PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
CEPHEID
CONDENSED CONSOLIDATED BALANCE SHEETS
(amounts in thousands)
September 30 December 31,
2003 2002 (1)
------------ -------------
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents ........................... $ 15,166 $ 14,505
Restricted cash ..................................... 1,166 2,296
Accounts receivable ................................. 3,521 3,044
Inventory ........................................... 4,627 3,850
Prepaid expenses and other current assets ........... 1,040 352
------------ -------------
Total current assets .............................. 25,520 24,047
Property and equipment, net ............................ 7,813 6,144
Other assets ........................................... 50 --
------------ -------------
Total assets ...................................... $ 33,383 $ 30,191
============ =============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable .................................... $ 2,382 $ 2,367
Accrued compensation ................................ 1,480 1,171
Other accrued liabilities ........................... 2,407 2,092
Current portion of equipment financing .............. 1,764 1,423
Current portion of bank loan payable................. 36 32
------------ -------------
Total current liabilities ......................... 8,069 7,085
Equipment financing, less current portion .............. 2,094 1,629
Bank loan payable, less current portion................. 374 364
Deferred rent .......................................... 464 355
Commitments
Shareholders' equity:
Common stock ........................................ 90,487 75,928
Additional paid-in capital .......................... 7,490 7,505
Deferred stock-based compensation ................... (6) (103)
Accumulated foreign exchange translation adjustment.. (2) 4
Accumulated deficit ................................. (75,587) (62,576)
------------ -------------
Total shareholders' equity ........................ 22,382 20,758
------------ -------------
Total liabilities and shareholders' equity ........ $ 33,383 $ 30,191
============ =============
(1) The balance sheet at December 31, 2002 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 Fianancial Statements.
CEPHEID
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
(in thousands, except per share amounts)
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------- --------------------
2003 2002 2003 2002
--------- --------- --------- ---------
Revenues:
Instrument sales ............................. $ 4,074 $ 3,315 $ 9,433 $ 7,814
Reagents and disposables sales ............... 568 450 1,523 949
--------- --------- --------- ---------
Total product sales ........................ 4,642 3,765 10,956 8,763
License and royalty revenue .................. 8 71 44 200
Contract revenue ............................. 717 593 2,250 1,038
--------- --------- --------- ---------
Total revenues ............................... 5,367 4,429 13,250 10,001
--------- --------- --------- ---------
Operating costs and expenses:
Cost of product sales ........................ 2,768 2,928 6,433 6,672
Research and development...................... 4,004 4,546 11,866 13,110
Selling, general and administrative........... 2,503 2,471 7,928 6,311
Restructuring expenses........................ -- 262 -- 262
--------- --------- --------- ---------
Total operating costs
and expenses ................................ 9,275 10,207 26,227 26,355
--------- --------- --------- ---------
Loss from operations ......................... (3,908) (5,778) (12,977) (16,354)
Interest (expense) income, net ............... 7 17 (34) 88
--------- --------- --------- ---------
Net loss ..................................... (3,901) (5,761) (13,011) (16,266)
Net loss per share, basic and diluted......... $ (0.11) $ (0.20) (0.40) (0.59)
========= ========= ========= =========
Shares used in computing net loss per share,
basic and diluted ........................... 33,985 29,302 32,596 27,342
========= ========= ========= =========
See accompanying notes to Condensed Consolidated Financial Statements.
CEPHEID
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
Nine Months Ended
September 30,
--------------------
2003 2002
--------- ---------
OPERATING ACTIVITIES:
Net loss ................................................ $ (13,011) $ (16,266)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization ....................... 1,543 1,561
Amortization of deferred stock-based compensation ... 82 469
Amortization of deferred rent ....................... 109 202
Changes in operating assets and liabilities:
Accounts receivable .............................. (477) (880)
Inventory ........................................ (777) (3)
Prepaid expenses and other assets ................ (738) (120)
Accounts payable and other current liabilities ... 324 1,976
Accrued compensation ............................. 309 1,157
--------- ---------
Net cash used in operating activities ................... (12,636) (11,904)
--------- ---------
INVESTING ACTIVITY:
Capital expenditures .................................... (3,212) (3,656)
Restricted cash.......................................... 1,130 --
Proceeds from maturities of marketable securities ....... -- 8,775
--------- ---------
Net cash (used in) provided by investing activities ..... (2,082) 5,119
--------- ---------
FINANCING ACTIVITIES:
Net proceeds from the sale of common shares ............. 14,559 9,947
Proceeds from loan arrangements ......................... 1,900 2,094
Principal payments under loan arrangements .............. (1,080) (871)
--------- ---------
Net cash provided by financing activities ............... 15,379 11,170
--------- ---------
Net increase in cash and cash equivalents ............... 661 4,385
Cash and cash equivalents at beginning of period ........ 14,505 15,905
--------- ---------
Cash and cash equivalents at end of period .............. $ 15,166 $ 20,290
========= =========
See accompanying notes to Condensed Consolidated Financial Statements.
CEPHEID
Notes to Condensed Consolidated Financial Statements
(unaudited)
1. ORGANIZATION, BUSINESS AND BASIS OF PRESENTATION
Cepheid (the "Company") was incorporated in the State of
California on March 4, 1996. The Company develops, manufactures, and markets
fully-integrated systems that enable sophisticated genetic and DNA analysis of
patients and organisms by automating complex manual laboratory procedures.
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 GAAP. 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, 2003 are not necessarily indicative of the results that may be
expected for the year ending December 31, 2003 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, 2002 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 the Company and its wholly-owned subsidiaries.
All significant intercompany balances and transactions have been eliminated.
Use of Estimates
The preparation of the 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
We recognize revenue from product sales when goods are shipped, when there is
persuasive evidence that an arrangement exists, delivery has occurred, the price
is fixed and determinable, and collectibility is reasonably assured. No right
of return exists for our products with the exception of damaged goods. We have
not experienced any significant returns of our products.
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, where there is no
continuing involvement required of us are recognized on the earlier of the date
the payments are received or when collection is reasonably 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 provided that the related milestone was at risk at the inception of
the arrangement. Deferred revenue is recorded when funds are received in advance
of services to be performed.
Warranty Accrual
The Company warrants its products against defects 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. The Company's warranty accrual is
established using management's estimate for future costs of repairing any
instrument failures during the one-year warranty period. The Company's accrued
warranty liability at September 30, 2003 and December 31, 2002 was $0.4 and $0.6
million, respectively. The activity in the warranty accrual for the nine-month
period ended September 30, 2003 consisted of the following (in thousands):
Balance at December 31, 2002........... $ 634
Cost incurred & charged against reserve (751)
Provision for warranty................. 543
---------
Balance at September 30, 2003.......... $ 426
=========
The Company generally sells products with a limited indemnification against
intellectual property infringement claims related to the Company's products.
The Company's policy is to accrue for known indemnification issues if a loss is
probable and can be reasonably estimated, and accrues for estimated incurred but
unidentified issues based on historical activity. To date, there are no such
accruals or related expenses.
Comprehensive (Income) Loss
Comprehensive loss includes net loss as well as other
comprehensive income or loss. Other comprehensive loss consists of net
unrealized gains and losses on available-for-sale marketable securities.
Comprehensive loss approximated net loss for the three and nine month periods
ended September 30, 2003 and 2002.
Stock-Based Compensation
As permitted by the provisions of Statement of Financial Accounting
Standards No. 123, "Accounting for Stock-Based Compensation," (SFAS
123), the Company has elected to continue to apply the intrinsic value method of
Accounting Principle Board Opinion No. 25, "Accounting for Stock Issued to
Employees," (APB 25) and related interpretations in accounting for its
employee stock option plans and the Employee Stock Purchase Plan. Under APB 25,
if the exercise price of its employee and director stock options equals or
exceeds the fair value of the underlying stock on the date of grant, no
compensation expense is recognized.
The presentation of pro forma net loss set forth in this
footnote has been determined as if the Company had accounted for its employee
stock options granted using the fair value method of SFAS 123. The fair value
of these options was estimated at the date of grant using the Black-Scholes
option pricing model, with the following weighted-average assumptions: risk free
interest rates of 3.14% and 2.87% for the three and nine month periods ended
September 30, 2003, respectively, and 4% for grants in the three and nine month
periods ended September 30, 2002, respectively; a weighted average expected life
of five years; and a dividend yield of zero. The weighted average fair value of
options granted during the three and nine month periods ended September 30, 2003
was $4.46 and $3.82, respectively, and $3.73 and $3.53, respectively for the
three and nine month periods ended September 30, 2002. The expected volatility
of the Company's common stock used in the pricing model was 1.3 for the three
and nine months ended September 30, 2003 and 1.4 for the three and nine months
ended September 30, 2002.
For purposes of disclosure pursuant to FAS 123 as amended by
SFAS 148, "Accounting for Stock-Based Compensation, Transition and
Disclosure," the estimated fair value of options is amortized to expense
over the options' vesting period. The following table illustrates the effect on
net loss per share as if we had applied the fair value recognition provision of
SFAS 123 to stock based employee compensation (in thousands, except per share
data):
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------- ------------------
2003 2002 2003 2002
--------- -------- -------- --------
Net loss as reported .................................. $ (3,901) $ (5,761) $(13,011) $(16,266)
Deduct: Total stock-based employee compensation
determined under the fair value method for all
awards, net of tax related effects...................... (898) (670) (2,362) (1,791)
Add: Amortization of deferred stock based compensation.. 5 47 82 469
--------- -------- -------- --------
Pro forma net loss...................................... (4,794) (6,384) (15,291) (17,588)
Basic and diluted net loss per share:
As reported.......................................... $ (0.11) $ (0.20) $ (0.40) $ (0.59)
Pro forma............................................ $ (0.14) $ (0.22) $ (0.47) $ (0.64)
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, 2003, product sales through distributors represented
46% and 53%, 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 25%, 8%, and 13%,
respectively, of total product sales for the three month period ended September
30, 2003, and 33%, 10%, and 10%, respectively, of total product sales for the
nine month period ended September 30, 2003. Such distributors accounted for
29%, 11%, and 3%, respectively, of total product sales for the corresponding
three month period of the previous year, and 38%, 15%, and 3%, respectively, of
total product sales for the corresponding nine month period of the prior year.
For the three month period ended September 30, 2003, there was one direct
customer that represented 12% of total product sales. For the nine month period
ended September 30, 2003, there was no one direct customer that represented
greater than 10% of total product sales. For the corresponding three and nine
month periods of the prior year, there was no one direct customer that
represented greater than 10% of total product sales.
The Company relies on several companies as sole sources 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 and 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,
-------------------- ------------------
2003 2002 2003 2002
--------- -------- -------- --------
Net loss .............................................. $ (3,901) $ (5,761) $(13,011) $(16,266)
========= ======== ======== ========
Basic and diluted:
Weighted-average shares of common stock outstanding .... 34,009 29,419 32,634 27,582
Less: weighted-average shares subject to repurchase .... (24) (117) (38) (240)
--------- -------- -------- --------
Shares used in computing basic and diluted net
loss per share ...................................... 33,985 29,302 32,596 27,342
========= ======== ======== ========
Basic and diluted net loss per share .................. $ (0.11) $ (0.20) $ (0.40) $ (0.59)
========= ======== ======== ========
5. 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
out ("FIFO") method. The Company maintains a reserve for inventory
obsolescence. The inventory reserve is established using management's estimate
of the potential future obsolescence of inventory
The components of inventories (in thousands) are as follows:
September 30, December 31,
2003 2002
------------ -------------
Raw materials .................................... $ 2,270 $ 2,361
Work in process .................................. 946 988
Finished goods ................................... 1,411 501
------------ -------------
$ 4,627 $ 3,850
============ =============
6. SUBSEQUENT EVENT
On October 16, 2003, the Company received a $2.0 million
option payment from a potential partner in a strategic commercial relationship.
If the option is exercised, the payment would be credited towards amounts
payable to the Company; if the option is not exercised, the Company would retain
the option payment.
On November 7, 2003, the Company completed the sale of
555,556 common shares at $3.75 for net proceeds of approximately $2.0 million to
an institutional investor. The shares were sold pursuant to an option issued in
connection with its common stock offering in August 2003.
On November 6, the Company entered into series of agreements
with Infectio Diagnostics, Inc which resulted in the restructuring of our
previously existing collaborative relationship. In connection with these
agreements, the Aridia joint venture was dissolved.
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," "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 are collaborating with strategic partners to
co-develop assays, or biological tests, and to provide marketing and sales support
across a broad range of markets.
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. We began
shipping the Smart Cycler II, which features various enhancements to the Smart
Cycler, in November 2002. We believe our Smart Cycler products allow users to
analyze biological samples faster and more efficiently than with any other
product currently available.
Our GeneXpert system, currently in the final stages of
development, integrates automated sample preparation with our Smart Cycler
amplification and detection technology. Following clinical trials and FDA
approval, we anticipate commercial launch of the GeneXpert system to the
clinical genetic assessment market in the second half of 2005. We believe that
the GeneXpert system is the only genetic analysis system that integrates
automated sample preparation with genetic analysis, while also offering
customers a complete testing system comprised of both instrumentation and
disposable cartridges containing all necessary reagents for a particular test.
SIGNIFICANT ACCOUNTING POLICIES AND MANAGEMENT
JUDGMENTS
We consider certain accounting policies related to
revenue recognition, inventory reserves, and warranty accruals to be critical
accounting policies. Inherent in our determination of when to recognize
revenue, and in our calculation of our inventory reserve and warranty accrual
are a number of 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 persuasive evidence that an
arrangement exists, delivery has occurred, the price is fixed and determinable,
and collectibility is reasonably assured. No right of return exists for our
products with the exception of damaged goods. We have not experienced any
significant returns of our products. 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, where there is no continuing involvement required of us are
recognized on the earlier of the date the payments are received or when
collection is reasonably 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 provided that the related milestone was
at risk at the inception of the arrangement. 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 using management's estimate of the potential future obsolescence of
inventory. A substantial decrease in demand for our products could lead to
excess inventories and could require us to increase our reserve for inventory
obsolescence.
Our warranty accrual is established using management's
estimate for the future costs of 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, 2003 COMPARED TO THREE AND NINE
MONTHS ENDED SEPTEMBER 30, 2002
REVENUES
We derive our revenues principally from sales of our
Smart Cycler system and associated reagents and 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, 2003 were $5.4 million and $13.3 million
respectively, an increase over the corresponding prior year periods of $0.9
million or 21%, and $3.2 million or 32%, respectively.
Product sales for the three and nine month periods ended
September 30, 2003 were $4.6 million and $11.0 million respectively, an increase
over the corresponding prior year periods of $0.9 million or 23%, and $2.2
million or 25%, respectively. The increase in product sales for the three and
nine month periods ended September 30, 2003 resulted primarily from the growth
of sales of our Smart Cycler system, particularly in Europe. The increase in
product sales in Europe was due primarily to the establishment of several new
distributors in this region through our wholly owned French subsidiary, Cepheid
SA. For the three and nine month periods ended September 30, 2003, product
sales through distributors represented 46% and 53% of total product sales
(including instruments, reagents, and disposables). For the three month period
ended September 30, 2003, there was one direct customer that represented 12% of
total product sales. For the nine month period ended September 30, 2003, there
was no one direct customer that represented greater than 10% of total product
sales. For the corresponding three and nine month periods of the prior year,
there was no one direct customer that represented greater than 10% of total
product sales. For the three month period ended September 30, 2003, product
sales in North America, Europe, and the Far East represented 79%, 14%, and 7%
respectively, of total product sales, as compared to 85%, 4%, 11% for the
corresponding period of 2002. For the nine month period ended September 30,
2003, product sales in North America, Europe, and the Far East represented 76%,
15%, and 9%, respectively, of total product sales as compared to 79%, 6%, and
15% for the corresponding period of 2002. We expect that the percentage of
sales contributed by each of the three geographical areas for the nine-month
period ended September 30, 2003 will remain relatively constant for the
remainder of 2003.
We are part of a Northrop Grumman-led consortium that has
been selected by the U.S. Postal Service (USPS) to produce a DNA-based biothreat
detection system for installation in USPS mail sorting facilities. We expect to
realize approximately 15-17% of the initial contract award of $175 million, with
the majority of the revenue to be recognized in 2004. The contract award
includes an option for placement of an additional number of units and associated
GeneXpert anthrax test cartridges, which may be exercised in 2004. We also
expect to realize continuing demand for GeneXpert anthrax test cartridges beyond
the initial contract awards. However, our participation in the USPS biothreat
detection system program is subject to a number of risks and uncertainties,
including uncertainties in the timing and decision-making and deployment of the
biothreat detection system and sensitivity to changes in national and
international priorities and budgets. Accordingly, the program may not yield
the revenues we anticipate.
Contract revenues for the three and nine month periods ended September 30,
2003 were $0.7 million and $2.3 million respectively, an increase over the
corresponding prior year periods of $0.1 million or 21%, and $1.2 million or
117%, respectively. Our contract revenues were derived principally from our
research and development contract with the United States Military Institute for
Infectious Disease ("USAMRIID"). We do not expect to experience a
continued increase in quarterly contract revenue in the remainder of 2003 as we
continue to focus on increasing our product marketing efforts and shifting our
business away from contract 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, 2003 were
$2.8 million and $6.4 million, respectively, a decrease from the corresponding
prior year periods of $0.2 million or 5%, and $0.2 million or 4%, respectively.
Our product gross margin percentage for the three and nine month periods ended
September 30, 2003 was 40% and 41%, respectively as compared to 22% and 24% for
the corresponding prior year periods. The increase in product gross margin
percentage for the three and nine month periods ended September 30, 2003, as
compared to the corresponding prior year periods, was due primarily to improved
product pricing and increased manufacturing economies of scale. For the three
month period ended September 30, 2003, improved product pricing accounted for
6%, decreased warranty costs accounted for 6%, and improved manufacturing
economies of scale accounted for the remaining 6% of the improvement in gross
margin percentage as compared to the prior year quarter. In the third quarter
of the prior year, we incurred approximately $0.4 million in warranty costs to
enhance the reliability of the Smart Cycler system which are not included in the
three and nine month periods of the prior year. For the nine month period ended
September 30, 2003, improved product pricing accounted for 8% while improved
manufacturing economies of scale accounted for the remaining 9% improvement in
product gross margin percentage as compared to the prior year period. We expect
our quarterly gross margin percentage to remain essentially unchanged from the
nine month period ended September 30, 2003 for the remainder of 2003.
RESEARCH AND DEVELOPMENT EXPENSES
Research and development expense consists of
salaries, deferred stock compensation, research and development materials, and
facility costs. Research and development expense for the three and nine month
periods ended September 30, 2003 was $4.0 million and $11.9 million,
respectively, a decrease from the corresponding prior year periods of $0.5
million or 12% and $1.2 million or 9%, respectively. The primary reason for the
decrease for the three and nine month periods ended September 30, 2003, as
compared to the corresponding prior year periods was a reduction in force that
we completed in September 2002. Specifically, the decrease for the three month
period ended September 30, 2003 as compared to the corresponding prior year
period was comprised of a $0.1 million decrease in wages and other
personnel-related expenses, a $0.1 million decrease in outside engineering and consulting
costs, a $0.1 million decrease in non-cash deferred stock compensation, a $0.4
decrease in facilities allocation, offset partially by a $0.2 million increase
in depreciation expenses. The decrease for the nine month period ended
September 30, 2003 as compared to the corresponding prior year period was
comprised of a $0.4 million decrease in wages and other personnel-related
expenses, a $0.5 million decrease in outside engineering and consulting costs,
and a $0.3 million decrease in non-cash deferred compensation expense. We
expect that our quarterly research and development expenses will increase
slightly in the fourth quarter of 2003 as we continue our product development
efforts, particularly with respect to developing 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 resources expenses. Selling,
general and administrative expense for the three and nine month periods ended
September 30, 2003 was $2.5 million and $7.9 million, respectively, an increase
over the corresponding prior year periods of $0.032 million or 1.3%, and $1.6
million or 26%, respectively. The primary reason for the increase for the three
and nine month periods ended September 30, 2003, as compared to the prior year
periods, was the organization and establishment of our wholly owned French
subsidiary, Cepheid SA, in the fourth quarter of 2002, and other increases in
sales and marketing headcount. The increase for the nine month period ended
September 30, 2003 was comprised of a $0.5 million increase in salaries and
personnel-related expenses resulting primarily from increased sales and
marketing and executive headcount, a $0.3 million increase in travel expenses
due to the increased sales force headcount, a $0.2 million increase in legal and
accounting costs, a $0.3 million increase in consulting costs, a $0.2 million
increase in advertising costs, and a $0.2 million increase in insurance costs,
partially offset by a $0.1 million decrease in non-cash deferred stock
compensation. We expect that our quarterly selling general and administrative
expense will increase slightly in fourth quarter of 2003 as we continue to make
additional investments in sales and marketing.
OTHER INCOME
Other income (expense) for the three and nine month
periods ended September 30, 2003 was $7,000 and ($34,000), respectively,
representing a decrease in other income from the corresponding prior year
periods of $10,000 or 59% and $122,000 or 139%, respectively. The decrease for
both periods was due to a decrease in our cash balances, decreased investment
yield due to lower interest rates, and increased interest expense due to
increased equipment financing borrowings
LIQUIDITY AND CAPITAL RESOURCES
As of September 30, 2003, we had $16.3 million in
cash, cash equivalents and short-term investments, (including $1.1 million in
restricted cash) as compared to $16.8 million (including $2.3 million in
restricted cash) as of December 31, 2002. Net cash used for operating activities
was $12.6 million for the nine month period ended September 30, 2003 as compared
to $11.9 million for the corresponding prior year period. The $0.7 million
increase in net cash used in operating activities for the nine month period
ended September 30, 2003 as compared to the corresponding prior year period
included a $3.5 million increased investment in working capital including
accounts receivable, inventory, and prepaid assets, a $0.4 million decrease in
non-cash deferred stock compensation, and a $0.1 million decrease in
amortization of deferred rent partially offset by a $3.3 million decrease in net
loss.
Through September 30, 2003, we had received net proceeds of
approximately $90.5 million from sales of common and convertible preferred stock
since inception, including our initial public offering and recent offerings
pursuant to our shelf registration statement. Through September 30, 2003, we
had financed equipment, land and building purchases and leasehold improvements
totaling approximately $8.6 million. As of September 30, 2003, we had $3.9
million in equipment financing obligations under an equipment financing
agreement. These obligations are secured by the financed equipment, bear
interest at a weighted average fixed rate of 9.2% per year and are due in
monthly installments through September 2006. Under the equipment
financing agreement, a balloon payment is due at the end of each individual
lease term of the underlying equipment. As additional security for our
obligations under this agreement, we provided a letter of credit in the amount
of $1.1 million to the creditor in October 2002, and our ability to draw down
additional funding under our agreement was suspended. In September 2003, the
creditor waived the letter of credit and we were permitted to draw down
additional amounts under the equipment financing agreement.
In December 2002, we purchased land and a building for
approximately $0.4 million for our newly formed subsidiary in France. We
financed the purchase with a ten-year mortgage loan, which bears interest at
4.75% per year and is secured by the land and building. Additionally, the loan
is guaranteed by the Company through a standby letter of credit in the amount of
$0.5 million. The collateral for this standby letter of credit is classified as
a component of restricted cash at September 30, 2003.
For the nine month period ended September 30, 2003, net cash
used in investing activities consisted of $3.2 million in capital expenditures
for property and equipment partially offset by a $1.1 million decrease in
restricted cash, while, for the nine month period ended September 30, 2002, net
cash provided by investing activities consisted of proceeds from maturities of
marketable securities of $8.8 million, partially offset by capital expenditures
of $3.7 million. The decrease in capital expenditures for the nine month period
ended September 30, 2003, as compared to the corresponding prior year period,
was primarily the result of capital expenditures made for leasehold improvements
to our new headquarter facility during the nine month period ended September 30,
2002. Nominal capital expenditures for leasehold improvements were made during
the nine month period ended September 30, 2003.
Net cash provided by financing activities for the nine month
period ended September 30, 2003 consisted of $14.6 million in net proceeds from
sales of common stock under our shelf registration statement and our stock
option and employee stock purchase plans and $1.9 million in amounts financed
under our equipment financing arrangement, partially offset by $1.1 million in
principal payments under our equipment financing arrangements. Net cash
provided by financing activities for the nine month period ended September 30,
2002 consisted of $2.1 million in amounts borrowed pursuant to loan arrangements
and, $9.9 million in net proceeds from sales of common shares under our shelf
registration statement and stock option and employee stock purchase plans
partially offset by $0.9 million in principle payments under the loan
arrangements.
Our contractual obligations for the next five years, and
thereafter, are currently as follows as of December 31, 2002 (in thousands):
LESS
THAN 1 1-3 4-5 AFTER 5
CONTRACTUAL OBLIGATIONS(1) YEAR YEARS YEARS YEARS TOTAL
- ----------------------------------- --------- -------- -------- -------- ---------
Equipment and mortgage loans....... $ 1,681 $ 1,889 $ 100 $ 196 $ 3,866
Operating leases................... 1,352 4,304 3,089 5,372 14,117
Research funding................... 117 49 -- -- 166
Minimum royalty payments........... 260 844 620 3,031 4,755
--------- -------- -------- -------- ---------
Total contractual cash
obligations................... $ 3,410 $ 7,086 $ 3,809 $ 8,599 $ 22,904
========= ======== ======== ======== =========
We expect to have negative cash flow from operations through
at least the end of 2004. For the nine month period ended September 30, 2003,
total cash used was $0.5 million or $14.5 million excluding the approximately
$4.7 million in net proceeds received from our March 2003 common stock offering
and approximately $9.3 million in net proceeds from our August 2003 common stock
offering. After the net proceeds of approximately $9.3 million from our August
2003 common stock offering, the receipt in October 2003 of a $2.0 million option
payment from a prospective partner in connection with a potential collaboration
agreement, and the receipt of net proceeds of $2.0 million in November 2003 from
the sale of common shares, we anticipate that our existing capital resources
will enable us to maintain our currently planned levels of operations through
the first nine months of 2004. This expectation is based on our current
operating plan and may change as a result of many factors, including our future
capital requirements and our ability to reduce expenses, which, in many
instances, depend on a number of factors outside our control. For example, our
future cash use will depend on, among other things, 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. Announcements of potential
strategic commercial relationships, including the potential relationship
discussed above, are not an assurance that any such relationship will arise, and
options to participate in such relationships may never be exercised or otherwise
lead to additional revenues. Consequently, we may need additional funding
sooner than anticipated. We currently have no credit facility or committed
sources of capital.
To the extent our capital resources are insufficient to meet
future capital requirements, we expect that we will need to raise additional
capital or incur indebtedness to fund our operations. 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. In December 2001, we filed a shelf registration
statement for the issuance of up to $35.0 million in debt and/or equity
securities. After our common stock offering in August 2003, we have
approximately $9.4 million still available for sale 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 effort 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. To the extent that additional
capital is raised through the sale or 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.
FACTORS THAT MIGHT AFFECT FUTURE RESULTS
You should carefully consider the risks described
below, together with all of the other information included in this report, in
considering our business and prospects. The risks and uncertainties described
below are not the only ones facing Cepheid. Additional risks and uncertainties
not presently known to us or that we currently deem immaterial also may impair
our business operations. The occurrence of any of the following risks could
harm our business, financial condition or results of operations.
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.
We expect to have negative cash flow from operations
through the end of 2004. Although we anticipate that our existing capital
resources will enable us to maintain our currently planned levels of operations
through the first nine months of 2004, this expectation is based on our current
operating plan and may change as a result of many factors, including our future
capital requirements and our ability to reduce expenses, which, in many
instances, depend on a number of factors outside our control. For example, our
future cash use will depend on, among other things, 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. Consequently, we may need
additional funding sooner than anticipated. We currently have no credit
facility or committed sources of capital.
To the extent our capital resources are insufficient to meet future capital
requirements, we expect that we will need to raise additional capital or incur
indebtedness to fund our operations. 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.
There can 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 effort or obtain funds
through arrangements with collaborative partners or others that my require us to
relinquish rights to technologies or products that we might otherwise seek to
develop or commercialize. To the extent that additional capital is raised
through the sale or 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 right preferences or privileges senior to those of our common
stock.
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 2004. We experienced net losses of approximately $14.8 million in
2000, $15.5 million in 2001, $19.7 million in 2002 and $13.0 million for the
first nine months of 2003. As of September 30, 2003, we had an accumulated
deficit of approximately $75.6 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 the USPS BDS program in which
we are participating, and global economic and political conditions. Our ability
to become profitable also depends on our expense levels and product costs, which
are also influenced by a number of factors, including the resources we devote to
developing and supporting our products, to continued progress of our research,
and to development of potential products, and the need to acquire licenses to
new technology or to use our technology in new markets, including the
potentially significant ongoing royalty payments associated with such licenses.
If we fail to grow our revenue and manage our expenses and product costs, we may
never achieve profitability.
Our participation in the U.S. Postal Service bio-threat detection
program evaluation and other similar programs may not result in predictable
contracts or revenues.
Our participation in governmental contracting
programs, including the USPS biothreat detection system program, inevitably
involves significant uncertainties in the timing of decision-making and
deployment and is highly sensitive to changes in national and international
priorities and budgets. We cannot be certain that actual funding, deployment
and operating parameters, or product purchases, will be at currently expected
levels. In addition, we cannot be sure that we will be able to sufficiently
ramp up our manufacturing and implementation capacity to meet, in a timely
fashion, the demands that will be placed on us when we are requested to enter
full-scale production of the components of the BDS that we supply. In this and
any similar future programs, there may be no obligation on the part of the
eventual customer to buy a minimum number of units or tests, so, even if we are
awarded a production contract, we may be subject to our customer's future
spending patterns and budgetary cycles. Furthermore, if we participate in any
other collaborations bidding for government contracts, the bidding and
evaluation process could be lengthy and involve significant expense, and may
never result in a contract or a contract with acceptable terms. Accordingly,
our participation in the USPS biothreat detection system program and other
similar programs are subject to a number of risks and uncertainties and may
never yield significant revenues.
Delays in the time it takes for us to finalize
instrument sales can cause variability and unpredictability in our operating
results.
In recent periods, we have begun to experience longer
sales cycles for our products, which makes it more difficult for us to
accurately forecast revenues in a given period, and may cause revenues and
operating results to vary significantly from period to period. Over the first
nine months of 2003, we have encountered growing delays between the initial
decision to purchase our instruments and final approval of such purchases by our
customers's purchasing departments. We believe that this increase has resulted
mostly from delays in government funding to research institutions. As a result,
we may expend considerable resources on unsuccessful sales efforts or we may not
be able to complete transactions on the schedule anticipated. If this trend
continues, we may not recognize revenues in the timeframe we anticipate, harming
our operating results.
If we cannot successfully commercialize our GeneXpert system, we may
never achieve profitability.
Our GeneXpert system is in the final stages of development. We
anticipate that for the foreseeable future our ability to achieve profitability
will depend in part on the successful commercialization of GeneXpert. Many
factors may affect the market acceptance and commercial success of our GeneXpert
system, including:
- Availability of assays for use in the GeneXpert system;
- timely completion of the GeneXpert system for commercial sale;
- cost-effective commercial scale production of the GeneXpert system;
- the timing of market entry of our GeneXpert system relative to competitive
products;
- our ability to convince our potential customers of the advantages and
economic value of our GeneXpert systems over competing technologies and
products;
- the extent and success of our marketing and sales efforts, including our
ability to enter into successful collaborations with marketing partners;
and
- publicity concerning our GeneXpert system or any similar products.
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.
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. Furthermore, 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. However, we will
require additional 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 a
given product or product feature, or for certain reagents, on commercially
reasonable terms, if at all. Some of these licenses may include significant
upfront and ongoing royalty payments. Some of our competitors have rights to
technologies and reagents that we have not yet obtained. Our failure to obtain
similar rights would limit our ability to offer a system that includes certain
product features or reagents and would adversely affect our competitive position
and our performance.
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 if the
price of our common stock is below $5.00 per share, broker dealers may have to
follow specific disclosure and suitability 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.
The regulatory approval process is expensive, time-consuming, and
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 Food and Drug Administration or foreign
governmental entities prior to their marketing for commercial use. Products,
such as the Smart Cycler and, when it is launched commercially, the GeneXpert
system, when used for clinical diagnostic purposes will require such approval.
To date, we have only received FDA approval for use of the group B streptococcus
assay for Smart Cycler that was developed through our collaboration with
Infectio Diagnostics, Inc. We have not sought approval from the FDA or any
other governmental body for other assays for the Smart Cycler, and we have not
received any such approvals. 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:
- injunctions;
- recall or seizure of products;
- withdrawal of marketing clearances or approvals; and
- fines, civil penalties and criminal prosecutions.
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 face intense competition from a number of companies that offer
products in our targeted application areas. These competitors include:
- companies developing and marketing sequence detection systems for life
sciences research products;
- healthcare companies that manufacture laboratory-based tests and
analyzers;
- diagnostic and pharmaceutical companies;
- companies developing drug discovery technologies; and
- companies developing or offering biothreat detection technologies.
We also face competition from both established and development-stage
companies that continually enter these markets. 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.
We also need to compete effectively with companies developing their own
microfluidics technologies and products. Microfluidic technologies have
undergone and are expected to continue to undergo rapid and significant change.
Rapid technological development may result in our products or technologies
becoming obsolete. Products we offer could be made obsolete either by less
expensive or more effective products based on similar or other technologies.
Our future success will depend on our ability to establish and maintain a
competitive position in these and future technologies. 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 many instances particularly in the clinical genetic assessment 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.
If we fail to compete effectively against these and other competitors, we will
lose sales and our business will be harmed.
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:
- failure of products to perform as expected;
- governmental, academic or industry concerns regarding the reliability or
efficacy of the polymerase chain reaction (PCR) technology on which our systems
are based;
- a perception that our products are difficult to use; or
- litigation concerning the performance of our products or our
technology.
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 risk of exposure to product liability claims if
our technologies or systems are alleged to have caused harm, in part because our
products are used for sensitive applications. 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:
- decreased demand for our products;
- injury to our reputation;
- costs of related litigation; and
- substantial monetary awards to plaintiffs.
If we are the subject of a successful product liability lawsuit that exceeds
the limits of any insurance coverage we may have, we may incur substantial
liabilities, which would adversely affect our earnings and financial condition.
The world geopolitical climate has created increased financial
expectations that may not materialize.
The world geopolitical climate in the wake of the September 11, 2001
terrorist attacks has created increased interest in biothreat detection systems.
However, we are uncertain what the long-term impact will be on our product
sales. To date, we have not generated significant revenues from the market for
biothreat detection systems. As a result, we may not ever realize substantial
revenues from the use of our products in biothreat detection systems and, even
if we do, the amount and timing of such revenues would be subject to substantial
uncertainty.
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 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:
- Infectio Diagnostics, Inc. in a collaborative arrangement to develop a line
of assays adapted to our systems, including the group B streptococcos assay for
Smart Cycler, which began shipping in the second quarter of 2003;
- Northrop Grumman Corp.'s Automation and Information Systems Division,
Sceptor Industries and Smiths Detection, with whom we will jointly install and
test bio-threat detection systems for the USPS;
- Applied Biosystems Group, in a collaboration to develop and sell reagents to
detect biothreat agents for use with our GeneXpert system and cartridges;
and
- Takara Bio, Inc. in a collaboration to manufacture and sell a line of
general use PCR enzyme reagents optimized for use on our products.
Relying on these or other collaborative relationships is risky to our future
success because, among other things:
- our collaborative partners may not devote sufficient resources to the
success of our collaboration;
- our collaborative partners may not obtain regulatory approvals necessary to
continue the collaborations in a timely manner;
- our collaborative partners may develop technologies or components
competitive with our products;
- components developed by collaborators could fail to meet specifications,
possibly causing us to lose potential projects and subjecting us to
liability;
- some agreements with our collaborative partners may terminate prematurely
due to disagreements or may result in litigation between the partners;
- our collaborators may not have sufficient capital resources;
- our existing collaborations may preclude us from entering into additional
future arrangements; or
- we may not be able to negotiate future collaborative arrangements on
acceptable terms.
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 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.
If we launch 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 would be subject
to Quality System Regulation, or QSR, requirements of the FDA. If we fail to
maintain these 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 relatively small sales force compared to our competitors.
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 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
the nine-month period ended September 30, 2003, product sales through
distributors represented 53% 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 33%, 10%, and 10%, respectively,
of total product sales for the nine months ended September 30, 2003. Such
distributors accounted for 38%, 15%, and 4%, respectively, of total product
sales for the corresponding nine month period of the prior year. Takara Bio,
Inc. is the exclusive distributor of Smart Cycler in the life sciences research
market in Japan, South Korea, China 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 is risky
to our future for various reasons, including:
- agreements with distributors may terminate prematurely due to disagreements
or may result in litigation between the partners;
- our distributors may not devote sufficient resources to the sale of
products;
- our distributors may be unsuccessful;
- our existing relationships with distributors may preclude us from entering
into additional future arrangements; and
- we may not be able to negotiate future distributor agreements on acceptable
terms.
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.
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. In addition, some of these licenses could
result in substantial additional royalties, which could adversely impact our
product costs and have an impact on our business.
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, as many countries do not offer the same level of legal protection for
intellectual property as the United States. Furthermore, 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:
- costs of customizing products for foreign countries;
- laws and business practices favoring local competitors;
- dependence on local vendors;
- uncertain regulation of electronic commerce;
- compliance with multiple, conflicting and changing governmental laws and
regulations;
- longer sales cycles;
- potential for exchange and currency risks;
- greater difficulty in collecting accounts receivable;
- import and export restrictions and tariffs;
- difficulties staffing and managing foreign operations;
- greater difficulties and expense in enforcing intellectual property
rights;
- business risks (including fluctuations in demand for our products and the
cost and effort to conduct international operations and travel abroad to promote
international distribution) associated with international military operations,
and the global economic slowdown;
- multiple conflicting tax laws and regulations; and
- political and economic instability.
We intend to expand our international sales and marketing activities,
including through our European subsidiary, 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 the Smart Cycler,
the GeneXpert system, 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.
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:
- government health administration authorities;
- private health coverage insurers;
- managed care organizations; and
- other organizations.
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 payers to contain or reduce
the costs of health care through various means. Additionally, third-party
payers 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
microbiology, regulatory, and sales and marketing. Retaining and training
personnel with the requisite skills is challenging even in today's economy, and,
if general economic conditions improve, is likely to become extremely
competitive again, particularly in the Silicon Valley area of California where
our main office is located. If at any point we are unable to hire, train and
retain a sufficient number of qualified employees to match our growth, 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 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 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
companies or technologies, we will likely face risks, uncertainties and
disruptions associated with the integration process, including difficulties in
the integration of these operations and services of an acquired company,
integration of acquired technology with our products, 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 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 intend to maintain our portfolio of cash equivalents 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 report on Form 10-Q.
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 the
majority of 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
Evaluation of Disclosure Controls and Procedures
Regulations under the Securities Exchange Act of 1934 require public
companies, including our company, to maintain "disclosure controls and
procedures", which are defined to mean a company's controls and procedures
that are designed to ensure that information required to be disclosed in the
reports that it files or submits under the Securities Exchange Act of 1934 is
recorded, processed, summarized and reported, within the time periods specified
in the Commission's rules and forms. Our Chief Executive Officer and Chief
Financial Officer, based on their evaluation of our disclosure controls and
procedures as of the end of the period covered by this report, concluded that
our disclosure controls and procedures were effective for this purpose.
Changes in Internal Controls Over Financial Reporting
Regulations under the Securities Exchange Act of 1934 require public
companies, including our company, to evaluate any change in our "internal
control over financial reporting," which is defined as a process to provide
reasonable assurance regarding the reliability of financial reporting and
preparation of financial statements for external purposes in accordance with
generally accepted accounting principles in the United States. In connection
with their evaluation of our disclosure controls and procedures as of the end of
the period covered by this report, our Chief Executive Officer and Chief
Financial Officer did not identify any change in our internal control over
financial reporting during the three-month period ended September 30, 2003 that
materially affected, or is reasonably likely to materially affect, our internal
control over financial reporting.
PART II
ITEM 1. LEGAL PROCEEDINGS
None
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
None
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
- Exhibits
| |
|
Incorporated by
Reference |
|
Exhibit Number |
Exhibit Description |
Form |
File No. |
Exhibit |
Filing Date |
Filed Herewith |
10.1 |
Change of Control Agreement dated September 8, 2003 between
Cepheid and Ira Marks |
|
|
|
|
X |
31.1 |
Certification of Chief Executive Officer pursuant to Section 302
of the Sarbanes-Oxley Act of 2002. |
|
|
|
|
X |
31.2 |
Certification of Chief Financial Officer pursuant to Section 302
of the Sarbanes-Oxley Act of 2002. |
|
|
|
|
X |
32.1 |
Certification of Chief Executive Officer pursuant to 18 U.S.C.
Section 1350, adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.* |
|
|
|
|
X |
32.2 |
Certification of Chief Financial Officer pursuant to 18 U.S.C.
Section 1350, adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.* |
|
|
|
|
X |
*These certifications "accompany" Cepheid's quarterly report on
Form 10-Q; they are not deemed "filed" for purposes of Section 18 of
the Securities Exchange Act, or otherwise subject to the liability of that
section. Such certification will not be deemed to be incorporated by reference
into any filing under the Securities Act of 1933 or the Securities Exchange Act
of 1934, except to the extent that Cepheid specifically incorporates it by
reference.
- Reports on Form 8-K
On July 31, 2003, Cepheid filed a Current Report on Form 8-K reporting under
Item 12 Cepheid's issuance of a press release announcing its preliminary
financial results for the three months ended June 30, 2003 and certain other
information, and furnishing such press release as an exhibit to such Current
Report.; and
On August 14, 2003, Cepheid filed a Current Report on Form 8-K reporting,
under Item 5:
- Cepheid's issuance of a press release announcing its preliminary
financial results for the three months ended June 30, 2003 and certain other
information and filing such press release as an exhibit to such Current Report;
and
- The sales of 2,777,778 shares of its common stock for $10,000,000.80,
with an option to purchase up to an additional 555,556 shares for an additional
$2,083,335, directly to an institutional investor in an offering under Cepheid's
shelf registration statement on Form S-3.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act
of 1934, 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, 2003.
|
CEPHEID
(Registrant) |
|
By: /s/ John L. Bishop___________
John L. Bishop
Chief Executive Officer and Director
(Duly Authorized Officer) |
|
By: /s/ John R. Sluis
John R. Sluis
Chief Financial Officer
(Principal Accounting Officer) |
