D expenses decreased 1% during the first quarter of 2012 compared to the same period of the prior year. The $0.4 million decrease was primarily related to the reduction in development expenses as a result of the wind-down of the clinical trials for our HPV assay and lower development costs relating to our PANTHER instrument. These decreases were offset by increases in R&D expense relating to instrument development and virology programs. We have expanded our instrument development programs to include the addition of real-time PCR capabilities for the next-generation PANTHER system, and to develop a new instrument to further automate molecular testing from liquid-based cytology specimens.

Marketing and Sales
 
(Dollars in millions)
 
Three Months Ended March 31,
 
 
2012
 
2011
 
$ Change
 
% Change
Marketing and sales
 
$
19.0

 
$
16.5

 
$
2.5

 
15
%
As a percent of total revenues
 
12
%
 
12
%
 
 
 
 

Our marketing and sales expenses include salaries and other personnel-related expenses, promotional expenses, and fees for outside services.

Marketing and sales expenses increased 15% during the first quarter of 2012 compared to the same period of the prior year. The $2.5 million increase was primarily attributed to increases in headcount and personnel-related expenses attributable to our women’s health business and other marketing activities.

General and Administrative
 
(Dollars in millions)
 
Three Months Ended March 31,
 
 
2012
 
2011
 
$ Change
 
% Change
General and administrative
 
$
19.0

 
$
18.2

 
$
0.8

 
4
%
As a percent of total revenues
 
12
%
 
13
%
 
 
 
 

Our general and administrative, or G&A, expenses include expenses for finance, legal, strategic planning and business development, public relations and human resources.

G&A expenses increased 4% during the first quarter of 2012 compared to the same period of the prior year. The $0.8 million increase is primarily attributable to higher G&A costs relating to litigation and other professional services, and costs associated with our internal restructuring activities.

Total Other Income, Net
 
(Dollars in millions)
 
Three Months Ended March 31,
 
 
2012
 
2011
 
$ Change
 
% Change
Investment and interest income
 
$
2.5

 
$
0.7

 
$
1.8

 
257
 %
Interest expense
 
(0.5
)
 
(0.5
)
 

 
 %
Other income, net
 
0.1

 
0.2

 
(0.1
)
 
(50
)%
Total other income, net
 
$
2.1

 
$
0.4

 
$
1.7

 
425
 %

Investment and Interest Income

The $1.8 million increase in investment and interest income during the first quarter of 2012 compared to the same period of the prior year is primarily attributed to higher net realized gains on sales of marketable securities, partially offset by decreased interest income from lower investment balances during the first quarter of 2012 as a result of the sale of investments during 2011 to fund our stock repurchase programs.


27


Interest Expense

Interest expense was consistent, totaling $0.5 million during each of the first quarters of 2012 and 2011.

Other Income (Expense), Net

Other income (expense), net decreased by $0.1 million during the first quarter of 2012 compared to the same period of the prior year, primarily related to unfavorable exchange rate impacts.
Income Tax Expense
 
(Dollars in millions)
 
Three Months Ended March 31,
 
 
2012
 
2011
 
$ Change
 
% Change
Income tax expense
 
$
11.3

 
$
11.8

 
$
(0.5
)
 
(4
)%
As a percent of income before income tax
 
34
%
 
34
%
 
 
 
 

Our income tax expense decreased 4% during the first quarter of 2012 compared to the same period of the prior year. The $0.5 million decrease was attributable to lower 2012 pre-tax earnings.

Liquidity and Capital Resources
 
(Dollars in millions)
 
March 31, 2012
 
December 31, 2011
Cash, cash equivalents and current marketable securities
 
$
313.2

 
$
305.8

Working capital
 
$
183.0

 
$
164.9

Current ratio
 
1.6:1

 
1.5:1


Our working capital as of March 31, 2012 increased $18.1 million from December 31, 2011. This increase in working capital during the first quarter of 2012 was primarily attributable to increases in our trade accounts receivable, prepaid expenses and inventories, which totaled $9.4 million, $4.2 million and $3.4 million, respectively.

The primary objectives of our investment policy are liquidity and safety of principal. Consistent with these objectives, investments are made with the goal of achieving the highest rate of return. The policy places emphasis on securities of high credit quality, with restrictions placed on maturities and concentration by security type and issuer.

Our marketable securities include equity securities, mutual funds, treasury securities and tax advantaged municipal securities. Our investment policy limits the effective maturity on individual securities to six years and an average portfolio maturity to three years with a minimum Moody’s credit rating of A3 or a Standard & Poor’s credit rating of A-. As of March 31, 2012, our portfolios had an average maturity of three years and an average credit quality of AA1 as defined by Moody’s.

(Dollars in millions)
 
Three Months Ended March 31,
 
 
2012
 
2011
 
$ Change
Cash provided by (used in):
 
 
 
 
 
 
Operating activities
 
$
31.7

 
$
40.1

 
$
(8.4
)
Investing activities
 
5.7

 
12.8

 
(7.1
)
Financing activities
 
14.4

 
(19.5
)
 
33.9

Purchases of property, plant and equipment (included in investing activities above)
 
(9.3
)
 
(10.8
)
 
1.5


Our primary source of liquidity has been cash from operations, which includes the collection of accounts and other receivables related to product sales, collaborative research agreements, and royalty and license fees. Additionally, our liquidity was enhanced in 2009 by our credit facility with Bank of America, N.A., or Bank of America, described in Note 6 — Borrowings, of the Notes to Consolidated Financial Statements included elsewhere in this Quarterly Report. The term of our credit facility currently expires in February 2013. Our primary short-term cash needs, which are subject to change, include continued R&D expense to support

28


new products, costs related to commercialization of products and purchases of instrument systems for placement with our customers. In addition, we may use cash for strategic purchases which may include the acquisition of businesses and/or technologies complementary to our business and for stock repurchase programs. Certain R&D costs may be funded under collaboration agreements with our collaboration partners.

Operating activities provided net cash of $31.7 million during the first quarter of 2012, primarily from net income of $22.5 million and non-cash charges to net income of $18.7 million, offset by a net increase in operating assets and liabilities of $9.4 million. Non-cash charges primarily consisted of stock-based compensation expense of $6.2 million, depreciation of $6.1 million and amortization of intangible assets of $5.3 million. The net increase in operating assets and liabilities of $9.4 million was primarily due to higher trade accounts receivable balances at the end of the first quarter of 2012 as a result of the timing of our cash collections from our product sales. The $8.4 million decrease in cash from operating activities during the first quarter of 2012 compared to the same period of the prior year was primarily due to increases in our inventory and trade receivables balances during the first quarter of 2012, partially offset by a larger increase in our income tax payable during the first quarter of 2011.

Net cash provided by investing activities during the first quarter of 2012 was $5.7 million. We received $17.1 million in net proceeds from the sales and maturities of marketable securities, which was partially offset by purchases of property, plant and equipment of $9.3 million, purchases of capitalized software of $1.7 million and purchases of intangible assets, including license fees of $0.8 million. The $7.1 million decrease in cash from investing activities during the first quarter of 2012 compared to the same period of the prior year was primarily due to $7.6 million of higher net proceeds in 2011 from the sales and maturities of our marketable securities.

Net cash provided by financing activities during the first quarter of 2012 was $14.4 million, primarily driven by $14.2 million in proceeds from the issuance of common stock under our equity incentive and employee stock purchase plans. The $33.9 million increase in cash from financing activities during the first quarter of 2012 compared to the same period of the prior year was primarily due to $48.0 million spent during the first quarter of 2011 to repurchase shares of our common stock under our stock repurchase program offset by $10.0 million of additional borrowings made in the first quarter of 2011 under our credit facility.

We believe that our available cash balances, anticipated cash flows from operations, proceeds from stock option exercises and borrowings under our revolving credit facility will be sufficient to satisfy our operating needs for the foreseeable future. However, we operate in a rapidly evolving and often unpredictable business environment that may change the timing or amount of expected future cash receipts and expenditures. Accordingly, we may in the future be required to raise additional funds through the sale of equity or debt securities or from additional credit facilities. Additional capital, if needed, may not be available on satisfactory terms, or at all. Further, debt financing may subject us to covenants restricting our operations. Because our current credit facility is secured by our marketable debt securities, any significant needs for cash may cause us to liquidate some or all of our marketable debt securities resulting in the need to partially or completely pay down or refinance this indebtedness.

Contractual Obligations

We did not enter into any material contractual obligations during the three months ended March 31, 2012. We have no material contractual obligations that are not fully recorded on our consolidated balance sheets or fully disclosed in the Notes to Consolidated Financial Statements included elsewhere in this Quarterly Report.

Off-Balance Sheet Arrangements

We do not currently have and have never had any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. In addition, we do not engage in trading activities involving non-exchange traded contracts. As such, we are not materially exposed to any financing, liquidity, market or credit risk that could arise if we had engaged in these relationships.

Available Information

Copies of our public filings are available on our Internet website at http://www.gen-probe.com as soon as reasonably practicable after we electronically file such material with, or furnish it to, the Securities and Exchange Commission, or the SEC.




29



Item 3.
Quantitative and Qualitative Disclosures about Market Risk

Interest Rate Risk

Our exposure to market risk for changes in interest rates relates primarily to interest earned on our investment portfolio and the amount of interest payable on our senior secured revolving credit facility with Bank of America. As of March 31, 2012, the total principal amount outstanding under the revolving credit facility was $248.0 million. At our option, loans accrue interest at a per annum rate based on, either: the base rate (the base rate is defined as the greatest of (i) the federal funds rate plus a margin equal to 0.50%, (ii) Bank of America’s prime rate and (iii) the London Interbank Offered Rate, or LIBOR, plus a margin equal to 1.00%); or LIBOR plus a margin equal to 0.60%, in each case for interest periods of 1, 2, 3 or 6 months as selected by us. We do not believe that we are exposed to significant interest rate risk with respect to our credit facility based on our option to select the rate at which interest accrues under the credit facility, the short-term nature of the borrowings and our ability to pay off the outstanding balance in a timely manner if the applicable interest rate under the credit facility increases above the current interest rate yields on our investment portfolio. A 100 basis point increase or decrease in interest rates would increase or decrease our interest expense by approximately $2.5 million on an annual basis.

Our risk associated with fluctuating interest income is limited to our investments in interest rate sensitive financial instruments. Under our current policies, we do not use interest rate derivative instruments to manage this exposure to interest rate changes. We seek to ensure the safety and preservation of our invested principal by limiting default risk, market risk, and reinvestment risk. We mitigate default risk by investing in investment grade securities with an average portfolio maturity of no more than three years. A 25 basis point increase or decrease in interest rates would increase or decrease our current investment balance by approximately $1.6 million on an annual basis. While changes in interest rates may affect the fair value of our investment portfolio, any gains or losses are not recognized in our consolidated statements of income until the investment is sold or if a reduction in the fair value of the investment is determined to be other-than-temporary.

Equity Price Risk

In connection with a collaboration agreement we entered into with Pacific Biosciences of California, Inc., or Pacific Biosciences, in June 2010, we purchased $50.0 million of Pacific Biosciences’ Series F preferred stock as a participant in Pacific Biosciences’ Series F preferred stock round of financing, which raised a total of approximately $109.0 million. In October 2010, Pacific Biosciences completed an initial public offering of its common stock at a price of $16.00 per share, and the stock now trades on the NASDAQ Global Select Market under the symbol “PACB.” As a result of the initial public offering, our Pacific Biosciences’ preferred stock was converted into common stock.

Our investment in Pacific Biosciences is subject to market price volatility. Fluctuations in the market price of publicly traded securities may result from perceived changes in the underlying economic characteristics of the issuer, the relative price of alternative investments, general market conditions and other factors.

We originally recorded our $50.0 million investment in Pacific Biosciences’ preferred stock on a cost basis in our consolidated financial statements. Since Pacific Biosciences completed its initial public offering, our investment in Pacific Biosciences has been marked to fair market value each reporting period. We periodically review our marketable equity securities for other-than-temporary declines in fair value below their cost basis, or whenever events or circumstances indicate that the carrying amount of an asset may not be recoverable. In the third quarter of 2011, we recorded a $39.5 million other-than-temporary impairment, or OTTI, loss on our investment in Pacific Biosciences. As of March 31, 2012, our investment in Pacific Biosciences had a market value of $11.2 million.

A 10% percent increase or decrease in the fair value of our investment in Pacific Biosciences would result in an increase or decrease to the fair value of our investment of approximately $1.1 million. Because the market price for our investment in Pacific Biosciences is subject to ongoing fluctuation, the amount we may eventually realize from a subsequent sale of our investment may differ significantly from the reported market value.

Foreign Currency Exchange Risk

Although the majority of our revenue is realized in U.S. dollars, some portions of our revenue are realized in foreign currencies. As a result, our financial results could be affected by factors such as changes in foreign currency exchange rates or weak economic conditions in foreign markets. We translate the financial statements of our non-U.S. operations using the end-of-period exchange rates for assets and liabilities and the average exchange rates for each reporting period for results of operations. Net gains and losses resulting from the translation of foreign financial statements and the effect of exchange rates in intercompany

30


receivables and payables of a long-term investment nature are recorded as a separate component of stockholders’ equity under the caption “Accumulated other comprehensive income (loss).” These adjustments will affect net income upon the sale or liquidation of the underlying investment.

Under our collaboration agreement with Novartis, a growing portion of blood screening product sales is from western European countries. As a result, our international blood screening product sales are affected by changes in the foreign currency exchange rates of those countries where Novartis’ business is conducted in Euros or other local currencies. Based on international blood screening product sales during the first three months of 2012, a 10% increase or decrease of currency exchange rates would result in a blood screening product sales increase or decrease of approximately $5.0 million annually. Similarly, a 10% increase or decrease of currency exchange rates would result in a clinical diagnostic product sales increase or decrease of approximately $7.2 million annually. A 10% movement of currency exchange rates would result in a research products and services sales increase or decrease of approximately $1.1 million annually. The majority of our collaborative research revenues and royalty and license revenues are denominated in U.S. dollars and, as such, are not subject to exchange rate exposure. Our exposure for both blood screening and clinical diagnostic product sales is primarily in the U.S. dollar versus the Euro, British pound, Australian dollar and Canadian dollar.

Our total accounts payable denominated in foreign currencies as of March 31, 2012 were not material. Our trade accounts receivable by currency as of March 31, 2012 reflected in U.S. dollar equivalents were as follows (in millions):
 
 
 
 
U.S. dollar
 
$
52.7

Euro
 
6.9

British pound
 
4.4

Canadian dollar
 
2.2

Other
 
1.3

Total gross trade accounts receivable
 
$
67.5



Item 4.
Controls and Procedures

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our current and periodic reports is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable and not absolute assurance of achieving the desired control objectives. In reaching a reasonable level of assurance, management was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

In addition, the design of any system of controls is also based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, controls may become inadequate because of changes in conditions, or the degree of compliance with policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.

As of the end of the period covered by this Quarterly Report on Form 10-Q, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of March 31, 2012.

An evaluation was also performed under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of any change in our internal control over financial reporting that occurred during our last fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. That evaluation did not identify any change in our internal control over financial reporting that occurred during our latest fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

31



PART II — OTHER INFORMATION

Item 1.
Legal Proceedings

We are a party to the following litigation and may also be involved in other legal proceedings arising in the ordinary course of business from time to time. We intend to vigorously defend our interests in these matters. We expect that the resolution of these matters will not have a material adverse effect on our business, financial condition or results of operations. However, due to the uncertainties inherent in litigation, no assurance can be given as to the outcome of these proceedings. If any of these matters were resolved in a manner unfavorable to us, our business, financial condition and results of operations would be harmed.

Becton, Dickinson and Company

In October 2009, we filed a patent infringement action against Becton, Dickinson and Company, or BD, in the United States District Court for the Southern District of California. The complaint alleges that BD’s Viper™ XTR™ testing system infringes five of our U.S. patents covering automated processes for preparing, amplifying and detecting nucleic acid targets. The complaint also alleges that BD’s ProbeTec™ Female Endocervical and Male Urethral Specimen Collection Kits for Amplified Chlamydia trachomatis/Neisseria gonorrhoeae (CT/GC) DNA assays used with the Viper XTR testing system infringe two of our U.S. patents covering penetrable caps for specimen collection tubes. The complaint seeks monetary damages and injunctive relief. In March 2010, we filed a second complaint for patent infringement against BD in the United States District Court for the Southern District of California alleging that BD’s BD MAX System™ (formerly known as the HandyLab Jaguar system) infringes four of our U.S. patents covering automated processes for preparing, amplifying and detecting nucleic acid targets. The second complaint also seeks monetary damages and injunctive relief. In June 2010, these two actions were consolidated into a single legal proceeding. There can be no assurances as to the final outcome of this litigation.

Enzo Life Sciences, Inc.

In January 2012, Enzo Life Sciences, Inc., or Enzo, filed a patent infringement action against us in the United States District Court for the District of Delaware. The complaint alleges that our manufacture and sale of certain molecular diagnostic assays, including the APTIMA Combo 2 and APTIMA HPV assays, that incorporate our patented hybridization protection assay technology infringe Enzo’s U.S. patent number 6,992,180. The complaint seeks monetary damages and injunctive relief. We intend to vigorously defend the lawsuit. There can be no assurances as to the final outcome of this litigation.

Putative Shareholder Class Action Litigation

In the days following the announcement that we had entered into the Merger Agreement with Hologic and Merger Sub, purported stockholders of the company filed two lawsuits in connection with the proposed transaction, the first lawsuit, captioned Teamsters Local Union No. 727 Pension Fund v. Gen-Probe Incorporated, et al., was filed in the Superior Court of the State of California for the County of San Diego against us, our directors and Hologic, and the second lawsuit, captioned Timothy Coyne v. Gen-Probe Incorporated, et al., or the Delaware Action, was filed in the Delaware Court of Chancery against us, our directors, Hologic and Merger Sub. Both actions were brought as putative class actions and allege that our directors breached certain alleged fiduciary duties to our stockholders by approving the Merger Agreement, and that Hologic and/or Merger Sub aided and abetted those breaches. The complaints request an injunction of the transaction. The Delaware Action also seeks damages in the event the transaction is completed. We believe that each of these actions is without merit.

Item 1A. Risk Factors

Set forth below and elsewhere in this Quarterly Report on Form 10-Q, and in other documents we file with the SEC, are descriptions of risks and uncertainties that could cause our actual results to differ materially from the results contemplated by the forward-looking statements contained in this Quarterly Report. Because of the following factors, as well as other variables affecting our operating results, past financial performance should not be considered a reliable indicator of future performance and investors should not use historical trends to anticipate results or trends in future periods. The risks and uncertainties described below are not the only ones we face. Other events that we do not currently anticipate or that we currently deem immaterial may also affect our results of operations and financial condition. We have marked with an asterisk those risk factors that reflect substantive changes from the risk factors included in our Annual Report on Form 10-K for the year ended December 31, 2011.




32


Our business and results of operations may be affected by the announcement of our proposed acquisition by Hologic.*

On April 29, 2012, we entered into the Merger Agreement with Hologic and Merger Sub, pursuant to which Merger Sub will merge with and into us, and we will continue as the surviving corporation and as a wholly owned subsidiary of Hologic. The terms of the Merger Agreement and the Merger are described in more detail in Item 2 of Part I of this Quarterly Report on Form 10-Q.

The Merger could have an adverse effect on our revenue in the near term if customers delay, defer, or cancel purchases until the completion of the Merger. While we are attempting to mitigate this risk through communications with our customers, current and prospective customers could be reluctant to purchase our products and/or services due to potential uncertainty about the direction of our product offerings and our support and service of existing products. To the extent that the Merger creates uncertainty among customers or our employees such that any significant number of customers delay purchase decisions pending completion of the Merger, or our employees depart the company or become distracted, our results of operations and ability to operate profitably could be negatively affected. Decreased revenue or a failure to be profitable could have a variety of adverse effects, including negative consequences to our relationships with, and ongoing obligations to, customers, suppliers, employees, business partners, and others with whom we have business relationships. In addition, our quarterly operating results could fail to meet the expectations of market analysts, which could cause our stock price to decline.

We are also subject to additional risks in connection with the Merger, including: (1) the occurrence of an event or circumstance that could give rise to the payment of a termination fee by us of $128.0 million or the payment of Hologic’s out-of-pocket transaction-related expenses in an amount up to $20.0 million, in each case pursuant to and in accordance with the terms of the Merger Agreement, (2) the outcome of any legal proceedings that may be instituted against us, our directors and others relating to the transactions contemplated by the Merger Agreement, (3) the failure of the Merger to close for any reason, including due to the failure to obtain the necessary regulatory approvals or Hologic’s inability to secure adequate financing, (4) the restrictions imposed on our business, properties and operations pursuant to the affirmative and negative covenants set forth in the Merger Agreement and the potential impact of such covenants on our business, (5) the risk that the Merger will divert management’s attention resulting in a potential disruption of our current business plan, and (6) potential difficulties in employee retention arising from the Merger.

We may suffer additional consequences if the proposed acquisition by Hologic is not completed.*

If the Merger is not completed, we could suffer a number of consequences that may adversely affect our business, results of operations and stock price, including the following:

activities relating to the Merger and related uncertainties may divert our management’s attention from our day-to-day business and cause disruptions among our employees and to our relationships with customers and business partners, thus detracting from our ability to grow revenue and possibly leading to a loss of revenue and market position that we may not be able to regain if the Merger does not occur;

the market price of our common stock could decline following an announcement that the Merger has been abandoned, to the extent that the current market price reflects a market assumption that the Merger will be completed;

if the Merger Agreement is terminated under certain circumstances, we may be required to pay a termination fee to Hologic or reimburse Hologic for its transaction-related expenses;

if Hologic fails to secure adequate financing for the Merger, our remedies will be limited to receipt of a financing failure fee of $200.0 million;

certain costs related to the Merger, including the fees and/or expenses of our legal, accounting and financial advisors, must be paid even if the Merger is not completed;

we may be subject to legal proceedings related to the Merger;

we may be the subject of other acquisition proposals that require management attention and that may be less favorable to us and our stockholders than the Merger;

we may not be able to take advantage of alternative business opportunities or effectively respond to competitive pressures; and

a failed transaction may result in negative publicity and/or a negative impression of us in the investment community

33


or business community generally.

Our quarterly revenue and operating results may vary significantly in future periods and our stock price may decline.

Our operating results have fluctuated in the past and are likely to continue to do so in the future. Our revenues are unpredictable and may fluctuate due to changes in demand for our products, including fluctuations in demand or inventory levels for blood screening tests and instrumentation from our blood screening collaboration partner Novartis, the timing of acquisitions, the execution of customer contracts, the receipt of milestone payments, or the failure to achieve and receive the same, and the initiation or termination of corporate collaboration agreements. In addition, a significant portion of our costs can also vary substantially between quarterly or annual reporting periods. For example, the total amount of research and development costs in a period often depends on the amount of costs we incur in connection with manufacturing developmental lots and clinical trial lots. Moreover, a variety of factors may affect our ability to make accurate forecasts regarding our operating results. For example, certain of our products, including our APTIMA Trichomonas vaginalis, APTIMA HPV and PROGENSA PCA3 assays, have a relatively limited sales history, which limits our ability to accurately project future sales, prices and related sales cycles. In addition, we base our internal projections of blood screening product sales and international sales of various diagnostic products on projections prepared by our distributors of these products and therefore we are dependent upon the accuracy of those projections. We expect continuing fluctuations in our manufacture and shipment of blood screening products and instruments to Novartis, which vary each period based on Novartis’ inventory levels and supply chain needs. In addition, our respiratory infectious disease product line is subject to significant seasonal and year-over-year fluctuations. Furthermore, failure to achieve our operational goals may inhibit our targeted growth plans and the successful implementation of our strategic objectives. Because of all of these factors, our operating results in one or more future quarters may fail to meet or exceed financial guidance we may provide from time to time and the expectations of securities analysts or investors, which could cause our stock price to decline. In addition, the trading market for our common stock will be influenced by the research and reports that industry or securities analysts publish about our business and that of our competitors.

Our financial performance may be adversely affected by current global economic conditions.

Our business depends on the overall demand for our products and on the economic health of our current and prospective customers. Our projected revenues and operating results are based on assumptions concerning certain levels of customer demand. Although these effects are difficult to quantify, we believe that relative to our expectations we have experienced modest declines in product sales growth rates in recent periods, due in part to current macroeconomic conditions and pressures on health care utilization. A continued weakening of the domestic or global economies or a reduction in customer spending or credit availability, including as a result of actual or potential debt default by certain European countries, could result in decreased health care utilization, downward pricing pressures, the reduction or elimination of third-party payor coverage and/or reimbursement levels for our products, longer sales cycles and delayed or decreased purchases of our products. Furthermore, during challenging economic times our customers may face issues gaining timely access to sufficient credit, which could result in an impairment of their ability to make timely payments to us. If that were to occur, we may be required to increase our allowance for doubtful accounts. If economic and market conditions in the United States, Europe or other key markets persist, spread, or deteriorate, we may experience adverse effects on our business, operating results and financial condition.

We are dependent on Novartis and other third parties for the distribution of some of our products. If any of our distributors terminates its relationship with us or fails to adequately perform, our product sales will suffer.

We rely on Novartis to distribute blood screening products we manufacture. Commercial blood screening product sales to Novartis accounted for 34% of our total product sales for the first three months of 2012 and 35% of our total product sales for 2011. In January 2009, we extended the term of our blood screening collaboration with Novartis to June 30, 2025, subject to earlier termination under certain limited circumstances specified in the collaboration agreement. In addition, we supply our transcription mediated amplification, or TMA, assay for the qualitative detection of HCV and analyte specific reagents, or ASRs, for the quantitative detection of HCV to Siemens Healthcare Diagnostics, Inc., or Siemens, pursuant to a collaboration agreement. We also rely on distributors for the distribution of certain of our products in various territories throughout the world. Distribution rights generally revert back to us upon termination of the distribution agreements.

If any of our distribution or marketing agreements is terminated, particularly our collaboration agreement with Novartis, or if we elect to distribute new products directly, we will have to invest in additional sales and marketing resources, including additional field sales personnel, which would significantly increase future selling, general and administrative expenses. We may not be able to enter into new distribution or marketing agreements on satisfactory terms, or at all. If we fail to enter into acceptable distribution or marketing agreements or fail to successfully market our products, our product sales will decrease. We may also be exposed to risks as a result of transitioning a territory from a distributor sales model to a direct sales model, such as difficulties maintaining relationships with specific customers, hiring appropriately trained personnel or ensuring compliance with local product

34


registration requirements, any of which could result in lower revenues than we previously received from our distributor in that territory.

If we cannot maintain our current corporate collaborations and enter into new corporate collaborations, our product development could be delayed. In particular, any failure by us to maintain our blood screening collaboration with Novartis would have a material adverse effect on our business.

We rely, to a significant extent, on our corporate collaborators for funding the development of and marketing for certain of our products. In addition, we expect to rely on our corporate collaborators for the commercialization of certain products. If any of our corporate collaborators were to breach or terminate its agreement with us or otherwise fail to conduct its collaborative activities successfully and in a timely manner, the development or commercialization and subsequent marketing of the products contemplated by the collaboration could be delayed or terminated. We cannot control the amount and timing of resources our corporate collaborators devote to our programs or potential products.

In June 2010, for example, we entered into a collaboration agreement with Pacific Biosciences regarding the research and development of instruments integrating our sample preparation technologies and Pacific Biosciences’ single-molecule deoxyribonucleic acid, or DNA, sequencing technologies for use in clinical diagnostics. Subject to customary termination rights, the initial term of the collaboration will end on the earlier of December 15, 2012 or six months after Pacific Biosciences demonstrates the proof of concept of its “V2” single-molecule DNA sequencing system.

The continuation of any of our collaboration agreements depends on their periodic renewal by us and our collaborators. For example, in January 2009 we extended the term of our blood screening collaboration with Novartis to June 30, 2025, subject to earlier termination under certain limited circumstances specified in the collaboration agreement. The collaboration was previously scheduled to expire by its terms in 2013.

If any of our current collaboration agreements is terminated, or if we are unable to renew those collaborations on acceptable terms, we would be required to devote additional internal resources to product development or marketing or to terminate some development programs or seek alternative corporate collaborations. We may not be able to negotiate additional corporate collaborations on acceptable terms, if at all, and these collaborations may not be successful. In addition, in the event of a dispute under our current or any future collaboration agreements, such as our agreements with Novartis, Siemens or Pacific Biosciences, a court or arbitrator may not rule in our favor and our rights or obligations under an agreement subject to a dispute may be adversely affected, which may have an ad