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 September 30, 2002 or
[ ] 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 000-0030755
Cepheid
(Exact name of registrant as specified in its charter)
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904 Caribbean Drive
Sunnyvale, California 94089-1189
(408) 541-4191
Check whether the issuer (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file reports), and (2) has been subject to such filing requirements for the past 90 days. YES [X] NO [ ].
As of November 12, 2002, there were 30,830,771 shares of Common Stock outstanding.
Cepheid
Report on Form 10-Q for the
Quarter Ended September 30, 2002
INDEX
| PART I. Financial Information | Page No. |
| Item 1. Financial Statements (unaudited): |
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Consolidated Condensed Balance Sheets as of September 30, 2002 and December 31, 2001 |
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Consolidated Condensed Statements of Operations for the three and nine month periods ended September 30, 2002 and 2001 |
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Consolidated Condensed Statements of Cash Flows for the nine month periods ended September 30, 2002 and 2001 |
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| Notes to Condensed Consolidated Financial Statements |
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| Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations |
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| Item 3. Quantitative and Qualitative Disclosures About Market Risk |
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| Item 4. Controls and Procedures |
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| PART II. Other Information |
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| Item 1. Legal Proceedings |
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| Item 2: Changes in Securities and Use of Proceeds |
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| Item 3: Defaults Upon Senior Securities |
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| Item 4: Submission of Matters to a Vote of Security Holders |
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| Item 5: Other Information |
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| Item 6. Exhibits and Reports on Form 8-K |
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| Signatures |
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PART I -- FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS (UNAUDITED)
CEPHEID
CONDENSED CONSOLIDATED BALANCE SHEETS
(amounts in thousands)
September 30, December 31,
2002 2001 (1)
-------------- -------------
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents ........................ $ 20,290 $ 15,905
Short term investments ........................... -- 8,775
Restricted cash .................................. 661 661
Accounts receivable .............................. 2,901 2,020
Inventory ........................................ 3,571 3,568
Prepaid expenses and other current assets ........ 508 338
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Total current assets ........................... 27,931 31,267
Property and equipment, net ......................... 5,271 3,175
Other assets ........................................ -- 50
-------------- -------------
Total assets ................................... $ 33,202 $ 34,492
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LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable ................................. $ 2,029 $ 587
Accrued compensation ............................. 1,935 778
Other accrued liabilities ........................ 1,923 1,399
Current portion of equipment financing ........... 1,480 1,029
Current portion of deferred rent ................. 152 32
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Total current liabilities ...................... 7,519 3,825
Equipment financing, less current portion ........... 1,939 1,167
Deferred rent, less current portion ................. 105 22
Commitments
Shareholders' equity:
Common stock ..................................... 75,406 65,459
Additional paid-in capital ....................... 7,567 7,694
Deferred stock-based compensation ................ (236) (833)
Accumulated other comprehensive income ( loss) ... 3 (7)
Accumulated deficit .............................. (59,101) (42,835)
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Total shareholders' equity ..................... 23,639 29,478
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Total liabilities and shareholders' equity ..... $ 33,202 $ 34,492
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(1) The balance sheet at December 31, 2001 has been derived from the audited financial statements at the date which are included in the Company's Form 10-K filed with the Securities and Exchange Commission.
See accompanying notes to Condensed
Consolidated Financial Statements
CEPHEID
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
(in thousands, except per share amounts)
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------- --------------------
2002 2001 2002 2001
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Revenues:
Instrument sales ................................ $ 3,315 $ 1,887 $ 7,814 $ 5,523
Reagents and disposables sales .................. 450 89 949 296
License and royalty revenue ..................... 71 -- 200 --
Contract revenue ................................ 593 815 1,038 2,362
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Total revenues .................................. 4,429 2,791 10,001 8,181
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Operating costs and expenses:
Cost of product sales ........................... 2,928 1,394 6,672 4,637
Research and development......................... 4,546 3,783 13,110 11,091
Selling, general, and administrative.............
Recurring expenses............................... 2,233 1,869 6,073 4,866
Severance expenses............................... 238 -- 238 --
Total............................................ 2,471 1,869 6,311 4,866
Restructuring expenses............................. 262 -- 262 --
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Total operating costs
and expenses ................................... 10,207 7,046 26,355 20,594
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Loss from operations ............................ (5,778) (4,255) (16,354) (12,413)
Interest income, net ............................ 17 229 88 1,094
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Net loss ........................................ (5,761) (4,026) (16,266) (11,319)
Net loss per share, basic and diluted............ $ (0.20) $ (0.15) (0.59) (0.44)
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Shares used in computing net loss per share,
basic and diluted .............................. 29,302 26,054 27,342 25,861
========= ========= ========= =========
See accompanying notes to Condensed Consolidated Financial
Statements.
CEPHEID
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
Nine Months Ended
September 30,
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2002 2001
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OPERATING ACTIVITIES:
Net loss ................................................ $ (16,266) $ (11,319)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization ....................... 1,561 960
Amortization of deferred stock-based compensation ... 469 1,748
Amortization of deferred rent ....................... 202 (17)
Changes in operating assets and liabilities:
Accounts receivable .............................. (880) 665
Inventory ........................................ (3) (2,237)
Prepaid expenses and other assets ................ (120) 253
Accounts payable and other current liabilities ... 1,976 558
Accrued compensation ............................. 1,157 398
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Net cash used in operating activities ................... (11,904) (8,991)
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INVESTING ACTIVITY:
Capital expenditures .................................... (3,656) (1,275)
Proceeds from maturities of marketable securities ....... 8,775 --
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Net cash provided by (used in) investing activities ..... 5,119 (1,275)
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FINANCING ACTIVITIES:
Net proceeds from the sale of common shares ............. 9,947 256
Proceeds from notes receivable from shareholder ........... -- 35
Proceeds from loan arrangements ......................... 2,094 748
Principal payments under loan arrangements .............. (871) (756)
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Net cash provided by financing activities .............. 11,170 283
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Net (decrease) in cash and cash equivalents ............. 4,385 (9,983)
Cash and cash equivalents at beginning of period ........ 15,905 39,698
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Cash and cash equivalents at end of period .............. $ 20,290 $ 29,715
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See accompanying notes to Condensed Consolidated Financial Stateme
CEPHEID
Notes to Condensed Consolidated Financial Statements
(unaudited)
1. ORGANIZATION, BUSINESS AND BASIS OF PRESENTATION
Organization and Business
Cepheid (the "Company") was incorporated in the State of California on March 4, 1996. The Company is commercializing its I-CORE® microfluidic and microelectronic technologies as the preferred platform for rapid, on-site detection of DNA (or RNA) in complex biological samples for scientific, medical and industrial applications. The Company is developing fast, versatile systems that can perform all the steps required to analyze DNA in complex biological samples - sample preparation, amplification and detection - with results in less than 30 minutes on a single instrument.
The accompanying unaudited condensed consolidated financial statements have been prepared by management in accordance with generally accepted accounting principles in the United States ("GAAP") for interim financial information and with the instructions for Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include certain information and footnotes normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States. In the opinion of management, all adjustments (consisting only of normal recurring entries) considered necessary for a fair presentation have been included. Operating results for the three and nine month periods ended September 30, 2002 are not necessarily indicative of the results that may be expected for the year ending December 31, 2002 or for any other future period. The accompanying financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in the Company's Form 10-K for the year ended December 31, 2001 filed with the Securities and Exchange Commission.
2. SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
The condensed consolidated financial statements of the Company include the accounts of Cepheid and its wholly-owned subsidiary. All significant intercompany balances and transactions have been eliminated.
Use of Estimates
The preparation of condensed consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the condensed consolidated financial statements and accompanying notes. Actual results could differ from these estimates.
Revenue Recognition
The Company recognizes revenue from product sales when goods are shipped, there is persuasive evidence that an arrangement exists, delivery has occurred, the price is fixed and determinable and collectibility is reasonably assured. No rights of return exist for the Company's products except in the case of damaged goods.
Contract revenues related to research and development agreements and government grants are recognized as the related services are performed based on the performance requirements of the relevant contract. Non- refundable contract fees for which no further performance obligations exist, with no continuing involvement required on the part of the Company, are recognized on the earlier of the date the payments are received or when collection is assured. Under research and development agreements, the Company is required to perform specific research and development activities and is reimbursed based on the costs associated with each specific contract over the term of the agreement. Milestone related revenues are recognized upon the achievement of the specified milestone when the related milestone was at risk at the inception of the arrangement and milestone related obligations are fulfilled. Deferred revenue is recorded when funds are received in advance of services to be performed.
Warranty Accrual
The Company warrants its products from defect for a period of 12 months from the date of sale for material and labor costs to repair the product. Accordingly, a provision for the estimated cost of the warranty is recorded at the time revenue is recognized.
Inventory
Inventory is stated at the lower of standard cost (which approximates actual cost) or market, with cost determined on the first-in-first- out ("FIFO") method.
The Company maintains a reserve for inventory obsolescence. This reserve is established utilizing management's estimate of the potential future obsolescence of inventory.
Comprehensive (Income) Loss
Comprehensive loss includes net loss as well as other comprehensive loss. Other comprehensive loss consists of unrealized losses on available-for-sale marketable securities. Total accumulated other comprehensive income is presented as a separate component of shareholders' equity in the accompanying Condensed Consolidated Balance Sheets. Comprehensive loss for the quarters ended September 30, 2002 and 2001 totaled $5,761,000 and $4,026,000, respectively, and for the nine month periods ended September 30, 2002 and 2001, totaled $16,266,000 and $11,319,000, respectively.
3. SIGNIFICANT CONCENTRATIONS
The Company distributes its products through its direct sales force and through third-party distributors. For the three and nine month periods ended September 30, 2002, product sales through distributors represented 43% and 56%, respectively, of total product sales (consisting of sales of instruments, reagents and disposables). The Company's distributors in the United States, the Far East and Europe accounted for 29%, 11%, and 3%, respectively, of total product sales for the quarter ended September 30, 2002, and 38%, 15%, and 3%, respectively, of total product sales for the nine months ended September 30, 2002. For the same quarter of the previous year, distributors in the United States, the Far East, and Europe accounted for 45%, 1% and 0.6%, respectively of total product sales, and for the same nine month period of the previous year, accounted for 42%, 21% and 15% of total product sales, respectively. There were no direct customers that represented greater than 10% of total product sales for either the three or nine months ended September 30, 2002 or the corresponding periods of the prior year.
The Company relies on several companies as its sole source for various materials used in its manufacturing process. Any extended interruption in the supply of these materials could result in the failure to meet customer demand.
Financial instruments that potentially subject the Company to concentrations of credit risk primarily consist of cash equivalent debt securities.
4. NET LOSS PER COMMON SHARE
Basic net loss per common share has been calculated based on the weighted-average number of common shares outstanding during the period, less shares subject to the Company's right of repurchase. Common stock equivalents consisting of stock options and warrants (calculated using the treasury stock method) have been excluded from the computation of diluted net loss per share as their inclusion would be antidilutive.
The following table presents the calculation of basic and diluted net loss per share (in thousands, except per share data):
Three Months Ended Nine Months Ended
September 30, September 30,
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2002 2001 2002 2001
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(unaudited) (unaudited)
Net loss ............................................... $ (5,761) $ (4,026) $ (16,266) $ (11,319)
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Basic and diluted:
Weighted-average shares of common stock outstanding ..... 29,419 26,458 27,582 26,426
Less: weighted-average shares subject to repurchase ..... (117) (404) (240) (565)
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Shares used in computing basic and diluted net
loss per share ....................................... 29,302 26,054 27,342 25,861
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Basic and diluted net loss per share ................... $ (0.20) $ (0.15) $ (0.59) $ (0.44)
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5. INVENTORY
The components of inventories (in thousands) are as follows:
September 30, December 31,
2002 2001
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(unaudited)
Raw materials ................................. $ 2,171 $ 1,877
Work in process ............................... 1,268 1,387
Finished goods ................................ 132 304
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$ 3,571 $ 3,568
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6. COMMON STOCK OFFERING
On August 1, 2002, the Company completed the sale of 4,000,000 shares of common stock at price of $2.65 per share. The shares were sold pursuant to an existing shelf registration statement. The offering resulted in net proceeds to us of approximately $9.5 million, net of issuance costs of approximately $1.1 million.
7. RESTRUCTURING EXPENSES
In September 2002, the Company announced and implemented a restructuring plan. The restructuring plan resulted in the elimination of approximately 15% of the Company's workforce in primarily the research and development functions. As a result of this plan, the Company recorded a restructuring charge of $262,000. The charge consisted primarily of severance costs for affected employees, professional fees, and the write-off of impaired assets. The purpose of the restructuring plan was to realign our workforce to reflect our shift in emphasis from research and development to manufacturing and marketing of genetic- based instrument and reagent systems. The following table summarizes the Company's restructuring charge activity for the three months ended September 30, 2002 (in thousands):
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Restructuring Expense |
Cash Payments |
Write-Off of Impaired Assets |
Balance at September 30, 2002 |
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Severance and Benefits |
$ 210 |
($66) |
- |
$144 |
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Professional and Other Fees |
25 |
- |
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25 |
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Write-Off of Impaired Assets |
27 |
(27) |
- |
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Total |
$ 262 |
($66) |
($ 27) |
$169 |
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Certain statements in this Form 10-Q, including without limitation the information under the captions entitled "Management's Discussion and Analysis of Financial Condition and Results of Operations" contain or refer to forward-looking statements within the meaning of the federal securities laws. We also may provide oral or written forward-looking statements in other materials we release to the public from time to time. Statements that are not statements of historical fact are forward-looking statements. They are based on current expectations. In some cases, you can identify forward-looking statements by terminology such as "may," "will," "should," "expect," "anticipate," "believe," "estimate," "predict," "intend," "potential" or "continue" or the negative of these terms or other comparable terminology. Forward-looking statements involve risks and uncertainties that could cause actual results and the timing of events to differ materially from those anticipated in our forward- looking statements. These risks and uncertainties include the impact of the factors set forth under "Factors That Might Affect Future Results." We assume no obligation to update any of the forward-looking statements after the date of this report or to conform these forward-looking statements to actual results.
OVERVIEW
We develop, manufacture, and market fully integrated systems that enable sophisticated genetic and DNA analysis of patients and organisms by automating complex manual laboratory procedures. Based on state- of-the-art microfluidic and microelectronic technologies, our easy-to-use systems analyze complex biological samples in disposable cartridges designed to rapidly and automatically perform all of the steps associated with sophisticated molecular biological procedures. We are focusing our efforts on those applications where rapid genetic and DNA testing is particularly important, such as the infectious disease, biothreat and cancer testing markets. In particular, we have designed our systems to be capable of use in genetic management of disease, performing a broad range of genetic tests that include identifying infectious organisms, evaluating at-risk populations for the early detection of disease such as cancer, determining the stage of the disease and assessing what might be the most effective therapy. We have also designed our systems to rapidly detect food, air and water contaminants through genetic identification of disease causing agents.
We commenced commercial sales of our first product, the Smart Cycler, in May 2000. The Smart Cycler is a DNA amplification and detection system initially directed at the life sciences research market. Prior to the second quarter of 2001, we marketed our Smart Cycler primarily through distributors. During the second and third quarters of 2001, we established a small direct sales force that focused initially on the food quality and biothreat testing markets, and other markets outside of life science research. We have been expanding the size of this direct sales force in the United States and have begun to sell directly into the life science research market with the termination of the exclusivity of our distributor agreement in the United States. We expect to release the second version of our Smart Cycler product, Smart Cycler II in the fourth quarter of 2002.
Our GeneXpert system, currently in the final stages of development, integrates automated sample preparation with our Smart Cycler amplification and detection technology. We expect to launch the GeneXpert system in unregulated markets in the second or third quarter of 2003. Following clinical trials and FDA approval, we anticipate commercial launch of the GeneXpert system to the clinical market in late 2004.
We are collaborating with strategic partners to develop assays across a broad range of markets for both the Smart Cycler and GeneXpert. In February 2000, we formed Aridia Corp. ("Aridia"), a joint venture with Infectio Diagnostic, Inc ("IDI"). The focus of that collaboration is to develop a line of proprietary molecular diagnostic tests for the rapid, time critical identification of bacterial and fungal infections such as Group B Streptococcus, antibiotic resistant bacteria, meningitis, and sepsis. In July 2001, we entered into a cooperative research and development agreement with the University of Pittsburgh Medical Center under which we are collaborating to identify and evaluate new genetic markers for several cancers including lung, breast, esophagus, oral, head and neck cancer, and melanoma. In August 2001, we entered into a patent and technology licensing and supply agreement with Smiths Detection, formerly Environmental Technologies Group, Inc., ("Smiths"). Under this agreement, we are collaborating to develop biothreat detection systems for military and other domestic preparedness applications. In November 2001, we entered into a patent sublicense agreement with Smith and granted them the worldwide non-exclusive rights to key patents for the development of rapid, handheld DNA analysis systems for bioagent detection. Under the agreement, we receive royalties on any Smiths system sales and retain rights to commercialize the handheld system for other DNA-testing applications, including environmental testing and veterinary diagnostics. In May 2002, we announced that we were part of a Northrop-Grumman-led team selected by the U.S. Postal Service ("USPS") for a pilot program to evaluate the use of the team's integrated DNA-based biothreat detection system ("BDS") in mail sorting facilities. In October 2002, we entered into a collaborative agreement with the Applied Biosytems Group of Applera Corporation ("ABI") to develop reagents designed to detect biothreat agents for us with our GeneXpert system and cartridges in the USPS BDS environment if the USPS implements a biothreat detection program incorporating our technology. The agreement calls for ABI and us to share profits realized on the sale of these reagents.
CRITICAL ACCOUNTING POLICIES AND MANAGEMENT JUDGMENTS
We consider certain accounting policies related to revenue recognition, the inventory reserve, and warranty accrual to be critical policies. Inherent in our determination of when to recognize revenue, and in our calculation of our inventory reserve and warranty accrual are certain estimates, assumptions and judgments. These estimates, assumptions, and judgments include deciding whether the elements required to recognize revenue from a particular arrangement are present and estimating the amount of inventory obsolescence and warranty costs associated with shipped products.
Revenue Recognition. We recognize revenue from product sales when goods are shipped, when there is a persuasive evidence that an arrangement exists, delivery has occurred, the price is fixed and determinable and collectibility is reasonably assured. No rights of return exists for our products with the exception of damaged goods. Contract revenues related to research and development agreements and government grants are recognized as the related services are performed based on the performance requirements of the relevant contract. Non-refundable contract fees for which no further performance obligations exist, with no continuing involvement required by us are recognized on the earlier of the date the payments are received or when collection is assured. Under research and development agreements, we are required to perform specific research and development activities and are reimbursed based on the costs associated with each specific contract over the term of the agreement. Milestone related revenues are recognized upon the achievement of the specified milestone when the related milestone was at risk at the inception of the arrangement and milestone related obligations are fulfilled. Deferred revenue is recorded when funds are received in advance of services to be performed. Determining whether the elements required for us to recognize revenue are present (including, for example, determining whether there is sufficient evidence that an arrangement existing, the collectibility of billings and whether contractual performance obligations and milestones have been met) requires us to make estimates, assumptions and judgments that affect our operating results.
Inventory Reserve and Warranty Accrual. We maintain reserves for inventory obsolescence and warranty costs that we believe are reasonable and that are based on our historical experience and current expectations for future performance of operations. The inventory reserve is established utilizing management's estimate of the potential future obsolescence of inventory. A substantial decrease in demand for our product could lead to excess inventories and could require us to increase our reserve for inventory obsolescence.
Our warranty accrual is established utilizing management's estimate for the future costs of providing customers with a calibration as well as the cost of repairing any instrument failures during the one-year warranty period. A significant change in failure rates of our Smart Cycler system could lead to increased warranty costs and could require us to increase our warranty reserve. If such adverse conditions were to occur, we cannot readily predict what effect on our financial condition or results of operations would result, as any such effect would depend on both future results of operations and the magnitude and timing of the adverse conditions.
RESULTS OF OPERATIONS
THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2002 COMPARED TO THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2001
REVENUES
We derive our revenue principally from sales of our Smart Cycler system and associated disposable reaction tubes and, to a lesser extent, from contractual payments for services rendered in research and development arrangements. Total revenues for the three and nine month periods ended September 30, 2002 were $4.4 million and $10.0 million respectively, an increase over the corresponding prior year periods of $1.6 million or 59%, and $1.8 million or 22%, respectively. The increase in total revenues for the three and nine month periods ended September 30, 2002 as compared to the corresponding prior year periods, was due to an overall increase in product sales offset by a decline in contract revenues. Product sales for the three and nine months ended September 30, 2002 were $3.8 million and $8.8 million respectively, an increase over the prior year periods of $1.8 million or 91% and $2.9 million or 51%, respectively. The increase in product sales for the three and nine month periods ended September 30, 2002, as compared to the corresponding prior year periods, was due to a 76% and 42% increase respectively, in instrument sales, particularly of the Smart Cycler system, initial prototype sales of our GeneXpert system and an increase of more than 400% and 200% respectively, in reagent and disposable sales, particularly our disposable Smart Cycler reaction tubes. The increase resulted from the growth of sales through our international distribution network and direct sales force in the United States, and growing market acceptance of the Smart Cycler system. For the three and nine month periods ended September 30, 2002 product sales through distributors represented 43% and 56%, respectively, of total product sales (including instruments, reagents, and disposables). There were no direct customers that represented greater than 10% of product sales for either the three or nine months ended September 30, 2002, or for the corresponding periods of the prior year.
Contract revenues for the three and nine month period ended September 30, 2002 were $0.6 million and $1.0 million respectively, a decrease from the corresponding prior year periods of $0.2 million or 27% and $1.3 million or 56%, respectively. The decrease was primarily driven both by a decline in the number of active contracts being worked on during the three and nine month periods ended September 30, 2002 as compared to the corresponding prior year periods. We expect contract revenues to continue to decrease slightly in absolute dollars through the next fiscal year as we continue to increase our product marketing efforts and shift our business away from research and development.
COST OF PRODUCT SALES
Cost of product sales consists of raw materials, direct labor, manufacturing overhead, facility and warranty costs. Cost of product sales for the three and nine month periods ended September 30, 2002 was $2.9 million and $6.7 million respectively, an increase over the corresponding prior year periods of $1.5 million or 110%, and $2.0 million or 44%, respectively. The increase in absolute dollars of cost of product sales for both the three and nine months ended September 30, 2002 as compared to the corresponding prior year periods, was primarily due to the increase in product sales and warranty costs. The product gross margin percentage for the three and nine month periods ended September 30, 2002 was 22% and 24%, respectively, as compared to 29% and 20% for the corresponding prior year periods. The decline in product gross margin percentage for the three month period ended September 30, 2002, as compared to the corresponding prior year period, was primarily due to increased warranty costs offset by improved manufacturing economies of scale. In the three month period ended September 30, 2002, we incurred approximately $350,000 in warranty costs to enhance the reliability of the Smart Cycler system which contributed to the lower product gross margin percentage for the quarter. The increase in the product gross margin percentage for the nine-month period ended September 30, 2002, as compared to the corresponding prior year period was primarily due to improved manufacturing economies of scale offset by increased warranty costs.
RESEARCH AND DEVELOPMENT EXPENSES
Research and development expenses consist of salaries, deferred stock compensation, research and development materials and facility costs, and legal expenses for intellectual property protection and regulatory matters. Research and development expenses for the three and nine month periods ended September 30, 2002 were $4.5 million and $13.1 million, respectively, an increase over the corresponding prior year periods of $0.7 million or 20% and $2.0 million or 18%, respectively. The increase for the three month period ended September 30, 2002, as compared to the corresponding prior year period, was due to a $0.4 million increase in wages and other personnel related expenses based on increased headcount, a $0.4 million increase in facilities costs for our new company headquarters, and a $0.2 million increase in research and development materials primarily relating to the USPS pilot program, partially offset by a $0.3 million decrease in non-cash deferred stock compensation. The increase for the nine month period ended September 30, 2002 as compared to the corresponding prior year period was due to a $1.5 million increase in wages and other personnel related expenses based on increased headcount, a $1.1 million increase in facilities costs for our new company headquarters and a a $0.3 million increase in research and development supplies primarily relating to the USPS pilot program, offset by a $0.9 million decrease in non-cash deferred stock compensation. The overall increase in research and development expenses increased for the three and nine months ended September 30, 2002 as compared to the corresponding prior year periods was primarily related to our to our efforts to complete the development of the GeneXpert system. We expect that our research and development expenses will decline in the fourth quarter of 2002 due to our reduction in force in September 2002, and will increase slightly in future quarters of 2003 from the fourth quarter of 2002 as we realign or add where necessary to our existing resources to further our product development efforts, particularly with respect to developing additional assays for the Smart Cycler and GeneXpert systems.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses consist of salaries, deferred stock compensation, severance costs, accounting and other professional fees, facilities costs, and human resource expenses. Selling, general and administrative expenses for the three and nine month periods ended September 30, 2002 were $2.5 million and $6.3 million, respectively, an increase over the corresponding prior year periods of $0.6 million or 32% and $1.4 million or 30%, respectively. The increase for the three months ended September 30, 2002, as compared to the corresponding prior year period was due to a $0.3 million increase in salaries and personnel related expenses based primarily on increased sales and marketing and executive headcount, $0.2 million in severance costs, and a $0.1 million increase in sales commissions due to increased product sales. The increase for the nine month period ended September 30, 2002, as compared to the corresponding prior year period, was due to a $1.1 million increase in salaries and other personnel related expenses based primarily on increased sales and marketing and executive headcount, $0.2 million in severance costs, a $0.2 million increase in sales commissions based on increased product sales, and a $0.3 million increase in advertising and promotional costs partially offset by a $0.4 million decrease in non-cash deferred stock compensation. We expect that our selling general and administrative expenses will decline slightly in the fourth quarter of 2002 due to our reduction in force in September 2002, and will increase moderately in future quarters of 2003 from the fourth quarter of 2002 as we realign our existing resources or add where necessary in order to continue to execute our business strategy, particularly with respect to our efforts to increase European sales.
RESTRUCTURING EXPENSES
We incurred restructuring expenses of $262,000 related to the restructuring plan that we completed during the three months ended September 30, 2002. The restructuring charge was primarily composed of severance costs for affected employees, professional fees and the write-off of impaired assets. In connection with the plan, headcount was reduced by approximately 15%. The purpose of the restructuring plan was to realign our workforce to reflect our shift in emphasis from research and development to manufacturing and marketing of genetic-based instrument and reagent systems. As a result of the restructuring plan, we expect that we will realize a near-term reduction in our annual operating expenses of approximately $3.5 million. However, we will be redeploying a portion of those savings in 2003 as we expand our commercialization activities.
INTEREST INCOME, NET
Interest income, net for the three and nine month periods ended September 30, 2002 was $17,000 and $88,000, respectively, a decrease from the corresponding prior year periods of $0.2 million or 93% and $1.0 million or 92%, respectively. The decrease for both the three and nine months ended September 30, 2002, as compared to the prior year corresponding periods was due to a decrease in cash balance as well as decreased investment yield due to lower interest rates.
LIQUIDITY AND CAPITAL RESOURCES
As of September 30, 2002, we had $20.9 million in cash, cash equivalents, short term investments, and restricted cash as compared to $25.3 million as of December 31, 2001. Net cash used for operating activities was $11.9 million for the nine months ended September 30, 2002, and $9.0 million for the nine months ended September 30, 2001. The increase in net cash used in operating activities for the nine months ended September 30, 2002 as compared to the corresponding prior year period was composed of a $4.9 million increase in net loss and a $1.3 million decrease in non-cash deferred stock compensation, offset by a $0.6 million increase in depreciation expense and a $2.7 million decrease in investment in working capital.
Through September 30, 2002, we had received net proceeds of $75.4 million from sales of common and convertible preferred stock including net proceeds of $9.5 million from the sale of 4,000,000 shares of common stock under a shelf registration statement, net of issuance costs of $1.1 million. In addition through September 30, 2002, we had financed equipment purchases and leasehold improvements totaling approximately $6.2 million. As of September 30, 2002, we had $3.4 million in equipment financing obligations. These obligations are secured by the financed equipment, bear interest at a weighted average fixed rate of 10.02% and are due in monthly installments through September 2005. Under the terms of our current equipment financing agreement, a balloon payment is due at the end of each individual lease term for an item of equipment. In June 2002, our existing equipment line of credit was amended to allow us to borrow an additional $4.0 million of which we drew down $1.4 million in the second quarter of 2002 and $0.7 million in the third quarter of 2002. In connection with this amendment, we entered into a negative covenant pledge agreement pursuant to which we were required to complete a cumulative $20.0 million equity financing by September 30, 2002 or all funding under the equipment line of credit would cease and we would be required to provide a cash deposit or irrevocable letter of credit equivalent to 100% of all soft costs financed. We did not complete the required level of cumulative equity financing prior to September 30, 2002, and as a result we provided a letter of credit in the amount of $1.1 million to the creditor in October 2002 and will not be able to draw down additional funding.
Net cash provided by investing activities for the nine months ended September 30, 2002 consisted of proceeds from maturities of marketable securities of $8.8 million offset by capital expenditures for property and equipment of $3.7 million. Net cash used in investing activities for the nine months ended September 30, 2001 consisted of capital expenditures for property and equipment of $1.3 million. The increase in capital expenditures for the nine months ended September 30, 2002, as compared to the corresponding prior year period, was primarily the result of leasehold improvements and furniture for our new leased facility.
Net cash provided by financing activities consisted primarily of proceeds from sales of common stock and proceeds from loan arrangements partially offset by principal payments under the loan arrangements. For the nine months ended September 30, 2002, we received proceeds from sales of common stock for $10.0 million, composed of net proceeds of $9.5 million, from the August 2002 stock offering and $0.5 million related to common stock purchased under our employee stock purchase plan and through stock option exercises and $2.1 million of proceeds from equipment financing arrangements, partially offset by repayments under equipment financing arrangements of $0.9 million. For the nine months ended September 30, 2001, we received proceeds from the sale of common shares of $0.3 million and proceeds from equipment financing arrangements of $0.7 million, offset by repayments under equipment financing arrangements of $0.7 million.
We expect to have negative cash flow from operations through at least the end of 2003. Our future capital requirements depend on a number of factors, including market acceptance of our products, the resources we devote to developing and supporting our products, continued progress of our research and development of potential products, the need to acquire licenses to new technology or to use our technology in new markets, and the availability of other financing.
Consistent with prior periods of fiscal 2002, we expect our cash use to average approximately $1.5 million per month for the remainder of 2002. For the nine months ended September 30, 2002, total cash used was $4.4 million or $13.9 million net of the $9.5 million in net proceeds received from the August stock offering. Although we anticipate that our existing capital resources will enable us to maintain currently planned operations through at least September 2003, this expectation is based on our current operating plan and may change as a result of many factors, including market acceptance of our products and future opportunities with collaborators. Consequently, we may need additional funding sooner than anticipated. We currently have no credit facility or committed sources of capital. To the extent operating and capital are insufficient to meet future requirements, we will have to raise additional funds. These funds my not be available on favorable terms, if at all. If adequate funds are not available on attractive terms, we may be required to curtail operations significantly or to obtain funds by entering into financing, supply or collaboration agreements on unattractive terms.
To the extent our capital resources are insufficient to meet future capital requirements, we will need to raise additional capital or incur indebtedness to fund our operations. In December 2001, we filed a shelf registration statement for the issuance of up to $35 million in debt and/or equity securities. As of September 24, 2002, we had approximately $24.4 million still available under this registration statement. There can be no assurance that additional debt or equity financing will be available on acceptable terms, if at all. If adequate funds are not available, we may be required to delay, reduce the scope of, or eliminate our research and development programs, reduce our commercialization efforts or obtain funds through arrangements with collaborative partners or others that may require us to relinquish rights to technologies or products that we might otherwise seek to develop or commercialize. Although we have no current plans, agreements or commitments providing for any acquisition, we may, if the opportunity arises, use net proceeds from an offering of equity or debt securities to acquire or invest in products, technologies or companies. Please see our annual report on Form 10-K for the fiscal year ended December 31, 2001, filed on March 21, 2002, for information regarding our material contractual obligations and commitments.
FACTORS THAT MIGHT AFFECT FUTURE RESULTS
If we cannot successfully commercialize our GeneXpert system, we may never achieve profitability.
Our GeneXpert system is still in the development stage. We anticipate that for the foreseeable future our ability to achieve profitability will be dependent on the successful commercialization of GeneXpert. Many factors may affect the market acceptance and commercial success of our GeneXpert system, including:
We have not established the accuracy, reliability or ease of operation of the GeneXpert system in commercial use. If the GeneXpert system does not gain market acceptance, we will be unable to generate significant sales, which will prevent us from achieving profitability. If the GeneXpert system is not accepted in the marketplace, this could have a negative effect on our ability to sell subsequent systems.
Our participation in the U.S. Postal Service bio-threat detection program evaluation and other similar programs may not result in contracts or revenues.
We are part of a Northrop Grumman-led team being evaluated by the USPS to produce a DNA-based BDS for installation in USPS mail sorting facilities. We cannot state with certainty when this evaluation process will conclude, whether our team will be awarded a production contract, whether such a contract would be concluded on terms acceptable to all parties, or whether actual funding, deployment and operating parameters, or product purchases, will meet expected levels. The USPS BDS program, like many governmental contracting programs, involves significant uncertainties in the timing of decision-making and deployment and is highly sensitive to changes in national and international priorities and budgets. In addition, if components developed by us or our collaborators in the program fail to meet specifications, the entire proposal team could be rejected. In this and any similar future pilot programs, there may be no obligation on the part of the eventual customer to buy a minimum number of units, so, even if we are awarded a production contract, we may be subject to our customer's future spending patterns and budgetary cycles. Accordingly, our participation in the USPS BDS program and other similar programs are subject to a number of risks and uncertainties and may never yield significant revenues.
We may not achieve or maintain profitability and may be unable to continue our operations.
We have experienced significant operating losses each year since our inception and expect to have negative cash flow from operations through at least the end of 2003. We experienced net losses of approximately $3.3 million in 1998, $7.9 million in 1999, $14.8 million in 2000, $15.5 million in 2001 and $16.3 million for the first nine months of 2002. As of September 30, 2002, we had an accumulated deficit of approximately $59.1 million. Our ability to become profitable will depend on our revenue growth, which depends on a number of factors including market acceptance of our products, the success of any pilot programs in which we are participating, and our expense levels. Our expense levels are, in turn, influenced by a number of factors, including the resources we devote to developing and supporting our products, continued progress of our research and development of potential products and the need to acquire licenses to new technology or to use our technology in new markets. If we fail to grow our revenue and manage our expenses, we may never achieve profitability.
We may require licenses for new product features and products, and our strategic plans and growth could be impaired if we are unable to obtain such licenses.
We will need to introduce new products and product features in order to market our products to a broader customer base. Our products typically require licenses from third-party suppliers in order to be sold. Accordingly, our introduction of new products and product features could require us to obtain additional licenses. We may not be able to obtain such licenses on commercially reasonable terms, if at all. The failure to obtain necessary licenses or other rights could have a material adverse effect on our anticipated strategies and growth.
We will require licenses for certain reagents to produce a more complete solution, and our business will suffer if we are unable to obtain such licenses.
For certain markets, we intend to manufacture reagents for use with our Smart Cycler and GeneXpert systems to offer a more complete solution for the detection and analysis of DNA. We require licenses for many reagents. We believe that manufacturing reagents for use in our Smart Cycler and GeneXpert systems is important to our business and growth prospects. We may not be able to obtain licenses for certain reagents on commercially reasonable terms, if at all. Some of our competitors have rights to reagents. Our failure to obtain similar rights would limit our ability to offer a system that includes reagents and would adversely affect our competitive position and our performance.
The regulatory approval process is expensive, time-consuming, uncertain and may prevent us from obtaining required approvals for the commercialization of some of our products.
Some of our products, depending upon their intended use, will be subject to approval or clearance by the FDA or foreign governmental entities prior to their marketing for commercial use. Products, such as the GeneXpert, when used for clinical diagnostic purposes will require such approval. To date, we have not sought approval from the FDA or any foreign governmental body for the commercial sale of any of our products. The process of obtaining necessary FDA or foreign clearance or approvals can be lengthy, expensive and uncertain. We generally expect to rely on our collaborators to direct the regulatory approval process for our products. There are no assurances that such collaborators will timely and diligently pursue such process, or that they or we can obtain any required clearance or approval. Any such failure, or any material delay in obtaining the clearance or approval, could harm our business, financial condition and results of operations.
In addition, our failure or the failure of our collaborators to comply with regulatory requirements applicable to our products could result in significant sanctions, including:
If we fail to respond to changing technologies, demand for our products and our ability to enhance our revenues will suffer.
If we do not continue to improve our products and develop new products that keep pace with competitive product introductions and technological developments, satisfy diverse and rapidly evolving customer requirements and achieve market acceptance; we might be unable to attract new customers. The development of proprietary technology and necessary service enhancements entails significant technical and business risks and requires substantial expenditures and lead-time. We may also need to modify our manufacturing processes with respect to changes in product design or new product introductions. We might not be successful in developing and marketing product enhancements and new products that respond to technological advances and market changes, on a timely or cost- effective basis. In addition, even if these products are developed and released, they might not achieve market acceptance.
If our competitors and potential competitors develop superior products and technologies our competitive position and results of operations would suffer.
We expect to encounter intense competition from a number of companies that offer products in our targeted application areas. We anticipate that these competitors will include:
We face competition from both established and development-stage companies that continually enter these markets.
In many instances, particularly in the clinical diagnostics area, our competitors have substantially greater financial, technical, research and other resources and larger, more established marketing, sales, distribution and service organizations than we have. Moreover, these competitors may offer broader product lines and tactical discounts and have greater name recognition.
We also compete against universities and public and private research institutions. While these organizations primarily have educational or basic research objectives, they may develop proprietary technology and acquire patents that we need for the development of our products. Licenses to this proprietary technology may not be available to us on acceptable terms, if at all.
In addition, several companies are currently making or developing products that may or will compete with our products. Our competitors may succeed in developing, obtaining FDA approval for, or marketing technologies or products that are more effective or commercially attractive than our potential products, or that render our technologies and potential products obsolete. As these companies develop their technologies, they may develop proprietary positions that prevent us from successfully commercializing our products.
If our products do not perform as expected, or the reliability of the technology on which our products are based is questioned, we could experience lost revenue, delayed or reduced market acceptance of our products, increased costs and damage to our reputation.
Our success depends on the market's confidence that we can provide reliable, high quality genetic and DNA testing systems. We believe that customers in the life sciences research, biothreat applications and genetic management of disease markets are likely to be particularly sensitive to product defects and errors. Our reputation and the public image of our products or technologies may be impaired for any of the following reasons:
Even after any underlying concerns or problems are resolved, any widespread concerns regarding our technology or any manufacturing defects or performance errors in our products could result in lost revenue, delay in market acceptance, damage to our reputation, increased service and warranty costs, and claims against us.
If product liability lawsuits are successfully brought against us, we may face reduced demand for our products and incur significant liabilities.
We face an inherent business risk of exposure to product liability claims if our technologies or systems are alleged to have caused harm. We cannot be certain that we can successfully defend any product liability lawsuit brought against us. Regardless of merit or eventual outcome, product liability claims may result in:
If we are the subject of a successful product liability lawsuit which exceeds the limits of any insurance coverage we may obtain, we may not be able to obtain insurance for such potential liability on acceptable terms with adequate coverage or may be excluded from coverage under the terms of the policy. If we are not able to maintain insurance on acceptable terms, we may incur substantial liabilities, which would adversely affect our earnings and financial condition.
The September 11, 2001 terrorist attacks have created increased financial expectations that may not materialize.
The September 11, 2001 terrorist attacks have created an increase in demand for bio-threat detection systems. However, we are uncertain what the long-term impact will be on our product sales. Additionally, it is uncertain what, if any, solutions will be adopted as a result of the terrorism and whether we will be a part of the ultimate solution. Additionally, should our products be considered as a part of the solution for the detection of a bioterrorist attack, it is unclear what the level and how quickly funding may be made available. These factors may adversely impact us and create unpredictability in our revenues and operating results.
If we are unable to maintain our relationships with collaborative partners, we may have difficulty selling our products and services.
We believe that our success in penetrating our target markets and in bidding for certain kinds of contracts (such as the USPS pilot program) depends in part on our ability to develop and maintain collaborative relationships with key companies. However, our collaborative partners may not be able to perform their obligations as expected or devote sufficient resources to the development, supply or marketing of potential products developed under these collaborations. Also, if a key collaborative partner fails to perform its obligations as expected, including, for example, if it becomes insolvent or is acquired by another company with which we have no relationship, we may not be able to develop an adequate alternative in a timely manner.
Currently, our significant collaborative partners include:
Relying on these or other collaborative relationships is risky to our future success because, among other things:
If we are unable to manufacture the GeneXpert system and reagents in sufficient quantities and at acceptable costs, we may be unable to meet demand for our products and our ability to generate revenue will be diminished.
We are in the process of launching our manufacturing process for our GeneXpert system and reagents to support our commercial sales. We have limited manufacturing experience, and we cannot assure you that manufacturing or quality control problems will not arise as we attempt to produce our GeneXpert systems or reagents, or that we can scale-up manufacture and quality control in a timely manner or at commercially reasonable costs. If we are unable to manufacture GeneXpert systems or reagents consistently on a timely basis because of these or other factors, our product sales will be negatively affected.
With the launch of a diagnostic product, our manufacturing facilities, where we produce the Smart Cycler system and the GeneXpert system, cartridges and reagents, will be subject to periodic regulatory inspections by the FDA and other federal and state regulatory agencies. These facilities are subject to Quality System Regulation, or QSR, requirements of the FDA. If we fail to maintain our facilities in accordance with the QSR requirements, international quality standards or other regulatory requirements, the manufacturing process could be suspended or terminated, which would impair our business.
If our direct selling efforts for our products fail, our business expansion plans could suffer and our ability to generate revenue will be diminished.
We are utilizing a direct sales force to market our products in some markets. We have a small sales force and limited experience with the direct sales of our products in these markets. Failure to effectively promote and sell our products in these markets could have a negative impact on their market acceptance. If our systems fail to penetrate these expanding markets, this could have a negative effect on our ability to sell subsequent systems and hinder the planned expansion of our business.
If we fail to effectively manage our modifications and planned modifications to our distribution network, our sales could decline.
We are currently in the process of modifying our distribution network, phasing in new distributors, changing our relationships with our existing distributors and increasing our direct sales efforts. These relationships are new and we cannot predict whether they will be successful. Furthermore, we have limited experience and infrastructure for managing a larger network of distributors. If we cannot effectively manage this new broader network of distributors, our sales and marketing efforts in these geographic areas would be adversely affected and our operating results could suffer.
If our distributor relationships are not successful, our ability to market and sell our products in the life sciences research market would be harmed and our financial performance will be adversely affected.
We are dependent on relationships with distributors for the marketing and sales of our products in the life sciences research market in various geographic regions and we have a limited ability to influence their efforts. For example, Takara Shuzo Co., Ltd. is the exclusive distributor of Smart Cycler in the life sciences research market in Japan, South Korea and Taiwan and we also rely on various distributors for our sales of Smart Cycler in the European life sciences research market. Relying on distributors for our sales and marketing in these regions is risky to our future for various reasons, including:
We may be subject to third- party claims that we require additional licenses for our products, and such claims could interfere with our business.
Our industry is characterized by a large number of patents, claims of which appear to overlap in many cases. As a result, there is a significant amount of uncertainty regarding the extent of patent protection and infringement. Obtaining licenses to relevant patents could be costly and could materially harm our results of operations and future cash flows. Failing to obtain a license could result in litigation which may consume our resources and lead to significant damages, royalty payments or an injunction on the sale of our currently existing products.
If our products infringe on the intellectual property rights of others, we could face costly litigation, which could cause us to pay substantial damages and limit our ability to sell some or all of our products.
Our market success depends in part on us neither infringing valid, enforceable patents or proprietary rights of third parties, nor breaching any licenses that may relate to our technologies and products. We are aware of third-party patents that may relate to our technology. We plan to seek licenses, as we deem appropriate; however, it is possible that we may unintentionally infringe upon these patents or proprietary rights of third parties. In response, third parties may assert infringement or other intellectual property claims against us. We may consequently be subjected to substantial damages for past infringement or be required to modify our products if it is ultimately determined that our products infringe a third party's proprietary rights. Further, we may be prohibited from selling our products before we obtain a license, which, if available at all, may require us to pay substantial royalties. Even if these claims are without merit, defending a lawsuit takes significant time, may be expensive and may divert management attention from other business concerns. Any public announcements related to litigation or interference proceedings initiated or threatened against us could cause our stock price to decline.
We may need to initiate lawsuits to protect or enforce our patents, which would be expensive and, if we lose, may cause us to lose some, if not all, of our intellectual property rights, and thereby impair our ability to compete.
We rely on patents to protect a large part of our intellectual property. To protect or enforce our patent rights, we may initiate patent litigation against third parties, such as infringement suits or interference proceedings. These lawsuits could be expensive, take significant time and divert management's attention from other business concerns. They would also put our patents at risk of being invalidated or interpreted narrowly and our patent applications at risk of not issuing. We may also provoke these third parties to assert claims against us. Patent law relating to the scope of claims in the technology fields in which we operate is still evolving and, consequently, patent positions in our industry are generally uncertain. We cannot assure you that we would prevail in any of these suits or that the damages or other remedies awarded, if any, would be commercially valuable. During the course of these suits, there may be public announcements of the results of hearings, motions and other interim proceedings or developments in the litigation. If securities analysts or investors perceive any of these results to be negative, it could cause our stock to decline.
If we fail to maintain and protect our intellectual property rights, our competitors could use our technology to develop competing products and our business will suffer.
Our competitive success will be affected in part by our continued ability to obtain and maintain patent protection for our inventions, technologies and discoveries, including intellectual property that we license. Our pending patent applications may lack priority over others' applications or may not result in the issuance of patents. Even if issued, our patents may not be sufficiently broad to provide protection against competitors with similar technologies and may be challenged, invalidated or circumvented.
In addition to patents, we rely on a combination of trade secrets, copyright and trademark laws, nondisclosure agreements, licenses and other contractual provisions and technical measures to maintain and develop our competitive position with respect to intellectual property. Nevertheless, these measures may not be adequate to safeguard the technology underlying our products. For example, employees, consultants and others who participate in the development of our products may breach their agreements with us regarding our intellectual property and we may not have adequate remedies for the breach. We also may not be able to effectively protect our intellectual property rights in some foreign countries. For a variety of reasons, we may decide not to file for patent, copyright or trademark protection outside of the United States. Our trade secrets could become known through other unforeseen means. Notwithstanding our efforts to protect our intellectual property, our competitors may independently develop similar or alternative technologies or products that are equal or superior to our technology. Our competitors may also develop similar products without infringing on any of our intellectual property rights or design around our proprietary technologies.
Our international operations and proposed expansion subject us to additional risks and costs.
Our international operations are subject to a number of difficulties and special costs, including:
We intend to expand our international sales and marketing activities and enter into relationships with additional international distribution partners. We are in the early stages of developing our indirect distribution channels in markets outside the United States. We may not be able to attract distribution partners that will be able to market our products effectively.
Our international operations could also increase our exposure to international laws and regulations. If we cannot comply with foreign laws and regulations, which are often complex and subject to variation and unexpected changes, we could incur unexpected costs and potential litigation. For example, the governments of foreign countries might attempt to regulate our products and services or levy sales or other taxes relating to our activities. In addition, foreign countries may impose tariffs, duties, price controls or other restrictions on foreign currencies or trade barriers, any of which could make it more difficult for us to conduct our business.
The nature of our products may also subject us to export control regulation by the U.S. Department of State and the Department of Commerce. Violations of these regulations can result in monetary penalties and denial of export privileges.
If our single source suppliers fail to deliver key product components in a timely manner, our manufacturing ability would be impaired and our product sales could suffer.
We depend on long term delivery contracts with several single source suppliers that supply components used in the manufacture of our Smart Cycler, GeneXpert systems, disposable reaction tubes, and cartridges. If we need alternative sources for key component parts for any reason, such component parts may not be immediately available. If alternative suppliers are not immediately available, we will have to identify and qualify alternative suppliers, and production of such components may be delayed. We may not be able to find an adequate alternative supplier in a reasonable time period, or on commercially acceptable terms, if at all. Our inability to obtain a key source supplier for the manufacture of our potential products may force us to curtail or cease operations.
We expect that our operating results will fluctuate significantly, and any failure to meet financial expectations may disappoint securities analysts or investors and result in a decline in our stock price.
We expect that our quarterly operating results will fluctuate in the future as a result of many factors, some of which are outside of our control. Because our revenue and operating results are difficult to predict, we believe that period-to-period comparisons of our results of operations are not a good indication of our future performance. We expect our gross profit to fluctuate depending upon the timing of introduction and acceptance of our products. In addition, our operating results may be affected by the inability of some of our customers to consummate anticipated purchases of our products, whether due to changes in internal priorities or, in the case of governmental customers, problems with the appropriations process. It is possible that in some future quarter or quarters our operating results will be below the expectations of securities analysts or investors. In this event, the market price of our common stock may fall abruptly and significantly.
Broad market fluctuations in our stock price could result in the loss of market makers for our common stock, which could, in turn, result in a decline in the price of our common stock. To maintain our eligibility for listing on Nasdaq, we must maintain a minimum number of market makers and meet and maintain other eligibility requirements, including a minimum trading value of our common stock. A prolonged decline in the price of our common stock could effect the operation of our business by severely limiting our ability to raise capital or to use our common stock in connection with acquisitions. In addition because the price of our common stock is below $5.00per share, broker dealers have to follow specific disclosure and suitability obligations requirements, which could limit the marketability of our common stock.
If revenue declines in a quarter, whether due to a delay in recognizing expected revenue or otherwise, our earnings will decline because many of our expenses are relatively fixed. In particular, research and development and selling, general and administrative expenses are not significantly affected by variations in revenue.
If we fail to obtain an adequate level of reimbursement for our products from third-party payers, our ability to sell products in some markets would be harmed.
Our ability to sell our products in the clinical diagnostics market will depend in part on the extent to which reimbursement for our products and related treatments will be available from:
If appropriate reimbursement cannot be obtained, we could be prevented from successfully commercializing some of our potential products.
There are efforts by governmental and third-party payors to contain or reduce the costs of health care through various means. Additionally, third-party payors are increasingly challenging the price of medical products and services. If purchasers or users of our products are not able to obtain adequate reimbursement for the cost of using our products, they may forego or reduce their use. Significant uncertainty exists as to the reimbursement status of newly approved health care products and whether adequate third-party coverage will be available.
If we fail to retain key members of our staff, our ability to conduct and expand our business would be impaired.
We are highly dependent on the principal members of our management and scientific staff. The loss of services of any of these persons could seriously harm our product development and commercialization efforts. In addition, we will require additional skilled personnel in areas such as manufacturing, quality control, project management, microbiology, software engineering, mechanical engineering and electrical engineering. Our business is located in the Silicon Valley area of California, where demand for personnel with these skills is high and is likely to remain high. As a result, competition for, and retention of, personnel, particularly for employees with technical expertise, is intense and the turnover rate is high. If we are unable to hire, train and retain a sufficient number of qualified employees, our ability to conduct and expand our business could be seriously reduced. The inability to retain and hire qualified personnel could also hinder the planned expansion of our business.
If we fail to raise additional capital, our ability to fund our operations and advance our development programs would be impaired and our business would be adversely affected.
Although we anticipate that our existing capital resources will enable us to maintain currently planned operations through at least September 2003, this expectation is based on our current operating plan and may change as a result of many factors, including market acceptance of our products and future opportunities with collaborators. Consequently, we may need additional funding sooner than anticipated. We currently have no credit facility or committed sources of capital. To the extent operating and capital resources are insufficient to meet future requirements, we will have to raise additional funds. These funds may not be available on favorable terms, if at all. If adequate funds are not available on attractive terms, we may be required to curtail operations significantly or to obtain funds by entering into financing, supply or collaboration agreements on unattractive terms.
In addition, we may choose to raise additional capital due to market conditions or strategic considerations even if we believe we have sufficient funds for our current or future operating plans. To the extent that additional capital is raised through the sale of equity or convertible debt securities, the issuance of these securities could result in dilution to our shareholders. In addition, such securities may be sold at a discount from the market price of our common stock, and may include rights preferences or privileges senior to those of our common stock.
If we acquire companies, products or technologies, we may face risks associated with those acquisitions.
If we are presented with appropriate opportunities, we may make other investments in complementary companies, products or technologies. We may not realize the anticipated benefit of any acquisition or investment. If we acquire another company, we will likely face risks, uncertainties and disruptions associated with the integration process, including difficulties in the integration of this operations, and services of the acquired company, the diversion of our management's attention from other business concerns and the potential loss of key employees or customers of the acquired businesses. If we fail to successfully integrate other companies that we may acquire, our business could be harmed. Furthermore, we may have to incur debt or issue equity securities to pay for any additional future acquisitions or investments, the issuance of which could be dilutive to our existing shareholders or us. In addition, our operating results may suffer because of acquisition-related costs or amortization expenses or charges relating to acquired goodwill and other intangible assets.
If a catastrophe strikes our manufacturing facilities, we may be unable to manufacture our products for a substantial amount of time and we would experience lost revenue.
Our manufacturing facilities are located in Sunnyvale, California. Even though we have business interruption insurance, our facilities and some pieces of manufacturing equipment are difficult to replace and could require substantial replacement lead-time. Various types of disasters, including earthquakes, fires, floods and acts of terrorism, may affect our manufacturing facilities. Earthquakes are of particular significance since the manufacturing facilities are located in an earthquake-prone area. In the event our existing manufacturing facilities or equipment is affected by man-made or natural disasters, we may be unable to manufacture products for sale, meet customer demands or sales projections. If our manufacturing operations were curtailed or ceased, it would seriously harm our business.
If we become subject to claims relating to improper handling, storage or disposal of hazardous materials, we could incur significant cost and time to comply.
Our research and development processes involve the controlled storage, use and disposal of hazardous materials, including biological hazardous materials. We are subject to federal, state and local regulations governing the use, manufacture, storage, handling and disposal of materials and waste products. We may incur significant costs complying with both existing and future environmental laws and regulations. In particular, we are subject to regulation by the Occupational Safety and Health Administration, or OSHA, and the Environmental Protection Agency, or EPA, and to regulation under the Toxic Substances Control Act and the Resource Conservation and Recovery Act. OSHA or the EPA may adopt regulations that may affect our research and development programs. We are unable to predict whether any agency will adopt any regulations that would have a material adverse effect on our operations.
Although we believe that our safety procedures for handling and disposing of these hazardous materials comply with the standards prescribed by law and regulation, the risk of accidental contamination or injury from hazardous materials cannot be eliminated completely. In the event of an accident, we could be held liable for any damages that result, and any liability could exceed the limits or fall outside the coverage of our insurance. We may not be able to maintain insurance on acceptable terms, if at all. We could be required to incur significant costs to comply with current or future environmental laws and regulations.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The primary objective of our investment activities is to preserve principal while at the same time maximizing the income we receive from our investments without significantly increasing risk. Some of the securities that we invest in may have market risk. This means that a change in prevailing interest rates may cause the principal amount of the investment to fluctuate. For example, if we hold a security that was issued with fixed interest rate at the then-prevailing rate and the prevailing interest rate later rises, the principal amount of our investment will probably decline. To minimize this risk in the future, we intent to maintain our portfolio of cash equivalents and short-term investments in short term commercial paper and money market funds. Due to the short term nature of the investments, we believe we have no material exposure to interest rate risk arising from our investments. Therefore we have not included quantitative tabular disclosure in this Form 10Q.
We do not enter into financial investments for speculation or trading purposes and are not a party to financial or commodity derivatives.
We have operated primarily in the United States and all sales to date have been made in U.S. Dollars. Accordingly, we have not made any material exposure to foreign currency rate fluctuations.
ITEM 4. CONTROLS AND PROCEDURES
PART II
ITEM 1. LEGAL PROCEEDINGS
There have been no material changes to the status of the legal proceedings disclosed on the Company's registration statement on Form 10Q for the quarter ended June 30, 2002.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
On September 24, 2002, our Board of Directors approved a number of technical amendments to the provisions of our 1997 Stock Option Plan (the "Plan"). These amendments did not change the aggregate number of shares reserved for issuance under the Plan, nor did they change the vesting or acceleration terms applicable to stock options issued pursuant to the Plan. The amendments also did not require shareholder approval.
ITEM 6. EXHIBITS AND REPORTS ON FORMS 8-K
(a) Exhibits
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Exhibit 3.1 - |
Certificate of Determination specifying the terms of the Series A Junior Participating Preferred Stock of registrant, as filed with the Secretary of State to the State of California on October 2, 2002 (incorporated herein by reference to the Exhibit 3.02 of Cepheid's Registration Statement on Form 8-A filed with the Securities and Exchange Commission on October 4, 2002.) |
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Exhibit 4.1 - |
Rights Agreement dated September 26, 2002 between Cepheid and Computershare Trust Company as Rights Agent, which includes as Exhibit A the form of Certificate of Detemination of Series A Junior Participating Preferred Stock, as Exhibit B the Summary of Stock Purchase Rights and as Exhibit C the Form of Rights Certificate (incorporated herein by reference to Exhibit 4.01 of Cepheid's Registration Statement on Form 8-A, filed with the Securities and Exchange Commission on October 4, 2002) |
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Exhibit 10.1 - |
1997 Stock Option Plan as amended and restated September 24, 2002 |
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Exhibit 10.2 - |
Severance Agreement, dated as of August 1, 2002 between Catherine A Smith and Cepheid |
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Exhibit 10.3 - |
Form of Stock Purchase Agreement, dated as of August 1, 2002, entered into by Cepheid and certain investors (incorporated inherein by reference to Exhibit 99.03 of Cepheid's Current Report on Form 8-K filed with the Securities and Exchange Commission on August 2, 2002) |
(b) Reports on Form 8-K
On July 16, 2002, Cepheid filed a Current Report on Form 8-K reporting under Item5 the issuance of a press release regarding its financial results for the three and six months periods ended June 30, 2002 and filing an unaudited consolidated condensed balance sheet and statement of operations for the three and six months periods ended June 30, 2002 and for the corresponding prior year periods.
On August 2, 2002, Cepheid filed a Current Report on Form 8-K reporting, under Item 5, the sale of 4,000,000 shares of its common stock at a price per share of $2.65 directly to investors in a public offering under a shelf registration statement on Form S-3.
On October 4, 2002, Cepheid filed a Current Report on Form 8-K reporting under Item 5 the adoption on September 24, 2002 of a shareholder rights plan.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized, in the City of Sunnyvale, State of California on this 13th day of November, 2002.
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CEPHEID |
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By: /s/ John L. Bishop |
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By: /s/ John R. Sluis |
CERTIFICATIONS
I, John L. Bishop certify that:
Date: November 13, 2002
/s/John L. Bishop
John L. Bishop
Chief Executive Officer and Director
I, John R. Sluis certify that:
Date: November 13, 2002
/s/John R. Sluis
John R. Sluis
Chief Financial Officer