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CPHD > SEC Filings for CPHD > Form 10-Q on 31-Oct-2013All Recent SEC Filings

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Form 10-Q for CEPHEID


31-Oct-2013

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Forward-Looking Statements

This Quarterly Report on Form 10-Q, including this Management's Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 that relate to future events or our future financial performance. In some cases, you can identify forward-looking statements by terminology such as "may", "will", "should", "expect", "plan", "anticipate", "believe", "estimate", "intend", "potential", "project" or "continue", or the negative of these terms or other comparable terminology. Forward-looking statements are based upon current expectations that involve risks and uncertainties. Our actual results and the timing of events could differ materially from those anticipated in our forward-looking statements as a result of many factors, including, but not limited to, the following: our ability to successfully complete and bring on-line additional manufacturing lines; our ability to manage our inventory levels; consistency of product availability and delivery; sales organization productivity; improving gross margins, execution of manufacturing operations, product sales under the High Burden Developing Country ("HBDC") program, commercial test and commercial system sales and improvements in our manufacturing scale-up activities; our success in increasing our commercial and HBDC sales and the effectiveness of our sales personnel; the relative mix of commercial and HBDC sales; the performance and market acceptance of our new products; testing volumes for our products; unforeseen supply, development and manufacturing problems; the potential need for intellectual property licenses for tests and other products and the terms of such licenses; the environment for capital spending by hospitals and other customers for our diagnostic systems; our ability to successfully introduce and sell products in the Clinical market other than healthcare associated infections products; lengthy sales cycles in certain markets, including the HBDC program; long sales cycles and variability in systems placements and reagent pull-through in our HBDC program; the impact of competitive products and pricing; sufficient customer demand; customer confidence in product availability and available customer budgets for our customers; the level of testing at clinical customer sites, including for healthcare associated infections; our ability to consolidate customer demand through volume pricing; our ability to develop new products and complete clinical trials successfully in a timely manner for new products; our ability to obtain regulatory approvals and introduce new products; uncertainties related to FDA regulatory and European regulatory processes; our ability to respond to changing laws and regulations affecting our industry and changing enforcement practices related thereto; the product, geography and channel mix of our sales, each of which can affect our gross margins; our reliance on distributors to market, sell and support our products in certain geographic locations; the occurrence of unforeseen expenditures, asset impairments, acquisitions or other transactions; cost of litigation including settlement costs; our ability to integrate the businesses, technologies, operations and personnel of acquired companies; our ability to manage geographically-dispersed operations; the scope and timing of actual United States Postal Service ("USPS") funding of the Biohazard Detection System ("BDS") in its current configuration; the rate of environmental testing using the BDS conducted by the USPS, which will affect the amount of consumable products sold; underlying market conditions worldwide; and the other risks set forth under "Risk Factors" and elsewhere in this report. We neither undertake, nor assume any 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 are a molecular diagnostics company that develops, manufactures and markets fully-integrated systems for testing in the Clinical and Non-Clinical markets. Our systems enable rapid, sophisticated molecular testing for organisms and genetic-based diseases by automating otherwise complex manual laboratory procedures. Our objective is to become the leading supplier of integrated systems and tests for molecular diagnostics. Key elements of our strategy to achieve this objective include:

Provide a fully-integrated molecular testing solution to the Clinical market. We are focusing our investments on selling our systems and tests to the Clinical market and we believe our GeneXpert system will continue to significantly expand our presence in the Clinical market due to its ability to deliver accurate and rapid results, ease of use, flexibility and scalability. Features of the GeneXpert system and Xpert tests include:

an approach by which the reagents are typically prepackaged in a single vessel (the test cartridge) into which the specimen is added;

no further user intervention once the Xpert cartridge is loaded into the GeneXpert system;

all three phases of PCR: 1) sample preparation, 2) amplification and
3) detection, are performed within the single sealed test cartridge automatically;

primarily moderate complexity Clinical Laboratory Improvement Amendments ("CLIA") categorized, amplified molecular tests, which means the GeneXpert system can be operated without the need for highly-trained laboratory technologists;


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commercial availability in a variety of configurations ranging from one to 80 individual test modules, which enables testing in environments ranging from low volume to high volume, near-patient, core or central lab testing, and system capacity that can be expanded in support of growing test volumes by adding additional modules;

notably, to our knowledge, the only truly scalable real-time PCR system that operates entirely within a closed system architecture, reducing hands-on time, reducing the likelihood of human error and contamination, and enabling nested PCR capability, a proven process for maximizing real-time PCR sensitivity; and

full random access whereby different tests for different targets may be run simultaneously in different modules in the same GeneXpert system, which increases potential utilization and throughput of the system and also enables on-demand or "stat" testing, whereby the user can add a new test to the system at any time without regard to the stage of processing of any other test on the system.

Continue to develop and market new tests. We plan to capitalize on our strengths in nucleic acid chemistry and molecular biology to continue to develop new tests for our systems and offer our customers the broadest menu of Xpert tests designed to address many of the highest volume molecular test opportunities. The Company currently offers a menu of 14 Xpert tests in the U.S. market and a menu of 14 Xpert tests in the international market. Our strategy is to further extend the Xpert test menu to include healthcare associated infections, critical infectious disease, sexual health, women's health, virology, oncology and genetics. For example, our CT/NG test was made commercially available in the U.S. in the first quarter of 2013 and our tuberculosis test was made commercially available in the U.S. in the third quarter of 2013.

Obtain additional target rights. We expect to continue to expand our collaborations with academic institutions and commercial organizations to develop and obtain target rights to various infectious disease and oncology targets. For example, in the first quarter of 2013, we entered into license agreements with Oregon Health & Sciences University to further the development of our prostate and breast oncology tests. In addition, we will be focusing key business development activities on identifying infectious disease and oncology targets held by academic institutions or commercial organizations for potential license or acquisition.

Extend geographic reach. Our international sales and marketing operations are headquartered in France. As of September 30, 2013, we had direct sales forces in the United Kingdom ("U.K."), France, Australia, the Benelux region, Germany, Italy and South Africa, and we have offices in Dubai, China, Japan and Singapore. We acquired our distributor in Italy in April 2013. We will continue to expand our international commercial operations capability on both a direct and distributor basis in 2013 and beyond.

Extend High Burden Developing Countries sales programs. We are developing and expect to continue to expand our presence in HBDCs following the World Health Organization's endorsement of the Xpert MTB/RIF test in late 2010 to deliver GeneXpert systems and Xpert tests to HBDCs at a discount to our standard commercial prices. We believe that participation in the HBDC program considerably broadens the geographic reach of our products and increases recognition of the Cepheid brand and product portfolio. Our ongoing collaboration with the Foundation for Innovative New Diagnostics ("FIND") is expected to broaden the menu of tests available to HBDC customers at special pricing considerations.

CRITICAL ACCOUNTING POLICIES, ESTIMATES AND ASSUMPTIONS

The items that we disclosed as our critical accounting policies and estimates in Management's Discussion and Analysis of Financial Condition and Results of Operation in our 2012 Annual Report on Form 10-K filed with the Securities and Exchange Commission remain unchanged. For a description of the Company's critical accounting policies, please refer to our 2012 Annual Report on Form 10-K.

Comparison of the Three and Nine Months Ended September 30, 2013 and 2012

Sales

The following table summarizes total sales by type (in thousands, except
percentages):



                                          Three Months Ended September 30,                          Nine Months Ended September 30,
                                   2013          2012       $ Change       % Change         2013          2012        $ Change       % Change
Sales:
System and other sales          $   19,694     $ 15,905     $   3,789             24 %    $  54,500     $  48,235     $   6,265             13 %
Reagent and disposable sales        80,387       64,567        15,820             25 %      233,531       190,544        42,987             23 %

Total sales                     $  100,081     $ 80,472     $  19,609             24 %    $ 288,031     $ 238,779     $  49,252             21 %


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The following table summarizes sales in the Clinical and Non-Clinical and Other markets (in thousands, except percentages):

                                          Three Months Ended September 30,                          Nine Months Ended September 30,
                                   2013          2012       $ Change       % Change         2013          2012        $ Change       % Change
Sales by market:
Clinical Systems                 $  17,484     $ 13,049     $   4,435             34 %    $  46,732     $  39,440     $   7,292             18 %
Clinical Reagents                   74,367       54,527        19,840             36 %      212,188       164,727        47,461             29 %

Total Clinical                      91,851       67,576        24,275             36 %      258,920       204,167        54,753             27 %
Non-Clinical                         8,230       12,896        (4,666 )          -36 %       29,111        34,612        (5,501 )          -16 %

Total sales                      $ 100,081     $ 80,472     $  19,609             24 %    $ 288,031     $ 238,779     $  49,252             21 %

Clinical sales increased $24.3 million, or 36%, for the three months ended September 30, 2013 as compared to the same period in the prior year and increased $54.8 million, or 27%, for the nine months ended September 30, 2013 as compared to the same period in the prior year. This increase in Clinical sales for the three month comparative period was primarily due to growth in the commercial Clinical Reagent business, primarily due to growth in healthcare associated infection tests, our CT/NG test and our MTB/RIF test and increased reagent and system sales to our HBDC customers. This increase in Clinical sales for the nine month comparative period was primarily due to growth in the commercial Clinical Reagent business, primarily due to growth in healthcare associated infection tests, our CT/NG test and our MTB/RIF test and increased reagent and system sales to our HBDC customers, partially offset by a decrease in commercial system sales. Clinical sales for the three months ended September 30, 2012 were negatively impacted by challenges in our manufacturing operations which resulted in backorders in both our commercial and HBDC businesses.

Non-Clinical sales decreased $4.7 million, or 36%, for the three months ended September 30, 2013 as compared to the same period in the prior year and decreased $5.5 million, or 16%, for the nine months ended September 30, 2013 as compared to the same period in the prior year. The decreases in Non-Clinical revenues for the three and nine month comparative periods were primarily due to expected decreases in sales of anthrax test cartridges under the USPS BDS program and contract, grant and research revenue.

The following table summarizes sales by geographic region (in thousands, except percentages):

                                          Three Months Ended September 30,                          Nine Months Ended September 30,
                                   2013          2012       $ Change       % Change         2013          2012        $ Change       % Change
Geographic sales information:
North America
Clinical                         $  51,659     $ 42,726     $   8,933             21 %    $ 153,729     $ 135,692     $  18,037             13 %
Non-Clinical                         7,083       11,496        (4,413 )          -38 %       25,937        29,856        (3,919 )          -13 %

Total North America                 58,742       54,222         4,520              8 %      179,666       165,548        14,118              9 %
International
Clinical                            40,192     $ 24,850     $  15,342             62 %      105,191     $  68,475     $  36,716             54 %
Non-Clinical                         1,147        1,400          (253 )          -18 %        3,174         4,756        (1,582 )          -33 %

Total International                 41,339       26,250        15,089             57 %      108,365        73,231        35,134             48 %

Total sales                      $ 100,081     $ 80,472     $  19,609             24 %    $ 288,031     $ 238,779     $  49,252             21 %

North American Clinical sales increased $8.9 million, or 21%, for the three months ended September 30, 2013 as compared to the same period in the prior year and increased $18.0 million, or 13%, for the nine months ended September 30, 2013 as compared to the same period in the prior year. This increase in North American Clinical sales for the three month comparative period was driven by an increase in Xpert test sales and Clinical systems sales, partially offset by a decrease in non-Xpert test sales. This increase in North American Clinical sales for the nine month comparative period was driven by an increase in Xpert test sales, partially offset by a decrease in non-Xpert test sales and Clinical systems sales. North American Non-Clinical sales decreased $4.4 million, or 38%, for the three months ended September 30, 2013 as compared to the same period in the prior year and decreased $3.9 million, or 13%, for the nine months ended September 30, 2013 as compared to the same period in the prior year. The decreases in Non-Clinical revenue for the three and nine month comparative periods were primarily due to decreases in sales of anthrax test cartridges under the USPS BDS program and contract, grant and research revenue.

International sales increased $15.1 million, or 57%, for the three months ended September 30, 2013 as compared to the same period in the prior year and increased $35.1 million, or 48%, for the nine months ended September 30, 2013 as compared to the same period in the prior year. This increase in International sales was primarily driven by clinical reagent sales, commercial Clinical system placements and growth in HBDC systems and reagents.


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We recognized sales of $58.4 million and $51.7 million to U.S. customers for the three months ended September 30, 2013 and 2012, respectively, and $173.0 million and $157.1 million for the nine months ended September 30, 2013 and 2012, respectively. We recognized sales of $11.7 million and $7.8 million in South Africa for the three months ended September 30, 2013 and 2012, respectively, and $31.0 million and $14.9 million for the nine months ended September 30, 2013 and 2012, respectively. Other than South Africa, no other single country outside the United States represented more than 10% of our total sales or total assets in any period presented.

Costs and Operating Expenses

The following table summarizes costs and operating expenses (in thousands,
except percentages):



                                                  Three Months Ended September 30,                               Nine Months Ended September 30,
                                        2013           2012         $ Change         % Change          2013           2012         $ Change         % Change
Costs and operating expenses:
Cost of sales                         $  51,669      $  39,789      $  11,880               30 %     $ 147,450      $ 110,469      $  36,981               33 %
Collaboration profit sharing              1,410          2,438         (1,028 )            -42 %         4,945          5,767           (822 )            -14 %
Research and development                 18,558         16,154          2,404               15 %        54,857         54,374            483                1 %
Sales and marketing                      19,788         15,993          3,795               24 %        58,019         45,613         12,406               27 %
General and administrative                9,490         11,766         (2,276 )            -19 %        28,865         33,828         (4,963 )            -15 %
Loss from legal settlement                   -          15,110        (15,110 )           -100 %            -          15,110        (15,110 )           -100 %

Total costs and operating expenses    $ 100,915      $ 101,250      $    (335 )              0 %     $ 294,136      $ 265,161      $  28,975               11 %

Cost of Sales

Cost of sales consists of raw materials, direct labor and stock-based compensation expense, manufacturing overhead, facility costs and warranty costs. Cost of sales also includes royalties on systems and reagent sales, amortization of intangible assets related to technology licenses and acquired intangibles and the U.S. medical device tax under the Affordable Care Act, which became effective January 1, 2013.

Cost of sales increased $11.9 million, or 30%, for the three months ended September 30, 2013 as compared to the same period in the prior year and increased $37.0 million, or 33%, for the nine months ended September 30, 2013 as compared to the same period in the prior year. The increase for the three months ended September 30, 2013 as compared to the same period in the prior year was attributed to increased shipments of our system and reagent products and the U.S. medical device tax under the Affordable Care Act. The increase for the nine months ended September 30, 2013 compared to the same period in the prior year was attributed to increased shipments of our system and reagent products, manufacturing inefficiencies and increased inventory reserves resulting from scaling activities, and the U.S. medical device tax under the Affordable Care Act.

Our gross margin percentage was 48.4% and 49.1% for the three months ended September 30, 2013 and 2012, respectively, and 48.8% and 52.4% for the nine months ended September 30, 2013 and 2012, respectively. The decrease for the three months ended September 30 2013 as compared to the same period in the prior year was mainly attributable to an increase in our HBDC sales, which have lower gross margins, and the U.S. medical device tax under the Affordable Care Act. The decrease for the nine months ended September 30 2013 as compared to the same period in the prior year was mainly attributable to manufacturing inefficiencies and increased inventory reserves resulting from scaling activities, an increase in our HBDC sales, which have lower gross margins, and the U.S. medical device tax under the Affordable Care Act.

While we expect a trend of increasing gross margins over time, we also expect moderate fluctuations from quarter to quarter, depending on product, geography and channel mix. Of note, our HBDC business contributes significantly lower gross margins than our commercial business. Overall, we expect our gross margin in the fourth quarter of the year to be flat to modestly up from the nine months ended September 30, 2013.

Collaboration Profit Sharing

Collaboration profit sharing represents the amount that we pay to Life Technologies Corporation ("LIFE") under our agreement to develop reagents for use in the USPS BDS program. Under the agreement, computed gross margin on anthrax test cartridge sales is shared equally between the two parties.


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Collaboration profit sharing expense decreased $1.0 million, or 42%, for the three months ended September 30, 2013 as compared to the same period in the prior year and decreased $0.8 million, or 14%, for the nine months ended September 30, 2013 as compared to the same period in the prior year. The change for the three and nine month comparative periods was due to the decrease in anthrax test cartridge sales under the USPS BDS program.

Research and Development Expenses

Research and development expenses consist of salaries and employee-related expenses, including stock-based compensation, clinical trials, research and development materials, facility costs and depreciation. Research and development expenses increased $2.4 million, or 15%, for the three months ended September 30, 2013 as compared to the same period in the prior year. The increase was primarily due to an increase in salaries and employee-related expenses, including stock compensation, and clinical and beta trial expenses.

Research and development expenses increased $0.5 million, or 1%, for the nine months ended September 30, 2013 as compared to the same period in the prior year. The increase during the nine month comparative period was primarily due to increases in salaries and employee-related expenses, including stock based compensation expense.

Sales and Marketing Expenses

Sales and marketing expenses consist primarily of salaries and employee-related expenses, including commissions and stock-based compensation, travel, facility-related costs and marketing and promotion expenses. Sales and marketing expenses increased $3.8 million, or 24%, for the three months ended September 30, 2013 as compared to the same period in the prior year and increased $12.4 million, or 27%, for the nine months ended September 30, 2013 as compared to the same period in the prior year. The increases in both comparative periods were primarily due to an increase in salaries and employee-related expenses in connection with the expansion of our direct sales force and an increase in stock-based compensation expense.

General and Administrative Expenses

General and administrative expenses consist primarily of salaries and employee-related expenses, which include stock-based compensation, travel, facility costs, legal, accounting and other professional fees. General and administrative expenses decreased $2.3 million, or 19%, for the three months ended September 30, 2013 as compared to the same period in the prior year and decreased $5.0 million, or 15%, for the nine months ended September 30, 2013 as compared to the same period in the prior year. The decrease was primarily due to a decrease in legal expenses.

Litigation Settlement

Litigation settlement of $15.1 million consisted of a charge related to the Abaxis settlement in September 2012.

LIQUIDITY AND CAPITAL RESOURCES

Cash and Cash Flow



                                                               Nine Months Ended
                                                                 September 30,
                                                                                    Increase/
                                                   2013             2012            (Decrease)
                                                       (In thousands)
Net cash provided by (used in) operating
activities                                       $  11,748        $    (232 )      $     11,980
Net cash used in investing activities              (51,471 )        (36,681 )           (14,790 )
Net cash provided by financing activities           12,918           26,521             (13,603 )

The net cash provided by operating activities was $11.7 million in the first nine months of 2013. It was primarily comprised of the net effect of cash provided by non-cash expenses and working capital uses of cash. Non-cash expenses were comprised of stock-based compensation, depreciation and amortization expenses. The primary working capital uses of cash for the nine months ended September 30, 2013 were increases in inventory and prepaid expenses partially offset by decreases in accounts receivable and increases in accounts payable, other current liabilities, deferred revenue and accrued compensation.


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The net cash used in operating activities was $0.2 million in the first nine months in 2012. It was primarily comprised of net loss, a litigation settlement and the net effect of cash provided by non-cash expenses and working capital uses of cash. Non-cash expenses were comprised of stock-based compensation, depreciation and amortization expenses and amortization of intangible assets. The primary working capital uses of cash for the nine months ended September 30, 2012 were increases in inventory, prepaid expenses and other current assets and decreases in accrued compensation, accounts payable and other current liabilities partially offset by an increase in deferred revenue and a decrease in accounts receivable.

The net cash used in investing activities was $51.5 million in the first nine months of 2013. It was primarily comprised of capital expenditures, purchases of marketable securities and investments, the cost of acquisitions and cash paid for a technology license.

The net cash used in investing activities was $36.7 million in the first nine months of 2012. It was primarily comprised of capital expenditures and the cost of acquisitions, net of cash received.

The net cash provided by financing activities was $12.9 million in the first nine months of 2013. It was primarily comprised of net proceeds from the issuance of common shares and exercises of stock options.

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