Cepheid (CPHD) 10-Q 2010 Q3 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

þ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2010

OR

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                to              

Commission file number 000-30755

CEPHEID

(Exact Name of Registrant as Specified in its Charter)

California	77-0441625
(State or Other Jurisdiction of Incorporation or Organization)	(I.R.S. Employer Identification No.)
904 Caribbean Drive, Sunnyvale, California	94089-1189
(Address of Principal Executive Office)	(Zip Code)

(408) 541-4191

(Registrant’s Telephone Number, Including Area Code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large Accelerated Filer	x	Accelerated Filer	¨
Non-Accelerated Filer	¨  (Do not check if smaller reporting company)	Smaller Reporting Company	¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    ¨  Yes    x  No

As of October 22, 2010 there were 60,275,573 shares of the registrant’s common stock outstanding.

REPORT ON FORM 10-Q FOR THE

QUARTER ENDED SEPTEMBER 30, 2010

INDEX

		Page
Part I.	Financial Information
Item 1.	Financial Statements		3
	Condensed Consolidated Balance Sheets as of September 30, 2010 and December 31, 2009		3
	Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2010 and 2009		4
	Condensed Consolidated Statements of Cash Flows for the three and nine months ended September 30, 2010 and 2009		5
	Notes to Condensed Consolidated Financial Statements		6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		21
Item 3.	Quantitative and Qualitative Disclosures About Market Risk		27
Item 4.	Controls and Procedures		28
Part II.	Other Information
Item 1.	Legal Proceedings		29
Item 1A	Risk Factors		29
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds		39
Item 3.	Defaults Upon Senior Securities		39
Item 4.	(Removed and Reserved)		39
Item 5.	Other Information		39
Item 6.	Exhibits		39
Signatures			41

Cepheid^®, the Cepheid logo, GeneXpert^®, Xpert^®, Xpertise, SmartCycler^®, SmartCycler II, SmartCap^®, I-CORE^®, SmartMix^®, Smart EBV, Smart VZV, and OmniMix^® are trademarks of Cepheid.

PART I — FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

CEPHEID

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except share data)

	September 30, 2010			December 31, 2009
	(unaudited)
ASSETS
Current assets:
Cash and cash equivalents	$	65,191		$	35,786
Short-term investments		—			21,636
Put option		—			3,295
Accounts receivable, net		25,426			23,014
Inventory		37,800			38,015
Prepaid expenses and other current assets		3,871			2,421
Total current assets		132,288			124,167
Property and equipment, net		26,261			24,021
Other non-current assets		739			495
Intangible assets, net		26,803			30,817
Goodwill		18,401			18,626
Total assets	$	204,492		$	198,126
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	23,363		$	22,068
Accrued compensation		9,798			8,869
Accrued royalties		8,805			12,929
Accrued and other liabilities		2,261			1,800
Current portion of deferred revenue		4,492			2,923
Current portion of notes payable		1,139			108
Bank borrowing		—			14,618
Total current liabilities		49,858			63,315
Long-term portion of deferred revenue		2,257			2,279
Notes payable, less current portion		3,891			732
Other liabilities		3,368			4,234
Total liabilities		59,374			70,560
Commitments and contingencies (Note 8)
Shareholders’ equity:
Preferred stock, no par value; 5,000,000 shares authorized, none issued or outstanding		—			—
Common stock, no par value; 100,000,000 shares authorized, 60,200,281 and 58,644,990 shares issued and outstanding at September 30, 2010 and December 31, 2009, respectively		285,241			273,052
Additional paid-in capital		68,792			56,408
Accumulated other comprehensive income		612			371
Accumulated deficit		(209,527	)		(202,265	)
Total shareholders’ equity		145,118			127,566
Total liabilities and shareholders’ equity	$	204,492		$	198,126

The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.

3

CEPHEID

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data)

(unaudited)

	Three Months Ended September 30,						Nine Months Ended September 30,
	2010			2009			2010			2009
Revenues:
Product sales		54,877			40,798			150,707			116,946
Other revenue		1,178			837			3,035			4,477
Total revenues		56,055			41,635			153,742			121,423
Costs and operating expenses:
Cost of product sales		27,279			23,765			78,565			67,705
Collaboration profit sharing		2,404			1,306			5,713			6,547
Research and development		10,986			8,744			30,837			29,397
Sales and marketing		9,969			7,040			28,214			20,769
General and administrative		6,033			5,223			17,596			15,832
Gain from legal settlement		—			(243	)		—			(243	)
Restructuring charge		—			—			—			747
Total costs and operating expenses		56,671			45,835			160,925			140,754
Loss from operations		(616	)		(4,200	)		(7,183	)		(19,331	)
Other income (expense):
Interest income		6			69			160			317
Interest expense		(107	)		(99	)		(218	)		(247	)
Foreign currency exchange gain (loss) and other		(8	)		146			(588	)		577
Other income (expense), net		(109	)		116			(646	)		647
Loss before benefit (provision) for income taxes		(725	)		(4,084	)		(7,829	)		(18,684	)
Benefit (provision) for income taxes		(397	)		245			567			464
Net loss	$	(1,122	)	$	(3,839	)	$	(7,262	)	$	(18,220	)
Basic net loss per share	$	(0.02	)	$	(0.07	)	$	(0.12	)	$	(0.31	)
Diluted net loss per share	$	(0.02	)	$	(0.07	)	$	(0.12	)	$	(0.31	)
Shares used in computing basic net loss per share		59,987			58,335			59,476			58,075
Shares used in computing diluted net loss per share		59,987			58,335			59,476			58,075

The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.

4

CEPHEID

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

	Nine Months Ended September 30,
	2010			2009
Cash flows from operating activities:
Net loss	$	(7,262	)	$	(18,220	)
Adjustments to reconcile net loss to net cash provided by operating activities:
Depreciation and amortization		6,877			6,345
Amortization of intangible assets		5,220			5,117
Amortization of prepaid compensation expense		—			147
Stock-based compensation related to employees and consulting services rendered		12,314			11,031
Write-offs of other intangible assets acquired in acquisitions		25			—
Unrealized gain on auction rate securities		(1,714	)		(8,490	)
Unrealized loss on put option		1,844			7,900
Deferred rent		19			(5	)
Changes in operating assets and liabilities:
Accounts receivable		(2,412	)		(2,113	)
Inventory		285			(319	)
Prepaid expenses and other current assets		(790	)		1,574
Other non-current assets		(244	)		394
Accounts payable and other current liabilities		(2,913	)		8,465
Accrued compensation		929			(646	)
Deferred revenue		1,547			498
Net cash provided by operating activities		13,725			11,678
Cash flows from investing activities:
Capital expenditures		(9,261	)		(7,119	)
Payments for technology licenses		(1,000	)		(1,500	)
Cost of acquisitions, net		(1,300	)		(148	)
Proceeds from the sales of short-term investments		24,800			100
Proceeds from the sale of fixed assets		89			16
Transfer from restricted cash		—			1,500
Net cash provided by (used in) investing activities		13,328			(7,151	)
Cash flows from financing activities:
Net proceeds from the issuance of common shares and exercise of stock options		12,189			5,174
Proceeds from notes payable		4,448			—
Principal payment of bank borrowing		(14,618	)		(40	)
Principal payment of notes payable		(258	)		—
Net cash provided by financing activities		1,761			5,134
Effect of exchange rate change on cash		591			202
Net increase in cash and cash equivalents		29,405			9,863
Cash and cash equivalents at beginning of period		35,786			23,478
Cash and cash equivalents at end of period	$	65,191		$	33,341

The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.

5

CEPHEID

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1. Organization and Summary of Significant Accounting Policies

Organization and Business

Cepheid (the “Company” or “we”) was incorporated in the State of California on March 4, 1996. The Company is a broad-based molecular diagnostics company that develops, manufactures, and markets fully-integrated systems for testing in the Clinical market, as well as for application in the Company’s legacy Industrial, Biothreat and Partner markets. The Company’s systems enable rapid, sophisticated molecular testing for organisms and genetic-based diseases by automating otherwise complex manual laboratory procedures.

The condensed consolidated balance sheet at September 30, 2010, the condensed consolidated statements of operations for the three and nine months ended September 30, 2010 and 2009, and the condensed consolidated statements of cash flows for the nine months ended September 30, 2010 and 2009 are unaudited. In the opinion of management, these condensed consolidated financial statements reflect all normal recurring adjustments that we consider necessary for a fair presentation of our financial position at such dates and the operating results and cash flows for those periods. The accompanying condensed consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States (“U.S.”). However, certain information or footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles (“GAAP”) have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). The results of operations for such periods are not necessarily indicative of the results expected for the remainder of 2010 or for any future period. The condensed consolidated balance sheet as of December 31, 2009 is derived from audited financial statements as of that date but does not include all of the information and footnotes required by accounting principles generally accepted in the U.S. for complete financial statements. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2009. Within the cash flow from operating activities section of the condensed consolidated statements of cash flows and within the current liabilities section of the condensed consolidated balance sheets, certain amounts have been reclassified to conform to the current period presentation.

Principles of Consolidation

The condensed consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries after elimination of intercompany transactions and balances. All gains and losses realized from foreign currency transactions denominated in currencies other than the foreign subsidiary’s functional currency are included in foreign currency exchange gain and other. Adjustments resulting from translating the financial statements of all foreign subsidiaries into U.S. dollars are reported as a separate component of accumulated other comprehensive income in shareholders’ equity. The assets and liabilities of the Company’s foreign subsidiaries are translated from their respective functional currencies into U.S. dollars at the rates in effect at the balance sheet date, and revenue and expense amounts are translated at rates approximating the weighted average rates during the period.

Use of Estimates

The preparation of condensed consolidated financial statements in conformity with U.S. 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.

Fair Value of Financial Instruments

The Company defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Our valuation techniques used to measure fair value maximized the use of observable inputs and minimized the use of unobservable inputs. The fair value hierarchy is based on the following three levels of inputs:

• Level 1—Quoted prices in active markets for identical assets or liabilities.

6

CEPHEID

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

• Level 2—Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

• Level 3—Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

See Note 2, “Fair Value,” for information and related disclosures regarding our fair value measurements.

Cash, Cash Equivalents and Short-Term Investments

Cash and cash equivalents consist of cash on deposit with banks and money market instruments. Interest income includes interest, dividends, amortization of purchase premiums and discounts and realized gains and losses on sales of securities.

The Company designates marketable securities and short-term investments as either trading or available-for-sale and records them at fair value. Realized and unrealized gains and losses on investments are determined on the specific identification method. If designated as a trading security, unrealized gains and losses are recorded to current period operating results. If designated as an available-for-sale security, unrealized holding gains or losses are reported as a component of accumulated other comprehensive income. Marketable securities and short-term investments with maturities greater than 90 days and less than one year are classified as short-term; otherwise they are classified as long-term. When an investment is sold, we report the difference between the sales proceeds and its carrying value (determined based on specific identification) as a capital gain or loss. An impairment charge is recognized when the decline in the fair value of a security below the amortized cost basis as a result of credit losses or otherwise is determined to be other-than-temporary. The Company considers various factors in determining whether to recognize an impairment charge, including the duration of time and the severity to which the fair value has been less than our amortized cost basis, any adverse changes in the investees’ financial condition and whether it is more-likely-than-not that the Company will hold the investment for a period of time sufficient to allow for any anticipated recovery in market value.

Auction Rate Securities

We no longer hold any auction rate securities at September 30, 2010. On June 30, 2010, we notified UBS, the fund manager with which we held our auction rate securities, of our intent to exercise our put option to sell our portfolio of auction rate securities, which were classified as trading securities and recorded at fair value, at par to UBS for $11.8 million. The sale of the auction rate securities settled on July 1, 2010, and $10.5 million of cash was received on the same day, representing the par value of the auction rate securities, net of the related line of credit.

Prior to July 1, 2010, we valued our auction rate securities using a discounted cash flow methodology with significant inputs that included credit quality of the issuer, the percentage and the types of guarantees, contractual maturity, the timing and probability of the auction succeeding or security being called and discount factors. Our portfolio of auction rate securities had failed to settle at auction since March 2008. We collected interest on the investments that failed to settle at auction at the maximum contractual rate.

On November 10, 2008, we accepted a comprehensive settlement arrangement offered by UBS, the fund manager with which we held our auction rate securities. Under the settlement, we had the option (“the put option”) to sell the auction rate securities held in our accounts with UBS to UBS at par value during the period beginning June 30, 2010 and ending July 2, 2012 (“put option exercise period”). Since the settlement agreement was a legally enforceable firm commitment, the put option was recognized as a financial asset at fair value in our financial statements, and accounted for separately from the associated securities. The fair value of the put option was based on the difference in value between the par value and the fair value of the associated auction rate securities. We elected to measure the put option at its fair value, and subsequent changes in fair value also were recognized in respective period financial results. At December 31, 2009, our put option was recorded at fair value, at par for $3.3 million and we had classified these securities as trading. On June 30, 2010, we notified UBS of our intent to exercise our put option to sell our portfolio of auction rate securities, which were classified as trading securities and recorded at fair value, at par to UBS for $11.8 million. In addition, the rights permitted us to establish a demand revolving credit line, payable on demand, in an amount up to 75% of fair value of the securities at a net no cost, meaning that the interest that we paid on the credit line would not exceed the interest that we received on the auction rate securities that we had pledged as security for the credit line. We borrowed $14.7 million on the line of credit on November 10, 2008. On July 1, 2010, we paid down the outstanding loan balance of $1.3 million at June 30, 2010, such that there was no outstanding balance at September 30, 2010, and had an outstanding balance of $14.6 million, which approximated the carrying value, at December 31, 2009.

7

CEPHEID

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

In the third quarter of 2010, we did not record any gain or loss to other income (expense) related to auction rate securities and the put option. In the third quarter of 2009, we recorded a gain to other income (expense), net of $1.6 million to increase the value of our auction rate securities investments classified as trading securities, offset by a loss of $1.4 million to reduce the estimated fair value of the put option. In the first nine months of 2010, we recorded a gain to other income (expense), net of $1.7 million to increase the value of our auction rate securities investments classified as trading securities, offset by a loss of $1.8 million to reduce the estimated fair value of the put option. In the first nine months of 2009, we recorded a gain to other income (expense), net of $8.5 million to increase the value of our auction rate securities investments classified as trading securities, offset by a loss of $7.9 million to reduce the estimated fair value of the put option.

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 method. Accordingly, allocation of fixed production overheads to conversion costs is based on normal capacity of production. Abnormal amounts of idle facility expense, freight, handling costs and spoilage are expensed as incurred and not included in overhead. In addition, unrecognized stock-based compensation cost of approximately $1.2 million was included in inventory as of each of September 30, 2010 and December 31, 2009.

The components of inventory were as follows (in thousands):

	September 30, 2010		December 31, 2009
Raw Materials	$	15,331	$	16,615
Work in Process		12,182		10,933
Finished Goods		10,287		10,467
	$	37,800	$	38,015

Warranty Reserve

The Company warrants its systems to be free from defects for a period of generally 12 to 15 months from the date of sale and its disposable products to be free from defects, when handled according to product specifications, for the stated life of such products. Accordingly, a provision for the estimated cost of warranty repair or replacement is recorded at the time revenue is recognized. The Company’s warranty provision is established using management’s estimate of future failure rates and future costs of repairing any failures during the warranty period or replacing any disposable products with defects. The activities in the warranty provision consisted of the following (in thousands):

	Three Months Ended September 30,						Nine Months Ended September 30,
	2010			2009			2010			2009
Balance at beginning of period	$	918		$	650		$	652		$	655
Costs incurred and charged against reserve		(99	)		(91	)		(455	)		(418	)
Accrual related to current period product sales		459			294			1,228			850
Adjustment to pre-existing warranties		(169	)		(208	)		(316	)		(442	)
Balance at end of period	$	1,109		$	645		$	1,109		$	645

Revenue Recognition

The Company recognizes revenue from product sales when there is persuasive evidence that an arrangement exists, delivery has occurred, the price is fixed or determinable and collectibility is reasonably assured. No right of return exists for the Company’s products except in the case of damaged goods. The Company has not experienced any significant returns of its products. Contract revenues include fees for technology licenses and research and development services, royalties under license and collaboration agreements. Contract revenue related to technology licenses is generally fully recognized only after the license period has commenced, the technology has been delivered and no further involvement of the Company is required. When the Company has continuing involvement related to a technology license, revenue is recognized over the license term. Royalties are typically based on licensees’ net sales of products that utilize the Company’s technology, and royalty revenues are recognized as earned in accordance with the contract terms when the royalties can be reliably measured and their collectibility is reasonably assured, such as upon the receipt of a royalty statement from the customer. Service revenue is recognized when the services have been provided. Shipping and handling costs are expensed as incurred and included in cost of product sales. In those cases where the Company bills shipping and handling costs to customers, the amounts billed are classified as revenue.

8

CEPHEID

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

The Company recognizes revenue from both one-time product sales and longer-term contract arrangements. The Company enters into certain revenue arrangements with multiple deliverables under Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (the “Codification” or “ASC”) 605-25-25. Multiple element revenue agreements are evaluated to determine whether the delivered item has value to the customer on a stand-alone basis and whether objective and reliable evidence of the fair value of the undelivered item exists. Deliverables in an arrangement that do not meet the separation criteria must be treated as one unit of accounting for purposes of revenue recognition. Advance payments received in excess of amounts earned, such as funds received in advance of products to be delivered or services to be performed, are classified as deferred revenue until earned.

Grants and government sponsored research revenue and contract revenue related to research and development services are recognized as the related services are performed based on the performance requirements of the relevant contract. Under such agreements, the Company is required to perform specific research and development activities and is compensated either based on the costs or costs plus a mark-up associated with each specific contract over the term of the agreement or when certain milestones are achieved and recoverability is reasonably assured.

Stock-Based Compensation

Stock-based compensation cost is measured at the grant date based on the fair value of the award and is recognized as expense on a straight-line basis over the requisite service period, which is generally the vesting period. The value of the portion of the award that is ultimately expected to vest is recognized as expense over the requisite service periods in our condensed consolidated statements of operations. We recognize the fair value of our stock option awards as compensation expense over the requisite service period of each award, which is generally four years.

In determining fair value of the share-based compensation payments, we use the Black–Scholes model and a single option award approach, which requires the input of subjective assumptions. These assumptions include: estimating the length of time employees will retain their vested stock options before exercising them (expected term), the estimated volatility of our common stock price over the expected term (volatility), risk-free interest rate and the number of shares subject to options that will ultimately not complete their vesting requirements (forfeitures). Changes in the following assumptions can materially affect the estimate of fair value of stock–based compensation.

• Expected term is determined based on historical experience, giving consideration to the contractual terms of the stock-based awards, vesting schedules and expectations of future employee behavior as influenced by changes to the terms of its stock-based awards.

• Expected volatility is based on the historical volatility for the past 5 years, which approximates the expected term of the option grant.

• Risk-free interest rate is based on the implied yield currently available on U.S. Treasury zero-coupon issues with a remaining term equivalent to the expected term of a stock award.

• Estimated forfeitures are based on voluntary termination behavior as well as analysis of actual option forfeitures.

Foreign Currency Hedging

The Company recognizes derivative instruments, including foreign exchange contracts, in the balance sheet in other assets or liabilities at their fair value. The Company utilizes foreign exchange forward contracts in order to reduce the impact of fluctuations in the value of non-functional currency monetary assets and liabilities upon its financial statements and cash flows. These instruments are used to hedge foreign currency exposures of underlying non-functional currency monetary assets and liabilities primarily arising from intercompany transactions such as intercompany inventory purchases between Cepheid and its foreign subsidiaries. These foreign exchange contracts, carried at fair value, generally have a maturity of three months or less. The Company’s accounting policies for these instruments are based on whether they are designated as hedging transactions. Our foreign exchange contracts were not designated as hedging transactions, therefore, the changes in fair value of the derivatives are recorded in earnings. The Company enters into approximately two to six derivatives per quarter ranging from $0.1 million to $11.5 million in notional value each with a total notional value of approximately $11.0 million and $8.4 million in the third quarter of 2010 and 2009, respectively. As of September 30, 2010, we had two outstanding foreign exchange forward contracts, which were recorded as a derivative liability within accrued and other liabilities with a fair value of approximately $34,000. As of December 31, 2009, we had two outstanding foreign exchange forward contracts, which were recorded as liabilities within accrued and other liabilities with a fair value of approximately $28,000. During the three months ended September 30, 2010 and 2009, the effect of our hedging transactions, consisting entirely of foreign currency forward contracts, on our condensed consolidated statement of operations was a pre-tax loss of approximately $0.9 million and $0.5 million, respectively. During the nine months ended September 30, 2010 and 2009, the effect of our hedging transactions, consisting entirely of foreign currency forward contracts, on our condensed consolidated statement of operations was a pre-tax gain of approximately $0.6 million and a pre-tax loss of approximately $0.8 million, respectively.

9

CEPHEID

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

Net Loss per Share

Basic net loss per share has been calculated based on the weighted-average number of common shares outstanding during the period. Shares used in diluted net loss per share calculations exclude anti-dilutive common stock equivalent shares, consisting of stock options. These anti-dilutive common stock equivalent shares totaled 5,897,000 and 6,392,000 for the three months ended September 30, 2010 and 2009, respectively, and 5,491,000 and 7,745,000 for the nine months ended September 30, 2010 and 2009, respectively.

Comprehensive Loss

Comprehensive loss includes net loss as well as other comprehensive income. As of September 30, 2010 and 2009, the Company’s accumulated other comprehensive income consists solely of cumulative foreign currency translation adjustments.

	Three Months Ended September 30,						Nine Months Ended September 30,
	2010			2009			2010			2009
Net loss	$	(1,122	)	$	(3,839	)	$	(7,262	)	$	(18,220	)
Other comprehensive income (loss):
Foreign currency translation adjustments		102			429			241			487
Comprehensive loss	$	(1,020	)	$	(3,410	)	$	(7,021	)	$	(17,733	)

Income Taxes

The Company accounts for income taxes using an asset and liability approach, which requires recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been recognized in the Company’s condensed consolidated financial statements, but have not been reflected in the Company’s taxable income. A valuation allowance is established to reduce deferred tax assets to their estimated realizable value. Therefore, the Company provides a valuation allowance to the extent that the Company does not believe it is more likely than not that it will generate sufficient taxable income in future periods to realize the benefit of its deferred tax assets.

The Company recognizes interest and penalties related to uncertain tax positions in income tax expense. For the periods presented, the Company did not recognize any interest or penalties related to uncertain tax positions in the condensed consolidated statements of operations.

Recent Accounting Pronouncements

In September 2009, the FASB issued ASU No. 2009-13, “Multiple-Deliverable Revenue Arrangements—a consensus of the FASB Emerging Issues Task Force” (“ASU 2009-13”). It updates the existing multiple-element revenue arrangements guidance currently included under ASC 605-25, which originated primarily from the guidance in EITF Issue No. 00-21, “Revenue Arrangements with Multiple Deliverables.” The revised guidance primarily provides two significant changes: 1) eliminates the need for objective and reliable evidence of the fair value for the undelivered element in order for a delivered item to be treated as a separate unit of accounting, and 2) eliminates the residual method to allocate the arrangement consideration. In addition, the guidance also expands the disclosure requirements for revenue recognition. We will adopt ASU 2009-13 on January 1, 2011. The Company is currently assessing the future impact of this new accounting update to its consolidated financial statements.

In October 2009, the FASB issued ASU No. 2009-14, “Certain Revenue Arrangements That Include Software Elements — a consensus of the FASB Emerging Issues Task Force” (“ASU 2009-14”). It modifies the scope of ASC subtopic 985-605 Software-Revenue Recognition to exclude from its requirements: 1) non-software components of tangible products and 2) software components of tangible products that are sold, licensed, or leased with tangible products when the software components and non-software components of the tangible product function together to deliver the tangible product’s essential functionality. We will adopt ASU 2009-14 on January 1, 2011. The Company is currently assessing the future impact of this new accounting update to its consolidated financial statements.

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(Unaudited)

2. Fair Value

The following table represents the fair value hierarchy for our financial assets (cash equivalents and short-term investments) and financial liabilities (foreign currency derivatives) measured at fair value on a recurring basis as of September 30, 2010 and December 31, 2009 (in thousands):

Balance as of September 30, 2010:	Level 1		Level 2		Level 3		Total
Assets:
Cash	$	65,191	$	—	$	—	$	65,191
Total	$	65,191	$	—	$	—	$	65,191
Liabilities:
Foreign currency derivatives		—	$	34		—	$	34
Total	$	—	$	34	$	—	$	34
Balance as of December 31, 2009:	Level 1		Level 2		Level 3		Total
Assets:
Cash	$	30,208	$	—	$	—	$	30,208
Cash equivalent - money market funds		5,578		—		—		5,578
Short-term investments - taxable auction rate securities		—		—		21,636		21,636
Put option		—		—		3,295		3,295
Total	$	35,786	$	—	$	24,931	$	60,717
Liabilities:
Foreign currency derivatives		—	$	28		—	$	28
Total	$	—	$	28	$	—	$	28

The Company recorded derivative assets and liabilities at fair value. The Company’s derivatives consist of foreign exchange forward contracts. The Company has elected to use the income approach to value the derivatives, using observable Level 2 market expectations at the measurement date and standard valuation techniques to convert future amounts to a single present amount assuming that participants are motivated, but not compelled to transact.

Level 2 inputs for the valuations are limited to quoted prices for similar assets or liabilities in active markets (specifically foreign currency spot rate and forward points) and inputs other than quoted prices that are observable for the asset or liability (specifically LIBOR rates, credit default spot rates, and company specific LIBOR spread). Mid-market pricing is used as a practical expedient for fair value measurements. The fair value measurement of an asset or liability must reflect the nonperformance risk of the entity and the counterparty. Therefore, the impact of the counterparty’s creditworthiness when in an asset position and the Company’s creditworthiness when in a liability position has also been factored into the fair value measurement of the derivative instruments and did not have a material impact on the fair value of these derivative instruments. Both the counterparty and the Company are expected to continue to perform under the contractual terms of the instruments.

Level 3 assets consist of auction rate securities whose underlying assets are student loans, most of which are guaranteed by the federal government. In February 2008, auctions began to fail for these securities, and since then each auction in our portfolio failed. Prior to the settlement of exercising our put option to sell the auction rate securities held in our accounts with UBS to UBS at par value on July 1, 2010, we had classified the auction rate securities as short-term assets on our condensed consolidated balance sheet as of December 31, 2009. These investments were valued at fair value. The following table provides a summary of changes in fair value of our auction rate securities and put option for the nine-month periods ended September 30, 2010 and 2009 (in thousands):

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(Unaudited)

	Level 3
Balance at January 1, 2010	$	24,931
Settlements		(24,800	)
Unrealized gain of auction rate securities included in current period earnings		1,714
Unrealized loss of put option included in current period earnings		(1,845	)
Balance at September 30, 2010	$	—
		Level 3
Balance at January 1, 2009	$	24,539
Settlements		(100	)
Unrealized gain of auction rate securities included in current period earnings		8,490
Unrealized loss of put option included in current period earnings		(7,899	)
Balance at September 30, 2009	$	25,030

Our investment portfolio of auction rate securities was structured with short-term interest rate reset dates of generally less than 30 days, but with contractual maturities well in excess of ten years. Our auction rate securities consisted of investments that were backed by pools of student loans, which were principally guaranteed by the Federal Family Educational Loan Program, or insured. We believed that the credit quality of these securities was high based on these guarantees. We determined the fair market values of our financial instruments based on the fair value hierarchy requirements for an entity to maximize the use of observable inputs (Level 1 and Level 2 inputs) and minimize the use of unobservable inputs (Level 3 inputs) when measuring fair value. Until the first quarter of 2008, the fair values of our auction rate securities were determinable by reference to frequent successful Dutch auctions of such securities, which settled at par. Therefore, at the adoption date, we had categorized our investments in auction rate securities as Level 1. Given the failures in the auction markets to provide quoted market prices of the securities, as well as the lack of any correlation of these instruments to other observable market data, we valued these securities using a discounted cash flow methodology with the most significant input categorized as Level 3. Significant inputs that went into the model were the credit quality of the issuer, the percentage and the types of guarantees, contractual maturity, the timing and probability of the auction succeeding or the security being called and discount factors.

On November 10, 2008, we accepted a comprehensive settlement arrangement offered by UBS, the fund manager with which we held our auction rate securities. Under the settlement, we had the option to sell the auction rate securities held in our accounts with UBS to UBS at par value during the put option exercise period. Since the settlement agreement was a legally enforceable firm commitment, the put option was recognized as a financial asset at fair value in our financial statements, and accounted for separately from the associated securities. The fair value of the put option was based on the difference in value between the par value and the fair value of the associated auction rate securities. We elected to measure the put option at its fair value, and subsequent changes in fair value also were recognized in respective period financial results. At December 31, 2009, our put option was recorded at fair value, at par for $3.3 million and we had classified these securities as trading. On June 30, 2010, we notified UBS of our intent to exercise our put option to sell our portfolio of auction rate securities, which were classified as trading securities and recorded at fair value, at par to UBS for $11.8 million. In addition, the rights permitted us to establish a demand revolving credit line, payable on demand, in an amount up to 75% of fair value of the securities at a net no cost, meaning that the interest that we paid on the credit line would not exceed the interest that we received on the auction rate securities that we had pledged as security for the credit line. We borrowed $14.7 million on the line of credit on November 10, 2008. On July 1, 2010, we paid down the outstanding loan balance of $1.3 million at June 30, 2010, such that there was no outstanding balance at September 30, 2010, and had an outstanding balance of $14.6 million, which approximated the carrying value, at December 31, 2009.

In the third quarter of 2010, we did not record any gain or loss to other income (expense) related to auction rate securities and the put option. In the third quarter of 2009, we recorded a gain to other income (expense), net of $1.6 million to increase the value of our auction rate securities investments classified as trading securities, offset by a loss of $1.4 million to reduce the estimated fair value of the put option. In the first nine months of 2010, we recorded a gain to other income (expense), net of $1.7 million to increase the value of our auction rate securities investments classified as trading securities, offset by a loss of $1.8 million to reduce the estimated fair value of the put option. In the first nine months of 2009, we recorded a gain to other income (expense), net of $8.5 million to increase the value of our auction rate securities investments classified as trading securities, offset by a loss of $7.9 million to reduce the estimated fair value of the put option.

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(Unaudited)

3. Intangible Assets and Goodwill

Intangible assets related to licenses are recorded at cost, less accumulated amortization. Intangible assets related to technology and other intangible assets acquired in acquisitions are recorded at fair value at the date of acquisition, less accumulated amortization. Intangible assets are amortized over their estimated useful lives, ranging from 3 to 20 years, on a straight-line basis, except for intangible assets acquired in acquisitions, which are amortized on the basis of economic useful life. Amortization of intangible assets is primarily included in cost of product sales in the accompanying condensed consolidated statements of operations.

The recorded value and accumulated amortization of major classes of intangible assets were as follows (in thousands):

Balance, September 30, 2010	Gross Carrying Amount		Accumulated Amortization			Net Carrying Amount
Licenses	$	44,507	$	(25,652	)	$	18,855
Technology acquired in acquisitions		8,724		(2,941	)		5,783
Other		4,303		(2,138	)		2,165
	$	57,534	$	(30,731	)	$	26,803
Balance, December 31, 2009	Gross Carrying Amount		Accumulated Amortization			Net Carrying Amount
Licenses	$	44,507	$	(21,792	)	$	22,715
Technology acquired in acquisitions		8,613		(2,027	)		6,586
Other		3,183		(1,667	)		1,516
	$	56,303	$	(25,486	)	$	30,817

During the first nine months of 2010, the Company completed 2 acquisitions of certain assets of distributors. These acquisitions were not material, individually nor in the aggregate. Technology acquired in acquisitions and other intangible assets increased a total of $1.2 million at September 30, 2010 from December 31, 2009. Of that increase, $1.1 million related to other intangibles acquired in the acquisitions of certain assets of distributors and $0.1 million as a result of currency translation to foreign subsidiaries whose functional currency is not the U.S. dollar.

Included in licenses was $19.9 million in connection with a patent license agreement with F. Hoffman-La Roche Ltd. (“Roche”), effective July 1, 2004. The net carrying value of this license was $7.5 million and $9.0 million at September 30, 2010 and December 31, 2009, respectively.

Amortization expense of intangible assets was $1.7 million for both the three months ended September 30, 2010 and 2009, and $5.2 million and $5.1 million for the nine months ended September 30, 2010 and 2009, respectively. The expected future annual amortization expense of intangible assets recorded on our condensed consolidated balance sheet as of September 30, 2010 is as follows, assuming no impairment charges (in thousands):

For the Years Ending December 31,	Amortization Expense
2010 (remaining three months)	$	1,765
2011		6,924
2012		5,545
2013		4,832
2014		3,494
Thereafter		4,243
Total expected future annual amortization	$	26,803

As of September 30, 2010, goodwill decreased $0.2 million from $18.6 million at December 30, 2009 to $18.4 million at September 30, 2010 as a result of currency translation to foreign subsidiaries whose functional currency is not the U.S. dollar.

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(Unaudited)

4. Segment and Significant Concentrations

We and our wholly owned subsidiaries operate in one business segment.

The following table illustrates product sales in the Clinical, Industrial, Biothreat and Partner markets:

	Three Months Ended September 30,				Nine Months Ended September 30,
	2010		2009		2010		2009
	(In thousands)				(In thousands)
Product sales by market:
Clinical Systems	$	8,543	$	5,804	$	21,665	$	16,246
Clinical Reagents		33,215		24,098		94,412		64,101
Total Clinical		41,758		29,902		116,077		80,347
Industrial		4,693		4,986		14,059		13,010
Biothreat		7,291		3,985		17,534		19,666
Partner		1,135		1,925		3,037		3,923
Total product sales	$	54,877	$	40,798	$	150,707	$	116,946

We currently sell our products through our direct sales force and through third-party distributors. There was one direct customer that accounted for 13% and 10% of total product sales for the three months ended September 30, 2010 and 2009, respectively, and the same customer accounted for 12% and 17% of total product sales for the nine months ended September 30, 2010 and 2009, respectively. The same customer’s accounts receivable balance represented 1% and 12% of total accounts receivable, net as of September 30, 2010 and December 31, 2009, respectively. We have distribution agreements with several companies to distribute products in the U.S. and have several regional distribution arrangements throughout Europe, Japan, China, Mexico and other parts of the world.

The following table provides a breakdown of product sales by geographic region (in thousands):

	Three Months Ended September 30,				Nine Months Ended September 30,
	2010		2009		2010		2009
Product Sales Geographic information:
North America
Clinical	$	33,796	$	22,913	$	91,506	$	61,424
Other		11,624		9,100		29,232		31,127
Total North America		45,420		32,013		120,738		92,551
International
Clinical	$	7,962	$	6,989	$	24,571	$	18,922
Other		1,495		1,796		5,398		5,473
Total International		9,457		8,785		29,969		24,395
Total product sales	$	54,877	$	40,798	$	150,707	$	116,946

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

5. Collaboration Profit Sharing

Collaboration profit sharing represents the amount that the Company pays to Life Technologies Corporation (“LIFE”) under our collaboration agreement to develop reagents for use in the Biohazard Detection System (“BDS”) developed for the United States Postal Service (“USPS”). Under the agreement, computed gross margin on anthrax cartridge sales are shared equally between the two parties. Collaboration profit sharing expense was $2.4 million and $1.3 million for the three months ended September 30, 2010 and 2009, respectively, and $5.7 million and $6.5 million for the nine months ended September 30, 2010 and 2009, respectively. The total revenues and cost of sales related to these cartridge sales are included in the respective balances in the consolidated statement of operations.

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(Unaudited)

6. Employee Equity Incentive Plans and Stock-Based Compensation Expense

The stock-based compensation expense in the condensed consolidated statement of operations was as follows (in thousands):

	Three Months Ended September 30,				Nine Months Ended September 30,
	2010		2009		2010		2009
Cost of product sales	$	828	$	647	$	1,835	$	1,729
Research and development		1,321		1,048		3,838		3,895
Sales and marketing		805		613		2,847		1,991
General and administrative		1,441		1,048		3,794		3,416
Total stock-based compensation expense	$	4,395	$	3,356	$	12,314	$	11,031

Stock-based compensation cost of approximately $1.2 million was included in inventory as of September 30, 2010 and December 31, 2009.

A summary of option activity under all plans is as follows (in thousands, except weighted average exercise price and weighted average remaining contractual term):

	Shares			Weighted Average Exercise Price		Weighted Average Remaining Contractual Term		Aggregate Intrinsic Value
Outstanding, December 31, 2009		9,752		$	11.52
Granted		1,338		$	19.65
Exercised		(1,032	)	$	8.85
Forfeited		(228	)	$	16.25
Outstanding, September 30, 2010		9,830		$	12.80		4.34	$	64,874
Exercisable, September 30, 2010		6,513		$	10.98		3.70	$	53,504
Vested and expected to vest, September 30, 2010		9,205		$	12.57		4.27	$	62,561

A summary of all restricted stock plan activity, which consists of restricted stock awards and restricted stock units, is as follows (in thousands, except weighted average grant date fair value):

	Shares			Weighted Average Grant Date Fair Value
Outstanding, December 31, 2009		65		$	14.60
Granted		282			15.02
Vested/Released		(58	)		15.14
Cancelled		(8	)		8.43
Outstanding, September 30, 2010		281		$	14.99

The fair value of our stock options granted to employees and shares purchased by employees under the ESPP was estimated using the following assumptions:

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(Unaudited)

	Three Months Ended September 30,						Nine Months Ended September 30,
	2010			2009			2010			2009
OPTION SHARES:
Expected Term (in years)		4.61			4.52			4.61			4.52
Volatility		0.55			0.75			0.56			0.73
Expected Dividends		—	%		—	%		—	%		—	%
Risk Free Interest Rates		1.41	%		2.21	%		2.19	%		1.82	%
Estimated Forfeitures		7.74	%		8.14	%		7.74	%		8.01	%
ESPP SHARES:
Expected Term (in years)		1.25			1.25			1.25			1.25
Volatility		0.59			0.84			0.65			0.84
Expected Dividends		—	%		—	%		—	%		—	%
Risk Free Interest Rates		0.37	%		0.62	%		0.46	%		0.62	%

The weighted average fair value of our stock options granted to employees was $7.80 and $7.42 for the three months ended September 30, 2010 and 2009, respectively, and $9.34 and $5.02 for the nine months ended September 30, 2010 and 2009, respectively. Also, the weighted average fair value for our shares purchased by employees under the ESPP was $7.00 and $3.60 for the three months ended September 30, 2010 and 2009, respectively, and $6.90 and $3.60 for the nine months ended September 30, 2010 and 2009, respectively.

7. Income Taxes

The income tax provision of $0.4 million for the three months ended September 30, 2010 relates primarily to an increase in taxable income in our French subsidiary, partially offset by a tax benefit for research and development tax credits and the amortization of acquired intangibles in Sweden. The income tax benefit of $0.2 million for the three months ended September 30, 2009 relates primarily to research and development tax credits and the amortization of acquired intangibles in Sweden. The income tax benefit of $0.6 million and $0.5 million for the nine months ended September 30, 2010 and 2009, respectively, relates primarily to research and development tax credits and the amortization of acquired intangibles in Sweden.

We utilize the liability method of accounting for income taxes. Under the liability method, deferred taxes are determined based on the temporary differences between the financial statement and tax bases of assets and liabilities using enacted tax rates. Our position is to record a valuation allowance when it is more likely than not that some of the deferred tax assets will not be realized.

For federal income tax purposes, the Company has open tax years from 1996 through 2009 due to net operating loss carryforwards relating to these years. Substantially all material state, local and foreign income tax matters have been concluded for years through December 31, 2001. For California state income tax purposes, the Company has open years from 2000 through 2009 due to either research credit carryovers or net operating loss carryforwards.

We recognize interest and penalties accrued on any unrecognized tax benefits as a component of income tax expense. For the periods presented the amount of any interest or penalties related to uncertain tax positions was not material.

Our total unrecognized tax benefit as of the January 1, 2007 adoption date and as of December 31, 2009 were $0.2 million and $4.7 million, respectively. Although unrecognized tax benefits for individual tax positions may have increased or decreased during the nine months ended September 30, 2010, we do not currently believe that there will be a significant increase or decrease in unrecognized tax benefits. Based on our analysis, no significant change to reserves has occurred in the nine months ended September 30, 2010.

8. Commitments and Contingencies

Net rent expense for all operating leases, partially offset by subleasing a portion of our office space to a third party, for the three months ended September 30, 2010 and 2009, was $1.1 million and $1.0 million, respectively, and for the nine months ended September 30, 2010 and 2009, was $3.0 million and $2.7 million, respectively . The minimum lease payments under non-cancelable operating leases, net of future minimum contractual sublease income, as of September 30, 2010, are as follows (in thousands):

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(Unaudited)

Years Ending December 31,	Net Lease Payments
2010 (remaining three months)	$	1,024
2011		5,482
2012		5,094
2013		4,759
2014 and thereafter		23,264
Total minimum payments	$	39,623

As of September 30, 2010, purchase commitments consisted of $4.6 million, $3.7 million, $2.5 million, $2.5 million and $0 for the remainder of 2010, 2011, 2012, 2013 and 2014 and thereafter, respectively.

We have certain royalty commitments associated with the shipment and licensing of certain products. Royalty expense is generally based on a dollar amount per unit shipped or a percentage of the underlying revenue.

In the normal course of business, we provide indemnifications of varying scope to customers against claims of intellectual property infringement made by third parties arising from the use of our products. Historically, costs related to indemnification provisions have not been significant and we are unable to estimate the maximum potential impact of these indemnification provisions on our future results of operations.

To the extent permitted under California law, we have agreements whereby we indemnify our directors and officers for certain events or occurrences while the director or officer is, or was serving, at our request in such capacity. The indemnification period covers all pertinent events and occurrences during the director’s or officer’s service. The maximum potential amount of future payments we could be required to make under these indemnification agreements is not specified in the agreements; however, we have director and officer insurance coverage that reduces our exposure and enables us to recover a portion of any future amounts paid. We believe the estimated fair value of these indemnification agreements in excess of applicable insurance coverage is minimal.

On June 28, 2010, Abaxis, Inc. filed suit in United States District Court for the Northern District of California against us, alleging that our Xpert MRSA product infringes on U.S. Patent No. 5,413,732, U.S. Patent No. 5,624,597, U.S. Patent No. 5,776,563 and U.S. Patent No. 6,251,684. On July 12, 2010, we filed our response to the suit, denying Abaxis’ allegations of infringement and asked the Court to find Abaxis’ patents invalid and not infringed. On August 5, 2010, Abaxis filed its response to our answer and counterclaim.

We may be subject to additional various claims, complaints and legal actions that arise from time to time in the normal course of business. Other than as described above, we do not believe we are party to any currently pending legal proceedings, the outcome of which could have a material adverse effect on our operations or financial position. There can be no assurance that existing or future legal proceedings arising in the ordinary course of business or otherwise will not have a material adverse effect on our business, consolidated financial position, results of operations or cash flows.

We respond to claims arising in the ordinary course of business. In certain cases, management has accrued estimates of the amounts it expects to pay upon resolution of such matters, and such amounts are included in other accrued liabilities. Should we not be able to secure the terms management expects, these estimates may change and will be recognized in the period in which they are identified. Although the ultimate outcome of such claims is not presently determinable, management believes that the resolution of these matters will not have a material adverse effect on our financial position, results of operations and cash flows.

9. Derivative Instruments and Hedging Activities

The Company is exposed to global market risks, including the effect of changes in foreign currency exchange rates and uses derivatives to manage financial exposures that occur in the normal course of business. The Company does not hold or issue derivatives for trading or speculative purposes.

The Company enters into foreign exchange forward contracts to mitigate the change in fair value of our net recognized foreign currency assets and liabilities and to reduce the risk that our earnings and cash flows will be adversely affected by changes in exchange rates. These derivative instruments are not designated as hedging instruments. Accordingly, changes in the fair value of these derivative instruments are recognized immediately in other income (expense), net on the statement of operations together with the transaction gain or loss from the hedged balance sheet position. These derivative instruments do not subject us to material balance sheet risk due to exchange rate movements because gains and losses on these derivatives are intended to offset gains and losses on the assets and liabilities being hedged.

The Company’s derivative financial instruments present certain market and counterparty risks; however, concentration of counterparty risk is mitigated as the Company deals with major banks with Standard & Poor’s and Moody’s long-term debt ratings of A or higher. In addition, only conventional derivative financial instruments are utilized. At this time, the Company does not require collateral or any other form of securitization to be furnished by the counterparties to its derivative financial instruments.

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(Unaudited)

The fair value of derivative instruments in our condensed consolidated balance sheet as of September 30, 2010 was as follows (in thousands):

	Fair Value of Derivative Instruments
	Asset Derivatives				Liability Derivatives
Category	Balance Sheet Location		Fair Value (assets)		Balance Sheet Location		Fair Value (liabilities)
Derivatives not designated as hedging instruments:
Forward exchange forward contracts		Prepaid expense and other current assets	$	—		Accrued and other liabilities	$	34

The fair value of derivative instruments in our condensed consolidated balance sheet as of December 31, 2009 was as follows (in thousands):

	Fair Value of Derivative Instruments
	Asset Derivatives				Liability Derivatives
Category	Balance Sheet Location		Fair Value (assets)		Balance Sheet Location		Fair Value (liabilities)
Derivatives not designated as hedging instruments:
Forward exchange forward contracts		Prepaid expense and other current assets	$	—		Accrued and other liabilities	$	28

The effect of derivative instruments on our condensed consolidated statement of operations for the three and nine months ended September 30, 2010 was as follows (in thousands):

			Three Months Ended September 30, 2010			Nine Months Ended September 30, 2010
Designation	Trade Type	Statement of Operations Location	Gain (Loss) Recognized			Gain (Loss) Recognized
Derivatives Not Designated as Hedging Instruments	Forward exchange forward contracts	Foreign currency exchange gain (loss) and other	$	(875	)	$	595

The effect of derivative instruments on our condensed consolidated statement of operations for the three and nine months ended September 30, 2009 was as follows (in thousands):

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(Unaudited)

			Three Months Ended September 30, 2009			Nine Months Ended September 30, 2009
Designation	Trade Type	Statement of Operations Location	Loss Recognized			Loss Recognized
Derivatives Not Designated as Hedging Instruments	Forward exchange forward contracts	Foreign currency exchange gain (loss) and other	$	(518	)	$	(809	)

10. Gain from Legal Settlement

During the third quarter of 2009, we entered into a settlement with a vendor regarding certain issues under multiple agreements. Pursuant to the settlement, the vendor paid us $0.2 million, which we have recorded as a gain.

11. Restructuring Charge

During the first quarter of 2009, we eliminated 47 positions that impacted employees, contractors and replacement positions, which resulted in $0.7 million of restructuring expense, mainly related to severance. All amounts pertaining to the 2009 restructuring were paid in 2009. We recognized no restructuring expenses during the first nine months of 2010.

12. Notes Payable and Bank Borrowing

Notes payable

On June 7, 2010, the Company entered into a loan and security agreement (the “Loan Agreement”) with Silicon Valley Bank (“SVB”), which provided for (i) a total revolving credit line of up to $15.0 million with a maturity date of June 7, 2012 and bearing interest no less than 4.0% with a commitment fee of 0.75% per annum on the unused portion, and (ii) a total term line of $6.0 million, $2.0 million of which was funded on the effective date of the Loan Agreement, $2.0 million of which was funded in the third quarter of 2010 and $2.0 million of which must be requested by the Company no later than November 1, 2010, with a maturity date for each term loan of 48 months following funding and bearing interest no less than 5.5%. The borrowings under the Loan Agreement are collateralized by a first priority security interest in certain assets of the Company. The Company had an outstanding balance of $3.8 million on the term line and no outstanding balance under the revolving credit line at September 30, 2010. The loan agreement requires the Company to maintain no less than 75% of its consolidated cash and cash equivalents in the operating bank accounts in the U.S. as collateral. Also, the loan agreement requires a covenant for the Company to satisfy a minimum consolidated EBITDA – Earnings Before Interest, Taxes, Depreciation and Amortization on a quarterly basis and a minimum liquidity covenant on a monthly basis. If the Company violates any of these covenants or otherwise breaches the loan agreement, the Company may be required to repay the loans prior to their stated maturity dates, and the bank may be able to foreclose on any collateral in the Company’s operating accounts. The Company was in compliance with these covenants as of September 30, 2010. As of September 30, 2010, the minimum SVB loan principal payments are as follows (in thousands):

Years Ending December 31,	SVB Loan Payments
2010 (remaining three months)	$	250
2011		1,000
2012		1,000
2013		1,000
2014 and thereafter		542
Total minimum payments	$	3,792

The Company had an outstanding note payable of $1.2 million and $0.8 million at September 30, 2010 and December 31, 2009, respectively, with its real property in France pledged as collateral for the loan.

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CEPHEID

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

Bank Borrowing

The UBS comprehensive settlement agreement permitted the Company to establish a demand revolving credit line, payable on demand, in an amount up to 75% of the fair market value of the auction rate securities at a net no cost, meaning that the interest the Company paid on the credit line would not exceed the interest that the Company received on the auction rate securities that the Company had pledged as security for the credit line. The Company borrowed $14.7 million on the line of credit on November 10, 2008 and had no outstanding balance at September 30, 2010 and an outstanding balance of $14.6 million at December 31, 2009.

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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: the impact of the current uncertainty in global economic conditions on our target markets and our business; continued market acceptance of our healthcare associated infection products; changes in the protocols, best practices or level of testing for healthcare associated infections; testing volumes for other infections; development and manufacturing problems; the need for additional intellectual property licenses for new tests and other products and the terms of such licenses; our ability to successfully sell additional products in the Clinical market; lengthy sales cycles in certain markets; the performance and market acceptance of our new products; our ability to obtain regulatory approvals and introduce new products into the Clinical market; our ability to respond to changing laws and regulations affecting our industry; the level of testing at existing clinical customer sites; the mix of products sold, which can affect gross margins; our reliance on distributors to market, sell and support our products; the occurrence of unforeseen expenditures, asset impairments, acquisitions or other transactions; litigation costs; our ability to integrate the businesses, technologies, operations and personnel of acquired companies; the scope and timing of actual USPS funding of the 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; our success in increasing our direct sales and the effectiveness of our sales personnel; the impact of competitive products and pricing; our ability to manage geographically-dispersed operations; our ability to continue to realize manufacturing efficiencies, which is an important factor in improving gross margins; 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 broad-based molecular diagnostics company that develops, manufactures, and markets fully-integrated systems for testing in the Clinical market, as well as for application in our legacy Biothreat, Industrial and Partner markets. Our systems enable rapid, sophisticated molecular testing for organisms and genetic-based diseases by automating otherwise complex manual laboratory procedures. Molecular testing historically has involved a number of complicated and time-intensive steps, including sample preparation, DNA amplification and detection. Our easy-to-use systems integrate these steps and analyze complex biological samples in our proprietary test cartridges. We were first to the U.S. market with a Clinical Laboratory Improvement Amendments (“CLIA”) moderate complexity categorization for an amplified molecular test, and the majority of our products are moderately complex, expanding our market opportunity beyond high complexity laboratories.

Our two principal systems are the GeneXpert and SmartCycler. The GeneXpert system, our primary offering in the Clinical market, integrates sample preparation in addition to DNA amplification and detection. The GeneXpert system is designed for a broad range of user types ranging from reference laboratories and hospital central laboratories to satellite testing locations, such as emergency departments and intensive care units within hospitals and doctors’ offices. The GeneXpert system is also our main system in the Biothreat market. The SmartCycler system integrates DNA amplification and detection to allow rapid analysis of a sample.

In September 2009, we launched the GeneXpert Infinity System (“Infinity”) for high volume testing. The Infinity uses robotic cartridge handling and a full touch screen driven menu, to run up to 1,300 different molecular tests during any 24-hour period, depending upon test selection. The GeneXpert system, including the Infinity, represents a paradigm shift in molecular diagnostics in terms of ease-of-use and flexibility, producing accurate results in a timely manner with minimal risk of contamination. Our Xpert tests for use on the GeneXpert system are unique in that they typically require less than two minutes of hands-on time for unprecedented ease of use, rapid results, in most cases under an hour, and the ability to do testing in any workflow environment: full random access; on-demand; or traditional batch testing.

The paradigm shift represented by the GeneXpert system includes (1) the ability to perform multiple, highly accurate and fast time-to-result molecular diagnostic tests, at any time, even if the system is simultaneously performing other tests, either in a batch or on-demand mode, (2) the system’s ease-of-use, which enables it to be operated without the need for highly-trained laboratory technicians, and (3) the scalability of the instrument, currently from one to 48 modules, enabling it to serve high volume testing

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requirements as well as lower volume requirements for testing at the point of patient care. Our GeneXpert system can provide rapid results with superior test specificity and sensitivity over comparable systems on the market today that are integrated but have open architectures. Our GeneXpert system operates with an entirely closed cartridge, eliminating potential human error and contamination issues. In addition, the instrument is particularly well suited to perform “nested” PCR, a detection method that provides an enhanced level of sensitivity. This method performs an additional amplification of the target specimen after the first PCR amplification. This second amplification is designed to selectively amplify only the desired target sequence. The routine laboratory use of nested PCR has been discouraged because of the high risk of cross-contamination during processing in an open lab environment. We have developed a method for performing the entire test procedure for both of these amplifications in a single closed vessel. This has led to our first commercial release of twoin vitrodiagnostic (“IVD”) products based on nested PCR.

We currently have available a broad and expanding menu of tests and reagents for use on our systems. Our reagents and tests are marketed along with our systems on a worldwide basis.

Sales Channels

Sales for products within our specific markets are conducted through both direct sales and indirect distribution channels worldwide. Clinical market sales in the U.S., the United Kingdom, France and the Benelux region are handled primarily through our direct sales force, while sales in all other markets are handled primarily through distributors. As international Clinical markets continue to develop, we expect to expand our direct sales efforts. Our marketing programs are managed on a direct basis.

Revenues

Currently, we derive our revenues primarily from the sales of our two systems and associated reagents and disposables in the Clinical, Biothreat, Industrial and Partner markets, and to a lesser extent from contract and government sponsored research.

Research and Development

The principal objective of our research and development program is to develop high-value clinical diagnostic products for the GeneXpert system. We focus our efforts on four main areas: a) assay development efforts to design, optimize, and produce specific tests that leverage the systems and chemistry we have developed, b) target discovery research to identify novel micro RNA targets to be used in the development of future assays, c) chemistry research to develop innovative and proprietary methods to design and synthesize oligonucleotide primers, probes and dyes to optimize the speed, performance and ease-of-use of our assays and d) engineering efforts to extend the multiplexing capabilities of our systems and to develop new low and high throughput systems.

CRITICAL ACCOUNTING POLICIES, ESTIMATES AND ASSUMPTIONS

Management believes that there have been no significant changes during the nine months ended September 30, 2010 to 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 2009 Annual Report on Form 10-K filed with the Securities and Exchange Commission. For a description of those critical accounting policies, please refer to our 2009 Annual Report on Form 10-K.

RESULTS OF OPERATIONS

Comparison of the Three and Nine Months Ended September 30, 2010 and 2009

Revenues

	Three Months Ended September 30,							Nine Months Ended September 30,
	2010		2009		% Change			2010		2009		% Change
	(In thousands)							(In thousands)
Revenues:
System sales	$	12,491	$	10,628		18	%	$	33,216	$	27,448		21	%
Reagent and disposable sales		42,386		30,170		40	%		117,491		89,498		31	%
Total product sales		54,877		40,798		35	%		150,707		116,946		29	%
Other revenue		1,178		837		41	%		3,035		4,477		-32	%
Total revenues	$	56,055	$	41,635		35	%	$	153,742	$	121,423		27	%

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The following table illustrates product sales in the Clinical, Industrial, Biothreat and Partner markets:

	Three Months Ended September 30							Nine Months Ended September 30
	2010		2009		% Change			2010		2009		% Change
	(In thousands)							(In thousands)
Product sales by market:
Clinical Systems	$	8,543	$	5,804		47	%	$	21,665	$	16,246		33	%
Clinical Reagents		33,215		24,098		38	%		94,412		64,101		47	%
Total Clinical		41,758		29,902		40	%		116,077		80,347		44	%
Industrial		4,693		4,986		-6	%		14,059		13,010		8	%
Biothreat		7,291		3,985		83	%		17,534		19,666		-11	%
Partner		1,135		1,925		-41	%		3,037		3,923		-23	%
Total product sales	$	54,877	$	40,798		35	%	$	150,707	$	116,946		29	%

Total product sales increased 35% to $54.9 million in the third quarter of 2010 from $40.8 million in the third quarter of 2009. The increase was primarily a result of an increase in our Clinical sales of $11.9 million, or 40%. Clinical Reagents grew $9.1 million, or 38%, driven primarily by an increase in sales of our healthcare associated infections (“HAI”) portfolio of tests as well as our Xpert EV, Xpert GBS and Xpert MTB/RIF tests. Clinical Systems grew $2.7 million, or 47%, primarily due to increased GeneXpert System sales. While uncertainty remains in the hospital capital equipment market, we believe it has stabilized, to some extent, from the challenging economic environment in the third quarter of 2009. In the Biothreat market, product sales increased $3.3 million, or 83%, primarily due to the timing of the contractual commitment of anthrax test cartridge sales to Northrop Grumman/USPS. Partner sales decreased $0.8 million, or 41%, primarily due to an overall decline in the legacy business. Industrial sales decreased $0.3 million, or 6%, due to decreased systems sales.

Total product sales increased 29% to $150.7 million in the first nine months of 2010 from $116.9 million in the first nine months of 2009. The increase was a result of an increase in our Clinical sales of $35.7 million, or 44%. Clinical Reagents grew $30.3 million, or 47%, driven primarily by an increase in sales of our HAI portfolio of tests as well as our Xpert Flu A Panel and Xpert MTB/RIF tests. Clinical Systems grew $5.4 million, or 33%, primarily due to increased GeneXpert System sales. Industrial sales increased $1.0 million, or 8%, primarily due to both increased reagent and systems sales. In the Biothreat market, product sales decreased $2.1 million, or 11%, primarily due to reduced anthrax test cartridge sales to Northrop Grumman/USPS. Partner sales decreased $0.9 million, or 23%, due to an overall decline in the legacy business.

The following table provides a breakdown of our product sales by geographic regions (in thousands):

	Three Months Ended September 30,							Nine Months Ended September 30,
	2010		2009		% Change			2010		2009		% Change
Product Sales Geographic information:
North America
Clinical	$	33,796	$	22,913		47	%	$	91,506	$	61,424		49	%
Other		11,624		9,100		28	%		29,232		31,127		-6	%
Total North America		45,420		32,013		42	%		120,738		92,551		30	%
International
Clinical	$	7,962	$	6,989		14	%	$	24,571	$	18,922		30	%
Other		1,495		1,796		-17	%		5,398		5,473		-1	%
Total International		9,457		8,785		8	%		29,969		24,395		23	%
Total product sales	$	54,877	$	40,798		35	%	$	150,707	$	116,946		29	%

Product sales in North America increased $13.4 million, or 42%, from $32.0 million in the third quarter of 2009 to $45.4 million in the third quarter of 2010. The increase in North American product sales was primarily driven by a $10.9 million increase in Clinical sales, driven by increases in both instrument and reagent sales, and $2.5 million increase in Other product sales due to an increase in anthrax test cartridge sales to Northrop Grumman/USPS in the Biothreat market. Product sales in North America increased $28.2 million, or 30%, from $92.6 million in the first nine months of 2009 to $120.7 million in the first nine months of 2010. The increase in North American product sales was primarily driven by a $30.1 million increase in Clinical sales,

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driven by increases in both instrument and reagent sales. The increase in Clinical sales was offset by a $1.9 million decline in Other product sales due to a decrease in anthrax test cartridge sales to Northrop Grumman/USPS in the Biothreat market.

International product sales, which primarily represent sales in Europe, increased $0.7 million, or 8%, from $8.8 million in the third quarter of 2009 to $9.5 million in the third quarter of 2010 and increased $5.6 million, or 23%, from $24.4 million in the first nine months of 2009 to $30.0 million in the first nine months of 2010 due to growth in Clinical sales. International Clinical sales growth was primarily driven by higher reagent sales of our HAI tests as well as Xpert MTB/RIF.

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

Other Revenue

Other revenue of $1.2 million for the three months ended September 30, 2010 increased 41% from $0.8 million for the same period in 2009. The increase was primarily due to preliminary work associated with a funded program for the commercialization and further development of our Xpert BCR-ABL test for monitoring the BCR-ABL gene transcript. Other revenue of $3.0 million for the nine months ended September 30, 2010 decreased 32% from $4.5 million for the same period in 2009. The decrease was primarily due to the completion of a funded grant program associated with the development of a 6-color GeneXpert system as well as the conclusion of the recognition of revenue related to a license fee received from bioMerieux, Inc. in the first quarter of 2009. We expect that our other revenue in the remainder of 2010 will increase as we continue the further development of our Xpert BCR-ABL test.

Costs and Operating Expenses

	Three Months Ended September 30,								Nine Months Ended September 30,
	2010		2009			% Change			2010		2009			% Change
	(In thousands)								(In thousands)
Costs and operating expenses:
Cost of product sales	$	27,279	$	23,765			15	%	$	78,565	$	67,705			16	%
Collaboration profit sharing		2,404		1,306			84	%		5,713		6,547			-13	%
Research and development		10,986		8,744			26	%		30,837		29,397			5	%
Sales and marketing		9,969		7,040			42	%		28,214		20,769			36	%
General and administrative		6,033		5,223			16	%		17,596		15,832			11	%
Gain from legal settlement		—		(243	)		-100	%		—		(243	)		-100	%
Restructuring charge		—		—			0	%		—		747			-100	%
Total costs and operating expenses	$	56,671	$	45,835			24	%	$	160,925	$	140,754			14	%

Cost of Product Sales

Cost of product sales consists of raw materials, direct labor and stock-based compensation expense, manufacturing overhead, facility costs and warranty costs. Cost of product sales also includes royalties on product sales and amortization of intangible assets related to technology licenses and intangibles acquired in the purchases of Sangtec and Stretton. Cost of product sales increased 15%, or $3.5 million, from $23.8 million in the third quarter of 2009 to $27.3 million in the third quarter of 2010, as a result of the increased overall product sales. Our product gross margin percentage was 50% for the third quarter of 2010 and 42% for the third quarter of 2009. Cost of product sales increased 16%, or $10.9 million, from $67.7 million in the nine months ended September 30, 2009 to $78.6 million in the nine months ended September 30, 2010, as a result of the increased overall product sales. Our product gross margin percentage was 48% for the nine months ended September 30, 2010 and 42% for the nine months ended September 30, 2009. The increase in product gross margin percentages in the three and nine months ended September 30, 2010 versus the same periods in 2009 was primarily due to favorable product mix with higher margin Clinical reagent sales comprising a higher percentage of our total product revenue, phase out in August 2010 of royalty payments to Roche related to U.S. PCR sales, a decrease in royalties to Abaxis, Inc. due to a manufacturing process change as well as Clinical reagent volume increases and manufacturing efficiencies driving lower Clinical reagent unit costs. We expect the product gross margin percentage to continue to increase in the remainder of 2010 as we continue to benefit from the phase out of certain royalties.

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Collaboration Profit Sharing

Collaboration profit sharing represents the amount that we pay to LIFE under our collaboration agreement to develop reagents for use in the USPS BDS program. Under the agreement, computed gross margin on anthrax cartridge sales are shared equally between the two parties. Collaboration profit sharing expense increased to $2.4 million for the three months ended September 30, 2010 from $1.3 million for the three months ended September 30, 2009, as a result of increased anthrax cartridge sales under the USPS BDS program. Collaboration profit sharing expense was $5.7 million and $6.5 million for the first nine months of 2010 and 2009, respectively, as a result of decreased anthrax 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 26% to $11.0 million for the third quarter of 2010 from $8.7 million for the third quarter of 2009. The increase in research and development expenses of approximately $2.2 million is primarily due to a $1.0 million increase in salaries and employee-related expenses, a $0.9 million increase in trial costs and a $0.1 million increase in contractor costs.

For the nine months ended September 30, 2010, research and development expenses increased 5% to $30.8 million as compared to $29.4 million for the nine months ended September 30, 2009. The increase in research and development expenses of $1.4 million is primarily due to a $1.2 million increase in research and development supplies for trials, a $1.0 million increase in salaries and employee-related expenses and a $0.1 million increase in contractor costs, offset by a $1.1 million decrease in trial costs. We expect that our research and development expenses will increase in the remainder of 2010 as we expect to have an increase in our trial costs for products currently under development.

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 42% to $10.0 million for the third quarter of 2010 from $7.0 million for the third quarter of 2009. The increase in sales and marketing expenses is primarily due to a $1.8 million increase in salaries and employee-related expenses, a $0.7 million increase in tradeshow and sales meeting expenses and a $0.1 million increase in contractor costs.

Sales and marketing expenses increased 36% to $28.2 million for the nine months ended September 30, 2010 from $20.8 million for the nine months ended September 30, 2009. The increase in sales and marketing expenses of $7.4 million is primarily due to a $3.9 million increase in salaries and employee-related expenses, a $2.0 million increase in tradeshow, advertising and sales meeting expenses and a $0.3 million increase in contractor costs. We expect our sales and marketing expenses will increase in the remainder of 2010 as we continue to expand our efforts in the Clinical market, with particular emphasis on pursuing the market opportunities for our HAI disease products.

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 16% to $6.0 million for the third quarter of 2010 from $5.2 million for the third quarter of 2009. The increase in general and administrative expenses of $0.8 million is primarily due to an increase of $0.9 million in salaries and employee-related expenses.

General and administrative expenses increased 11% to $17.6 million for the nine months ended September 30, 2010 from $15.8 million for the nine months ended September 30, 2009. The increase in general and administrative expenses of $1.8 million is primarily due to a $1.3 million increase in salaries and employee-related expenses and an increase of $0.6 million of professional services. We expect our general and administrative expenses to remain relatively flat as a percentage of total revenues in the remainder of 2010.

Gain from Legal Settlement

During the third quarter of 2009, we entered into a settlement with a vendor regarding certain issues under multiple agreements. Pursuant to the settlement, the vendor paid us $0.2 million, which we have recorded as a gain.

Restructuring Charge

During the first quarter of 2009, we eliminated 47 positions that impacted employees, contractors and replacement positions, which resulted in $0.7 million of restructuring expense, mainly related to severance. As of September 30, 2010, all amounts pertaining to the 2009 restructuring have been paid. We recognized no restructuring expenses during the first nine months of 2010.

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Other Income (Expense), Net

	Three Months Ended September 30,									Nine Months Ended September 30,
	2010			2009			% Change			2010			2009			% Change
	(In thousands)									(In thousands)
Other income (expense), net:
Interest income	$	6		$	69			-91	%	$	160		$	317			-50	%
Interest expense		(107	)		(99	)		8	%		(218	)		(247	)		-12	%
Foreign currency exchange gain (loss) and other		(8	)		146			-105	%		(588	)		577			-202	%
Total other income (expense), net	$	(109	)	$	116			-194	%	$	(646	)	$	647			-200	%

Other income (expense), net consists of interest income, interest expense and foreign currency exchange gain, net and other. Interest income decreased to $6,000 for the third quarter of 2010 from $69,000 for the third quarter of 2009 and decreased to $160,000 for the nine months ended September 30, 2010 from $317,000 for the nine months ended September 30, 2009 due to lower interest rates and lower auction rate securities portfolio balances in 2010 as compared to 2009. Interest expense increased slightly from $99,000 for the three months ended September 30, 2009 to $107,000 for the three months ended September 30, 2010. Interest expense decreased from $247,000 for the nine months ended September 30, 2009 to $218,000 for the nine months ended September 30, 2010 primarily due to lower interest expense related to our UBS loan, as the loan balance decreased from $14.6 million at September 30, 2009 to no outstanding balance at September 30, 2010. Foreign currency exchange gain (loss) and other decreased $0.2 million for the three months ended September 30, 2010 as compared to the same period ended September 30, 2009 and $1.2 million for the nine months ended September 30, 2010 as compared to the same period ended September 30, 2009 as a result of foreign exchange losses due to the strengthening of the U.S. dollar against other currencies, primarily the Euro.

LIQUIDITY AND CAPITAL RESOURCES

Cash and Cash Flow

	Nine Months Ended September 30,
	2010		2009			Increase/ (Decrease)
	(In thousands)
Net cash provided by operating activities	$	13,725	$	11,678		$	2,047
Net cash provided by (used in) investing activities		13,328		(7,151	)		20,479
Net cash provided by financing activities		1,761		5,134			(3,373	)

As of September 30, 2010, we had $65.2 million in cash and cash equivalents. The $29.4 million increase in total cash and cash equivalents for the nine months ended September 30, 2010 consisted primarily of $13.7 million provided by operating activities, $13.3 million provided by investing activities and $1.8 million provided by financing activities.

Net cash provided by operating activities was $13.7 million and $11.7 million for the nine months ended September 30, 2010 and September 30, 2009, respectively. The net cash provided by operating activities in the first nine months in 2010 was primarily comprised of net loss, which decreased from the first nine months of 2009, plus the net effect of non-cash expenses and working capital uses of cash, which increased from the first nine months in 2009. Non-cash expenses are comprised of stock-based compensation, unrealized loss on put option, depreciation and amortization expenses and deferred rent expense, offset by an unrealized gain on auction rate securities. The primary working capital uses of cash for the nine months ended September 30, 2010 were decreases in accounts payable and other liabilities, an increase in accounts receivable, driven by higher revenue than in the prior year and increases in prepaid expenses and other current assets. The primary working capital sources of cash were increases in deferred revenue and accrued compensation.

Net cash provided by (used in) investing activities was $13.3 million and $(7.2) million for the nine months ended September 30, 2010 and September 30, 2009, respectively. For the nine months ended September 30, 2010, net cash provided by investing activities consisted of proceeds from the sales and maturities of short-term investments, offset by net capital expenditures, the cost of asset acquisitions and payments for technology licenses. The sales and maturities of short-term investments were related to the settlement of $24.8 million of our auction rate securities. For the nine months ended September 30, 2009, net cash used in investing activities consisted of net capital expenditures, payments for technology licenses and the cost of an acquisition, offset by

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a transfer from restricted cash and proceeds from sales and maturities of short-term investments. The change in net cash provided by investing activities for the nine months ended September 30, 2010 from the same period ended September 30, 2009 is primarily due to an increase in proceeds from the maturities of short-term investments offset by an increase in capital expenditures.

Net cash provided by financing activities was $1.8 million and $5.1 million for the nine months ended September 30, 2010 and 2009, respectively. As of September, 2010, we have paid down the principal balances on our UBS loan due to $24.8 million of our auction rate securities that settled. The increase of principal payment of bank borrowing was offset by an increase in net proceeds from the issuance of common shares under our employee stock purchase plan and exercises of stock options.

See Note 8 to the Condensed Consolidated Financial Statements for detailed information regarding our minimum lease payments under non-cancelable operating leases and the net of future minimum contractual sublease income and Note 12 to the Condensed Consolidated Financial Statements for detailed information regarding our existing notes payable.

Off-Balance-Sheet Arrangements

As of September 30, 2010, 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.

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. 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. 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, in many instances, 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, 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, stockholders 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.

Please see Note 8 to our financial statements included herein for a description of certain changes to our commitments and contingencies.

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. Our investments in interest-bearing assets are subject to interest rate 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 a 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, we maintain our interest-bearing portfolio, which consists of cash and cash equivalents, in money market funds. Due to the short-term nature of the investments, we believe we currently have no material exposure to interest rate risk arising from our investments. Therefore, we have not included quantitative tabular disclosure in this Form 10-Q.

We operate primarily in the U.S. and a majority of our revenue, cost, expense and capital purchasing activities for the three months ended September 30, 2010 were transacted in U.S. dollars. As a corporation with international as well as domestic operations, we are exposed to changes in foreign exchange rates. We have operations in Sweden, France, the Benelux region, and the United Kingdom. In the third quarter of 2010 and the first nine months of 2010, international sales were approximately 17% and 20%, respectively, of our product sales. Our international sales are predominantly made in European countries. Our exposures to foreign currency risks may change over time and could have a material adverse impact on our financial results. We enter into approximately two to six derivatives per quarter ranging from $0.1 million to $11.5 million in notional value each with a total notional value of approximately $11.0 million and $8.4 million in the third quarter of 2010 and 2009, respectively. As of September 30, 2010, we had two outstanding foreign exchange forward contracts which were recorded as a derivative liability

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within accrued and other liabilities with a fair value of approximately $34,000. As of December 31, 2009, we had two outstanding foreign exchange forward contracts, which were recorded as liabilities within accrued and other liabilities with a fair value of approximately $28,000. During the nine months ended September 30, 2010 and 2009, the effect of our hedging transactions, consisting entirely of foreign currency forward contracts, on our condensed consolidated statement of operations was a pre-tax gain of approximately $0.6 million and a pre-tax loss of $0.8 million, respectively.

We will continue to use hedging programs in the future and may use currency forward contracts, currency options, and/or other derivative financial instruments commonly utilized to reduce financial market risks if it is determined that such hedging activities are appropriate to reduce risk. We do not hold or purchase any currency contracts for trading purposes.

As described above, we had $11.8 million invested in auction rate securities at cost and on July 1, 2010, we settled these auction rate securities, for which we received $10.5 million in cash, representing the par value of those auction rate securities net of the related line of credit. Please see Note 2 to our financial statements included herein for a description of our auction rate securities and settlement with UBS.

ITEM 4. CONTROLS AND PROCEDURES

EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES

Regulations under the Securities Exchange Act of 1934 (the “Exchange Act”) require public companies, including our company, to maintain “disclosure controls and procedures”, which are defined to mean a company’s controls and other procedures that are designed to ensure that information required to be disclosed in the reports that it files or submits under the Exchange Act is accumulated and timely communicated to management, including our Chief Executive Officer and Chief Financial Officer, and recorded, processed, summarized, and reported, within the time periods specified in the Securities and Exchange Commission’s rules and forms. Our Chief Executive Officer and our Chief Financial Officer, based on their evaluation of our disclosure controls and procedures as of the end of the period covered by of this report, concluded that our disclosure controls and procedures were effective for this purpose.

CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING

Regulations under the Exchange Act 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 accounting principles generally accepted in the U.S. 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 nine months ended September 30, 2010, that materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

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PART II — OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

On June 28, 2010, Abaxis, Inc. filed suit in United States District Court for the Northern District of California against us, alleging that our Xpert MRSA product infringes on U.S. Patent No. 5,413,732, U.S. Patent No. 5,624,597, U.S. Patent No. 5,776,563 and U.S. Patent No. 6,251,684. On July 12, 2010, we filed our response to the suit, denying Abaxis’ allegations of infringement and asked the Court to find Abaxis’ patents invalid and not infringed. On August 5, 2010, Abaxis filed its response to our answer and counterclaim.

We may be subject to additional various claims, complaints and legal actions that arise from time to time in the normal course of business. Other than as described above, we do not believe we are party to any currently pending legal proceedings, the outcome of which could have a material adverse effect on our operations or financial position. There can be no assurance that existing or future legal proceedings arising in the ordinary course of business or otherwise will not have a material adverse effect on our business, consolidated financial position, results of operations or cash flows.

ITEM 1A. RISK FACTORS

You should carefully consider the risks and uncertainties 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 us. 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.

We may not achieve profitability.

We have incurred operating losses in each period since our inception. We experienced net losses of approximately $22.4 million in 2008, $22.5 million in 2009 and $7.3 million for the first nine months of 2010 and we do not anticipate that we will achieve profitability for 2010. As of September 30, 2010, we had an accumulated deficit of approximately $209.5 million. Our ability to become profitable will depend on our ability to continue to increase our revenues, which is subject to a number of factors including the uncertainty of the impact of global economic conditions on our customers, suppliers and partners, our ability to continue to successfully penetrate the Clinical market, our ability to successfully market the GeneXpert system and develop additional effective GeneXpert tests, continued growth in sales of our healthcare associated infection and other tests, the extent of our participation in the USPS BDS program and the operating parameters of the USPS BDS program, which will affect the rate of our consumable products sold, our ability to compete effectively against current and future competitors, and global economic and political conditions. Our ability to become profitable also depends on our expense levels and product gross margin, which are also influenced by a number of factors, including the resources we devote to developing and supporting our products, the continued progress of our research and development of potential products, the ability to gain FDA clearance for our new products, our ability to improve manufacturing efficiencies, license fees or royalties we may be required to pay and the potential need to acquire licenses to new technology or to use our technology in new markets, which could require us to pay unanticipated license fees and royalties in connection with these licenses. Our expansion efforts may prove more expensive than we currently anticipate, and we may not succeed in increasing our revenues to offset higher expenses. These expenses, among other things, may cause our net income and working capital to decrease. If we fail to grow our revenue, manage our expenses and improve our product gross margin, we may never achieve profitability. If we fail to do so, the market price of our common stock will likely decline.

The current uncertainty in global economic conditions makes it particularly difficult to predict product demand and other related matters, and makes it more likely that our actual results could differ materially from expectations.

Our operations and performance depend on global economic conditions, which have been adversely impacted by the recent global recession. These conditions have and may continue to make it difficult for our customers and potential customers to accurately forecast and plan future business activities, and have caused our customers and potential customers to slow or reduce spending, particularly for systems. Furthermore, during challenging economic times, our customers have experienced and may continue to experience issues gaining timely access to sufficient credit, which could result in their unwillingness to purchase products or an impairment of their ability to make timely payments to us. If that were to continue to occur, we may experience decreased sales, be required to increase our allowance for doubtful accounts and our days sales outstanding would be negatively impacted. We cannot predict the reoccurrence, timing, strength or duration of any economic slowdown or any economic recovery, worldwide, in the U.S. or in our industry. These and other economic factors could have a material adverse effect on demand for our products and on our financial condition and operating results.

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Our operating results may fluctuate significantly and any failure to meet financial expectations may result in a decline in our stock price.

Our quarterly operating results may fluctuate in the future as a result of many factors, such as those described elsewhere in this section, many of which are beyond 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 indicator of our future performance. Our operating results may be affected by the inability of some of our customers to consummate anticipated purchases of our products, whether due to adverse economic conditions, changes in internal priorities or, in the case of governmental customers, problems with the appropriations process and variability and timing of orders, changes in procedures or protocols with respect to testing or manufacturing inefficiencies. If revenue declines in a quarter, whether due to a delay in recognizing expected revenue, adverse economic conditions, and unexpected costs or otherwise, our results of operations will be harmed because many of our expenses are relatively fixed. In particular, research and development, sales and marketing and general and administrative expenses are not significantly affected by variations in revenue. If our quarterly operating results fail to meet or exceed the expectations of securities analysts or investors, our stock price could drop suddenly and significantly.

Our sales cycle can be lengthy, which can cause variability and unpredictability in our operating results.

The sales cycles for our systems products can be lengthy, particularly during uncertain economic conditions, 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. For example, sales of our products involving our corporate accounts within the Clinical market and those within the Industrial market often involve purchasing decisions by large public and private institutions, and any purchases can require many levels of pre-approval. In addition, certain Industrial sales may depend on these institutions receiving research grants from various federal agencies, which grants vary considerably from year to year in both amount and timing due to the political process. 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 we cannot successfully commercialize our products, our business could be harmed.

If our tests for use on our systems do not gain continued market acceptance, we will be unable to generate significant sales, which will prevent us from achieving profitability. While we have received FDA clearance for a number of tests, these products may not continue to experience increased sales. Many factors may affect the market acceptance and commercial success of our products, including:

• timely expansion of our menu of tests and reagents;

• the results of clinical trials needed to support any regulatory approvals of our tests;

• our ability to obtain requisite FDA or other regulatory clearances or approvals for our tests under development on a timely basis;

• demand for the tests and reagents we introduce;

• the timing of market entry for various tests for the GeneXpert and the SmartCycler systems;

• our ability to convince our potential customers of the advantages and economic value of our systems and tests over competing technologies and products;

• the breadth of our test menu relative to competitors;

• changes to policies, procedures or what are considered best practices in clinical diagnostics, including practices for detecting and preventing healthcare associated infections;

• the extent and success of our marketing and sales efforts;

• the functionality of new products that address market requirements and customer demands;

• level of reimbursement for our products by third-party payers; and

• publicity concerning our systems and tests.

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In particular, we believe that the success of our business will depend in large part on our ability to continue to increase sales of our Xpert tests and our ability to introduce additional tests for the Clinical market. We believe that successfully expanding our business in the Clinical market is critical to our long-term goals and success. We have limited ability to forecast future demand for our products in this market. In addition, we have committed substantial funds to licenses that are required for us to compete in the Clinical market. If we cannot successfully penetrate the Clinical market to fully exploit these licenses, these investments may not yield significant returns, which could harm our business.

Regulations applicable to our products and operations are expensive, time-consuming, and uncertain and may prevent us from obtaining required approvals for the commercialization of some of our products.

In the Clinical market, our products are regulated as medical device products by the FDA and comparable agencies of other countries. In particular, FDA regulations govern activities such as product development, product testing, product labeling, product storage, premarket clearance or approval, manufacturing, advertising, promotion, product sales, reporting of certain product failures and distribution. Some of our products, depending on their intended use, will require premarket approval (“PMA”) or 510(k) clearance from the FDA prior to marketing. The 510(k) clearance process usually takes from three to four months from submission but can take longer. The PMA process is much more costly, lengthy and uncertain and generally takes from six months to one year or longer from submission. Clinical trials are generally required to support both PMA and 510(k) submissions. Certain of our products for use on our GeneXpert and SmartCycler systems, when used for clinical purposes, may require PMA, and all such tests will most likely, at a minimum, require 510(k) clearance. We are planning clinical trials for other proposed products. Clinical trials are expensive and time-consuming. In addition, the commencement or completion of any clinical trials may be delayed or halted for any number of reasons, including product performance, changes in intended use, changes in medical practice and the opinion of evaluator Institutional Review Boards. Additionally, since 2009, the FDA has significantly increased the scrutiny applied to its oversight of companies subject to its regulations, including 510(k) submissions, by hiring new investigators and increasing inspections of manufacturing facilities. The FDA has recently also significantly increased the number of warning letters issued to companies.

Failure to comply with the applicable requirements can result in, among other things, warning letters, administrative or judicially imposed sanctions such as injunctions, civil penalties, recall or seizure of products, total or partial suspension of production, refusal to grant premarket clearance or PMA for devices, withdrawal of marketing clearances or approvals, or criminal prosecution. With regard to future products for which we seek 510(k) clearance or PMA from the FDA, any failure or material delay to obtain such clearance or approval could harm our business. If the FDA were to disagree with our regulatory assessment and conclude that approval or clearance is necessary to market the products, we could be forced to cease marketing the products and seek approval or clearance. With regard to those future products for which we will seek 510(k) clearance or PMA from the FDA, any failure or material delay to obtain such clearance or approval could harm our business. In addition, it is possible that the current regulatory framework could change or additional regulations could arise at any stage during our product development or marketing, which may adversely affect our ability to obtain or maintain approval of our products and could harm our business.

Comprehensive healthcare reform legislation, signed into law on March 23, 2010, imposes stringent compliance, recordkeeping, and reporting requirements on companies in various sectors of the life sciences industry with which we may need to comply and enhanced penalties for non-compliance with the new healthcare regulations. Complying with new regulations may divert management resources, and inadvertent failure to comply with new regulations may result in penalties being imposed on us. Various healthcare reform proposals have also emerged at the state level, and it is unclear which, if any, of these proposals will be enacted and what impact any resulting laws would have on our operations.

Our manufacturing facilities located in Sunnyvale, California, Bothell, Washington, Bromma and Solna, Sweden, where we assemble and produce the GeneXpert and SmartCycler systems, cartridges and other molecular diagnostic kits and reagents, are subject to periodic regulatory inspections by the FDA and other federal and state and foreign regulatory agencies. For example, these facilities are subject to Quality System Regulations (“QSR”) of the FDA and are subject to annual inspection and licensing by the States of California and Washington and European regulatory agencies. If we fail to maintain these facilities in accordance with the QSR requirements, international quality standards or other regulatory requirements, our manufacturing process could be suspended or terminated, which would prevent us from being able to provide products to our customers in a timely fashion and therefore harm our business.

The federal medical device tax by the U.S. government could adversely affect our business, profitability and stock price.

The comprehensive healthcare reform legislation includes an annual excise tax on the sale of medical devices equal to 2.3% of the price of the device, starting on January 1, 2013, which we believe will include all of our Clinical products sold in the U.S. The exact impact of this excise tax is not currently clear. We may seek to pass this tax onto our customers. If we are unsuccessful, our future operating results could be harmed, which in turn could cause the price of our stock to decline. Additionally, because of the uncertainty surrounding these issues, the impact of this tax has not been reflected in our forward guidance.

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We rely on licenses of key technology from third parties and may require additional licenses for many of our new product candidates.

We rely on third-party licenses to be able to sell many of our products, and we could lose these third-party licenses for a number of reasons, including, for example, early terminations of such agreements due to breaches or alleged breaches by either party to the agreement. If we are unable to enter into a new agreement for licensed technologies, either on terms that are acceptable to us or at all, we may be unable to sell some of our products or access some geographic or industry markets. We also need to introduce new products and product features in order to market our products to a broader customer base and grow our revenues, and many new products and product features could require us to obtain additional licenses and pay additional license fees and royalties. Furthermore, for some markets, we intend to manufacture reagents and tests for use on our systems. We believe that manufacturing reagents and developing tests for our systems is important to our business and growth prospects but may require additional licenses, which may not be available on commercially reasonable terms or at all. Our ability to develop, manufacture and sell products, and our strategic plans and growth, could be impaired if we are unable to obtain these licenses or if these licenses are terminated or expire and cannot be renewed. We may not be able to obtain or renew licenses for a given product or product feature or for some reagents on commercially reasonable terms, if at all. Furthermore, some of our competitors have rights to technologies and reagents that we do not have which may put us at a competitive disadvantage in certain circumstances and could adversely affect our performance.

Our participation in the USPS BDS program may not result in predictable revenues in the future.

Our participation in the USPS BDS program involves significant uncertainties related to governmental decision-making and timing of deployment and is highly sensitive to changes in national priorities and budgets. Budgetary pressures may result in reduced allocations to projects such as the BDS program, sometimes without advance notice. We cannot be certain that actual funding and operating parameters, or product purchases, will occur at currently expected levels or in the currently expected timeframe.

We may face risks associated with acquisitions of companies, products and technologies, and our business could be harmed if we are unable to address these risks.

If we are presented with appropriate opportunities, we intend to acquire or make other investments in complementary companies, products or technologies. We may not realize the anticipated benefit of any acquisition or investment. We will likely face risks, uncertainties and disruptions associated with the integration process, including difficulties in the integration of the operations and services of an acquired company, integration of acquired technology with our products, diversion of our management’s attention from other business concerns, the potential loss of key employees or customers of the acquired businesses and impairment charges if future acquisitions are not as successful as we originally anticipate. If we fail to successfully integrate other companies, products or technologies that we 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. In addition, our operating results may suffer because of acquisition-related costs or amortization expenses or charges relating to acquired intangible assets.

If we are unable to manufacture our products in sufficient quantities and in a timely manner, our operating results will be harmed and our ability to generate revenue could be diminished.

Our revenues and other operating results will depend in large part on our ability to manufacture and assemble our products in sufficient quantities and in a timely manner. Any interruptions we experience in the manufacturing or shipping of our products could delay our ability to recognize revenues in a particular quarter. Manufacturing problems can and do arise, and as demand for our products increases, any such problems could have an increasingly significant impact on our operating results. In the past, we have experienced problems and delays in production that have impacted our product yield and caused delays in our ability to ship finished products, and we may experience such delays in the future. We may not be able to react quickly enough to ship products and recognize anticipated revenues for a given period if we experience significant delays in the manufacturing process. In addition, we must maintain sufficient production capacity in order to minimize such delays, which carries fixed costs that we may not be able to offset if orders slow, which would adversely affect our operating margins. If we are unable to manufacture our products consistently, in sufficient quantities, and on a timely basis, our revenues from product sales, gross margins and our other operating results will be materially and adversely affected.

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If certain 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 certain single source suppliers that supply some of the components used in the manufacture of our systems and our disposable reaction tubes and cartridges. Strategic purchases of components are necessary for our business. If we need alternative sources for key component parts for any reason, these component parts may not be immediately available to us. If alternative suppliers are not immediately available, we will have to identify and qualify alternative suppliers, and production of these 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. Shipments of affected products have been limited or delayed as a result of such problems in the past, and similar problems could occur in the future. In addition, many companies are experiencing financial difficulties as a result of the global economic slowdown. We cannot assure you that our suppliers will not be adversely affected by these conditions or that they will be able to continue to provide us with the components we need. Our inability to obtain our key source supplies for the manufacture of our products may require us to delay shipments of products, harm customer relationships or force us to curtail or cease operations.

If certain of our products fail to obtain an adequate level of reimbursement from third-party payers, our ability to sell products in the Clinical market would be harmed.

Our ability to sell our products in the Clinical market will depend in part on the extent to which reimbursement for tests using our products will be available from government health administration authorities, private health coverage insurers, managed care organizations, and other organizations. There are efforts by governmental and third-party payers to contain or reduce the costs of health care through various means, and the continuous growth of managed care, together with efforts to reform the health care delivery system in the U.S. and Europe, has increased pressure on health care providers and participants in the health care industry to reduce costs. Consolidation among health care providers and other participants in the healthcare industry has resulted in fewer, more powerful health care groups, whose purchasing power gives them cost containment leverage. Additionally, third-party payers are increasingly challenging the price of medical products and services. Furthermore, we are unable to predict what effect the current or any future healthcare reform will have on our business, or the effect these matters will have on our customers. 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.

The life sciences industry is highly competitive and subject to rapid technological change, 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 target markets, some of which have substantially greater financial resources and larger, more established marketing, sales and service organizations than we do. These competitors include:

• companies developing and marketing sequence detection systems for industrial research products;

• diagnostic and pharmaceutical companies;

• companies developing drug discovery technologies; and

• companies developing or offering biothreat detection technologies.

Several companies provide systems and reagents for DNA amplification or detection. LIFE and Roche sell systems integrating DNA amplification and detection (sequence detection systems) to the commercial market. Roche, Abbott, BDC, Qiagen, Celera, GenProbe and Meridian sell sequence detection systems, some with separate robotic batch DNA purification systems and sell reagents to the Clinical market. Other companies, including Siemens, Hologic, and bioMerieux, offer molecular tests.

The life sciences industry is characterized by rapid and continuous technological innovation. We may need to develop new technologies for our products to remain competitive. One or more of our current or future competitors could render our present or future products obsolete or uneconomical by technological advances. In addition, the introduction or announcement of new products by us or others could result in a delay of or decrease in sales of existing products, as we await regulatory approvals and as customers evaluate these new products. We may also encounter other problems in the process of delivering new products to the marketplace such as problems related to design, development or manufacturing of such products, and as a result we may be unsuccessful in selling such products. Our future success depends on our ability to compete effectively against current technologies, as well as to respond effectively to technological advances by developing and marketing products that are competitive in the continually changing technological landscape.

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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 molecular test systems. We believe that customers in our target 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 if our products fail to perform as expected or our products are perceived as difficult to use. Despite testing, defects or errors could occur in our products or technologies. Furthermore, with respect to the BDS program, our products are incorporated into larger systems that are built and delivered by others; we cannot control many aspects of the final system.

In the future, if our products experience a material defect or error, this could result in loss or delay of revenues, delayed market acceptance, damaged reputation, diversion of development resources, legal claims, increased insurance costs or increased service and warranty costs, any of which could harm our business. Furthermore, any failure in the overall BDS, even if it is unrelated to our products, could harm our business. 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, delayed market acceptance, damaged 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 or do not perform in accordance with specifications, in part because our products are used for sensitive applications. We cannot be certain that we would be able to 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.

Although we carry product liability insurance, if we become the subject of a successful product liability lawsuit, our insurance may not cover all substantial liabilities, which could harm 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 have a relatively small sales force compared to our competitors. If our direct sales force is not successful, or new additions to our sales team fail to gain traction among our customers, we may not be able to increase market awareness and sales of our products. If we fail to establish our systems in the marketplace, it 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 would be harmed and our financial performance will be adversely affected.

We depend on relationships with distributors for the marketing and sales of our products in the Industrial and Clinical markets in various geographic regions, and we have a limited ability to influence their efforts. We expect to continue to rely substantially on our distributor relationships for sales into other markets or geographic regions, which is key to our long-term growth potential. Relying on distributors for our sales and marketing could harm our business for various reasons, including:

• agreements with distributors may terminate prematurely due to disagreements or may result in litigation between the partners;

• we may not be able to renew existing distributor agreements on acceptable terms;

• our distributors may not devote sufficient resources to the sale of products;

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• our distributors may be unsuccessful in marketing our products;

• our existing relationships with distributors may preclude us from entering into additional future arrangements with other distributors; and

• we may not be able to negotiate future distributor agreements on acceptable terms.

We may be subject to third-party claims that require additional licenses for our products and 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 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. Companies may have pending patent applications, which are typically confidential for the first eighteen months following filing, that cover technologies we incorporate in our products. Accordingly, we may be subjected to substantial damages for past infringement or be required to modify our products or stop selling them if it is ultimately determined that our products infringe a third party’s proprietary rights. Moreover, from time to time, we receive correspondence and other communications from companies that ask us to evaluate the need for a license of patents they hold, and indicating or suggesting that we need a license to their patents in order to offer our products and services or to conduct our business operations. For example, we are currently engaged in litigation as further described in Item 1 “Legal Proceedings.” Even if we are successful in defending against claims, we could incur substantial costs in doing so. Any litigation related to this claim and others that may arise in the future of patent infringement could likely consume our resources and could lead to significant damages, royalty payments or an injunction on the sale of certain products. Any additional licenses to patented technology could obligate us to pay substantial additional royalties, which could adversely impact our product costs and harm our business.

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 our intellectual property that includes technologies that we license. Our ability to do so will depend on, among other things, complex legal and factual questions. We have patents related to some of our technology and have licensed some of our technology under patents of others. Our patents and licenses may not successfully preclude others from using our technology. Our pending patent applications may lack priority over applications submitted by third parties 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 U.S. Furthermore, for a variety of reasons, we may decide not to file for patent, copyright or trademark protection outside of the U.S. 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. Furthermore, any efforts to enforce our proprietary rights could result in disputes and legal proceedings that could be costly and divert attention from our business.

The U.S. Government has certain rights to use and disclose some of the intellectual property that we license and could exclusively license it to a third party if we fail to achieve practical application of the intellectual property.

Aspects of the technology licensed by us under agreements with third party licensors may be subject to certain government rights. Government rights in inventions conceived or reduced to practice under a government-funded program may include a non-exclusive, royalty-free worldwide license to practice or have practiced such inventions for any governmental purpose. In addition, the U.S. government has the right to require us or our licensors (as applicable) to grant licenses which would be exclusive under any of such inventions to a third party if they determine that: (1) adequate steps have not been taken to commercialize such inventions in a particular field of use; (2) such action is necessary to meet public health or safety needs; or (3) such action is necessary to meet requirements for public use under federal regulations. Further, the government rights include the right to use and

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disclose, without limitation, technical data relating to licensed technology that was developed in whole or in part at government expense. At least one of our technology license agreements contains a provision recognizing these government rights.

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. Any public announcements related to these suits could cause our stock price to decline.

Our international operations subject us to additional risks and costs.

We conduct operations on a global basis. These operations are subject to a number of difficulties and special costs, including:

• compliance with multiple, conflicting and changing governmental laws and regulations;

• laws and business practices favoring local competitors;

• foreign exchange and currency risks;

• difficulty in collecting accounts receivable or longer payment cycles;

• import and export restrictions and tariffs;

• difficulties staffing and managing foreign operations;

• 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 and overall global economic conditions;

• multiple conflicting tax laws and regulations; and

• political and economic instability.

We intend to expand our international sales and marketing activities, including through our subsidiary in France and our direct sales force in the United Kingdom, and enter into relationships with additional international distribution partners. We may not be able to attract international 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 some 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.

Our sales to customers outside the U.S. are subject to government export regulations that require us to obtain licenses to export such products internationally. In particular, we are required to obtain a new license for each purchase order of our biothreat products that are exported outside the U.S. Delays or denial of the grant of any required license, or changes to the regulations that make such delays or denials more likely or frequent, could make it difficult to make sales to foreign customers and could adversely affect our revenue. In addition, we could be subject to fines and penalties for violation of these export regulations if we were found

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in violation. Such violation could result in penalties, including prohibiting us from exporting our products to one or more countries, and could materially and adversely affect our business.

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 require skilled personnel in areas such as microbiology, clinical and sales, marketing and finance. We generally do not enter into employment agreements requiring these employees to continue in our employment for any period of time. Attracting, retaining and training personnel with the requisite skills remains challenging, 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.

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 foreign, 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 (“OSHA”) and the Environmental Protection Agency (“EPA”), and to regulation under the Toxic Substances Control Act and the Resource Conservation and Recovery Act in the U.S. 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.

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 workers’ compensation insurance. We may not be able to maintain insurance on acceptable terms, if at all.

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, Bothell, Washington, Bromma and Solna, Sweden. Although 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 our primary manufacturing facilities in California are located in an earthquake-prone area. In the event our existing manufacturing facilities or equipment are affected by man-made or natural disasters, we may be unable to manufacture products for sale or meet customer demands or sales projections. If our manufacturing operations were curtailed or ceased, it would seriously harm our business.

Failure to comply with covenants in our loan agreement with SVB could result in our inability to borrow additional funds and adversely impact our business.

We have entered into a loan and security agreement with the SVB to fund our business operations. This loan agreement imposes numerous financial and other restrictive covenants on our operations, including covenants relating to our general profitability and our liquidity. We were in compliance with these covenants as of September 30, 2010. If we violate these or any other covenants, any outstanding amounts under these agreements could become due and payable prior to their stated maturity dates, the bank could proceed against any collateral in our operating accounts and our ability to borrow funds in the future may be restricted or eliminated. These restrictions may also limit our ability to pursue business opportunities or strategies that we would otherwise consider to be in our best interests.

We might require additional capital to respond to business challenges or acquisitions, and such capital might not be available.

We may need to engage in additional equity or debt financing, such as the loan agreement with SVB we entered into in June 2010, to respond to business challenges or acquire complementary businesses and technologies. Equity and debt financing, however, might not be available when needed or, if available, might not be available on terms satisfactory to us. In addition, to the extent that additional capital is raised through the sale of equity or convertible debt securities, the issuance of these securities could result in dilution to our shareholders. In addition, these securities may be sold at a discount from the market price of our common stock and may include rights, preferences or privileges senior to those of our common stock. If we are unable to obtain adequate

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financing or financing on terms satisfactory to us, our ability to continue to support our business growth and to respond to business challenges could be significantly limited.

We rely on relationships with collaborative partners and other third parties for development, supply and marketing of certain products and potential products, and such collaborative partners or other third parties could fail to perform sufficiently.

We believe that our success in penetrating our target markets depends in part on our ability to develop and maintain collaborative relationships with other companies. Relying on collaborative relationships is risky to our future success for these products 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 be acquired by another company and decide to terminate our collaborative partnership or become insolvent;

• 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;

• disagreements with collaborators could result in the termination of the relationship or litigation;

• collaborators may not have sufficient capital resources;

• collaborators may pursue tests or other products that will not generate significant volume for us, but may consume significant research and development and manufacturing resources; and

• we may not be able to negotiate future collaborative arrangements, or renewals of existing collaborative agreements, on acceptable terms.

Because these and other factors may be beyond our control, the development or commercialization of these products may be delayed or otherwise adversely affected.

If we or any of our collaborative partners terminate a collaborative arrangement, we may be required to devote additional resources to product development and commercialization or we may need to cancel some development programs, which could adversely affect our product pipeline and business.

We enter into collaborations with third parties that may not result in the development of commercially viable products or the generation of significant future revenues.

In the ordinary course of our business, we enter into collaborative arrangements to develop new products or to pursue new markets. These collaborations may not result in the development of products that achieve commercial success, and these collaborations could be terminated prior to developing any products. In addition, our collaboration partners may not necessarily purchase the volume of products that we expect. Accordingly, we cannot be assured that any of our collaborations will result in the successful development of a commercially viable product or result in significant additional future revenues in the future.

Compliance with regulations governing public company corporate governance and reporting is complex and expensive.

Many laws and regulations, notably those adopted in connection with the Sarbanes-Oxley Act of 2002 by the SEC and the NASDAQ Global Market, impose obligations on public companies, such as ours, which have increased the scope, complexity, and cost of corporate governance, reporting, and disclosure practices. Compliance with these reforms and enhanced new disclosures has required and will continue to require substantial management time and oversight and requires us to incur significant additional accounting and legal costs. Furthermore, on July 21, 2010, President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. While this new law is primarily focused on bank reform and consumer protection, it also makes significant changes to corporate governance and executive compensation rules for public companies across all industries. The effects of this new law remain unclear and will likely require substantial management time and oversight and require us to incur significant additional accounting and legal costs.

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Our operating results could be materially affected by unanticipated changes in our tax provisions or exposure to additional income tax liabilities.

Our determination of our tax liability (like any company’s determination of its tax liability) is subject to review by applicable tax authorities. Any adverse outcome of such a review could have an adverse effect on our operating results and financial condition. In addition, the determination of our provision for income taxes and other tax liabilities requires significant judgment including our determination of whether a valuation allowance against deferred tax assets is required. Although we believe our estimates and judgments are reasonable, the ultimate tax outcome may differ from the amounts recorded in our financial statements and may materially affect our financial results in the period or periods for which such determination is made.

Our stock price is highly volatile and investing in our stock involves a high degree of risk, which could result in substantial losses for investors.

The market price of our common stock, like the securities of many other medical products companies, fluctuates over a wide range, and will continue to be highly volatile in the future. During the nine months ended September 30, 2010, the closing sale price of our common stock on the NASDAQ Global Market ranged from $12.48 to $20.69 per share. Because our stock price has been volatile, investing in our common stock is risky. Furthermore, volatility in the stock price of other companies has often led to securities class action litigation against those companies. Any future securities litigation against us could result in substantial costs and divert management’s attention and resources, which could seriously harm our business, financial condition and results of operations.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

Not Applicable.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

Not Applicable.

ITEM 4. (REMOVED AND RESERVED)

Not Applicable.

ITEM 5. OTHER INFORMATION

Not Applicable.

ITEM 6. EXHIBITS

(a) Exhibits

Exhibit Number		Incorporated by Reference			Filing	Filed
	Exhibit Description	Form	File No.	Exhibit	Date	Herewith
31.1	Certification of Chief Executive Officer pursuant to Rule 13a-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.						X
31.2	Certification of Chief Financial Officer pursuant to Rule 13a-14(a), as adopted 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, as 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, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.*						X

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Exhibit Number		Incorporated by Reference			Filing	Filed
	Exhibit Description	Form	File No.	Exhibit	Date	Herewith
101*	The following materials from Cepheid’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2010, formatted in XBRL (Extensible Business Reporting Language): (i) the unaudited Condensed Consolidated Balance Sheets, (ii) the unaudited Condensed Consolidated Statements of Operations, (iii) the unaudited Condensed Consolidated Statements of Cash Flows, and (iv) Notes to Condensed Consolidated Financial Statements, tagged as blocks of text.*

* This exhibit is being furnished and is not deemed filed with the Securities and Exchange Commission and is not to be incorporated by reference into any filing of the Company under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended (whether made before or after the date of the Report), irrespective of any general incorporation language contained in such filing.

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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 4th day of November 2010.

CEPHEID

(Registrant)

/S/    JOHN L. BISHOP        

John L. Bishop

Chief Executive Officer and Director

(Principal Executive Officer)

/S/    ANDREW D. MILLER        

Andrew D. Miller

Senior Vice President, Chief Financial Officer

(Principal Financial and Accounting Officer)

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Exhibit Index

Exhibit Number	Exhibit Description
31.1	Certification of Chief Executive Officer pursuant to Rule 13a-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2	Certification of Chief Financial Officer pursuant to Rule 13a-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1*	Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.*
32.2*	Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.*
101*	The following materials from Cepheid’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2010, formatted in XBRL (Extensible Business Reporting Language): (i) the unaudited Condensed Consolidated Balance Sheets, (ii) the unaudited Condensed Consolidated Statements of Operations, (iii) the unaudited Condensed Consolidated Statements of Cash Flows, and (iv) Notes to Condensed Consolidated Financial Statements, tagged as blocks of text.*

* This exhibit is being furnished and is not deemed filed with the Securities and Exchange Commission and is not to be incorporated by reference into any filing of the Company under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended (whether made before or after the date of the Report), irrespective of any general incorporation language contained in such filing.