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CPHD > SEC Filings for CPHD > Form 10-Q on 6-May-2014All Recent SEC Filings

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Form 10-Q for CEPHEID


6-May-2014

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: consistency of product availability and delivery; sales organization productivity; speed of test menu expansion and utilization, improving gross margins, execution of manufacturing operations; our success in increasing product sales under the High Burden Developing Country ("HBDC") program; commercial test and commercial system sales; 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; our ability to manage our inventory levels; our ability to successfully complete and improve our manufacturing scale up activities; 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; 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; 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 international 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 testing 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. Our strategy is to offer a portfolio of Xpert tests spanning healthcare associated infections, critical infectious disease, sexual health, women's health, virology, oncology and genetics. For example, Xpert CT/NG and Xpert MTB/RIF were made commercially available in the United States in 2013 and Xpert HPV and Xpert Norovirus were made commercially available in Europe in April 2014.

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. 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 March 31, 2014, we had direct sales forces in Australia, the Benelux region, France, Germany, Hong Kong, Italy, South Africa and the United Kingdom ("UK"), and we have offices in Brazil, China, Dubai, India, Japan and Singapore. We expect to continue to expand our international commercial operations capability on both a direct and distributor basis in 2014 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 2013 Annual Report on Form 10-K filed with the Securities and Exchange Commission remain unchanged. For a description of those critical accounting policies, please refer to our 2013 Annual Report on Form 10-K.

Results of Operations

Comparison of the Three Months Ended March 31, 2014 and 2013

Sales

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



                                               Three Months Ended March 31,
                                      2014          2013       $ Change       % Change
     Sales:
     System and other sales         $  18,529     $ 16,010     $   2,519             16 %
     Reagent and disposable sales      88,378       75,928        12,450             16 %

     Total sales                    $ 106,907     $ 91,938     $  14,969             16 %


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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 March 31,
                                 2014          2013       $ Change       % Change
           Sales by market:
           Clinical Systems    $  17,285     $ 12,537     $   4,748             38 %
           Clinical Reagents      83,160       67,049        16,111             24 %

           Total Clinical        100,445       79,586        20,859             26 %
           Non-Clinical            6,462       12,352        (5,890 )          -48 %

           Total sales         $ 106,907     $ 91,938     $  14,969             16 %

Total Clinical revenues increased $20.9 million, or 26%, for the three months ended March 31, 2014 as compared to the same period in the prior year. The increase in Clinical revenues was led by growth in both Clinical Reagents and Clinical Systems. Clinical Reagent growth of $16.1 million, or 24%, was driven by an increase in Commercial Clinical Reagents of $10.7 million, or 18%, primarily due to a 20% increase in Xpert test revenues, driven by growth across our portfolio of Xpert tests and an increase of $4.9 million, or 74%, in sales of our Xpert MTB/RIF test to our HBDC customers. Clinical Systems revenue increased by $4.7 million, or 38%, primarily driven by higher shipments to both commercial and HBDC customers.

Non-Clinical revenue decreased $5.9 million, or 48%, for the three months ended March 31, 2014 as compared to the same period in the prior year. The decrease in Non-Clinical revenue was primarily due to decreased sales of anthrax test cartridges under the USPS BDS program and decreased contract, grant and research revenue.

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

                                                Three Months Ended March 31,
                                       2014          2013       $ Change       % Change
     Geographic sales information:
     North America
     Clinical                        $  57,286     $ 52,165     $   5,121             10 %
     Non-Clinical                        5,549       11,391        (5,842 )          -51 %

     Total North America                62,835       63,556          (721 )           -1 %

     International
     Clinical                           43,159       27,421     $  15,738             57 %
     Non-Clinical                          913          961           (48 )           -5 %

     Total International                44,072       28,382        15,690             55 %

     Total sales                     $ 106,907     $ 91,938     $  14,969             16 %

North American Clinical sales increased $5.1 million, or 10%, for the three months ended March 31, 2014 as compared to the same period in the prior year. This increase in North American Clinical sales was driven by a 10% increase in Xpert test sales to new and existing customers. North American Non-Clinical sales decreased $5.8 million, or 51%, for the three months ended March 31, 2014 as compared to the same period in the prior year, primarily due to a decrease of anthrax test sales under the USPS BDS program and decreased contract, grant and research revenue.

International sales, which primarily represent sales in Europe and South Africa, increased $15.7 million, or 55%, for the three months ended March 31, 2014 as compared to the same period in the prior year. This increase was primarily driven by growth in commercial and HBDC Xpert test sales, in addition to strong system placements.

No single country outside of the U.S. represented more than 10% of our total sales in any period presented.


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Costs and Operating Expenses

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



                                                  Three Months Ended March 31,
                                         2014          2013       $ Change       % Change
  Costs and operating expenses:
  Cost of sales                        $  53,083     $ 42,892     $  10,191             24 %
  Collaboration profit sharing             1,291        2,110          (819 )          -39 %
  Research and development                21,740       17,727         4,013             23 %
  Sales and marketing                     23,458       19,126         4,332             23 %
  General and administrative              13,667        9,763         3,904             40 %

  Total costs and operating expenses   $ 113,239     $ 91,618     $  21,621             24 %

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 sales, amortization of intangible assets related to technology licenses and acquired intangibles and the U.S. medical device tax under the Affordable Care Act.

Cost of sales increased $10.2 million, or 24%, for the three months ended March 31, 2014 as compared to the same period in the prior year. This increase was attributed to increased shipments of our system and reagent products, offset by manufacturing efficiencies.

Our gross margin percentage was 50% and 53% for the three months ended March 31, 2014 and 2013, respectively. This decrease was attributable to an increase in our HBDC sales, which have significantly lower gross margins than our commercial sales.

While we expect a trend of increasing gross margins over time, we also expect moderate fluctuations from quarter to quarter, depending on product, geography, channel and HBDC mix.

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.

Collaboration profit sharing expense decreased $0.8 million, or 39%, for the three months ended March 31, 2014 as compared to the same period in the prior year. This decrease 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 $4.0 million, or 23%, for the three months ended March 31, 2014 as compared to the same period in the prior year. This increase was primarily due to increases in salaries and employee-related expenses, including stock based compensation expenses, research and development materials and clinical trials.

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 $4.3 million, or 23%, for the three months ended March 31, 2014 as compared to the same period in the prior year. This increase was primarily due to an increase in salaries and employee-related expenses in connection with the expansion of our direct sales force, including stock-based compensation expense, and increases in marketing programs.

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 increased $3.9 million, or 40%, for the three months ended March 31, 2014 as compared to the same period in the prior year. The increase was primarily due to higher legal expenses and an increase in salaries and employee-related expenses, including stock based compensation expense.


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LIQUIDITY AND CAPITAL RESOURCES

Cash and Cash Flow



                                                              Three Months Ended
                                                                   March 31,
                                                                                    Increase/
                                                    2014             2013          (Decrease)
                                                       (In thousands)
Net cash provided by (used in) operating
activities                                       $  (16,856 )      $ 10,477        $   (27,333 )
Net cash used in investing activities              (244,877 )        (9,929 )         (234,948 )
Net cash provided by financing activities           332,290           6,104            326,186

The net cash used in operating activities was $16.9 million in the first three months of 2014. It was primarily comprised of net loss 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 of property and equipment, amortization of debt discount and debt issuance costs and amortization of intangible assets. The primary working capital uses of cash for the three months ended March 31, 2014 were increases in inventory, prepaid expenses and other current assets and accounts receivable and decreases in accrued compensation partially offset by increases in accounts payable and other current liabilities and deferred revenue and a decrease in other non-current assets.

The net cash provided by operating activities was $10.5 million in the first three months of 2013. It was primarily comprised of net income 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 of property and equipment and amortization of intangible assets. The primary working capital uses of cash for the three months ended March 31, 2013 were increases in inventory, prepaid expenses and other current assets and accounts receivable and decreases in accrued compensation partially offset by increases in accounts payable and other current liabilities and deferred revenue and a decrease in other non-current assets.

The net cash used in investing activities was $244.9 million in the first three months in 2014. It was primarily comprised of purchases of marketable securities and investments and capital expenditures.

The net cash used in investing activities was $9.9 million in the first three months in 2013. It was primarily comprised of capital expenditures and cash paid for a technology license.

The net cash provided by financing activities was $332.3 million in the first three months in 2014. It was primarily comprised of net proceeds from the issuance of $345 million in principal amount of convertible senior notes and, to a lesser extent, the issuance of common shares and exercises of stock options, partially offset by the purchase of the capped call transaction for approximately $25.1 million.

The net cash provided by financing activities was $6.1 million in the first three months in 2013. It was primarily comprised of net proceeds from the issuance of common shares and exercises of stock options.

Our sales, earnings, cash flows, receivables and payables are subject to fluctuations due to changes in foreign currency exchange rates. Our risk management strategy utilizes foreign currency contracts to manage our exposure to foreign currency volatility that exists as part of our ongoing business operations. We utilize cash flow hedge contracts to reduce the exchange rate impact on a portion of the net revenue or operating expense of certain anticipated transactions. In addition, we use balance sheet hedge contracts to reduce the exchange rate risk associated primarily with foreign currency denominated receivables and payables. As of March 31, 2014, we had open cash flow and balance sheet hedge contracts with future settlements within one to twelve months. Contracts were primarily denominated in euros, Swedish krona, British pounds and South African rand. We do not enter into any foreign exchange derivative instruments for trading or speculative purposes. The notional principal amounts of our outstanding derivative instruments designated as cash flow hedges are $105.6 million and $96.6 million as of March 31, 2014 and December 31, 2013, respectively. The notional principal amounts of our outstanding derivative instruments not designated as cash flow hedges was $29.6 million and $24.2 million as of March 31, 2014 and December 31, 2013, respectively.

Off-Balance-Sheet Arrangements

As of March 31, 2014, we did not have any off-balance sheet arrangements, as defined in Item 303(a)(4)(ii) of Regulation S-K promulgated under the Securities Act of 1933.


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Financial Condition Outlook

We plan to continue to make expenditures to expand our manufacturing capacity and to support our activities in sales and marketing and research and development. These expenditures may vary from quarter to quarter. We plan to continue to support our working capital needs and anticipate that our existing cash resources will enable us to maintain currently planned operations. Based on past performance and current expectations, we believe that our current available sources of funds will be adequate to finance our operations for at least the next year. This expectation is based on our current and long-term operating plan and may change as a result of many factors, including our future capital requirements and our ability to increase revenues and reduce expenses, which depend on a number of factors outside our control, including general global economic conditions. 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, our ability to gain FDA clearance for our new products, the need to acquire licenses to new technology or to use our technology in new markets, expansion through acquisitions and the availability of other financing.

In the future, we may seek additional funds to support our strategic business needs and may seek to raise such additional funds through private or public sales of securities, strategic relationships, bank debt, lease financing arrangements, or other available means. If additional funds are raised through the issuance of equity or equity-related securities, shareholders may experience additional dilution, or such equity securities may have rights, preferences, or privileges senior to those of the holders of our common stock. If adequate funds are not available or are not available on acceptable terms to meet our business needs, our business may be harmed.

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