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Executives

John Bishop - Chief Executive Officer

Jacquie Ross - Senior Director of Investor Relation

Andrew Miller - Chief Financial Officer

Dr. David Persing - Chief Medical and Technology Officer

Rob Koska - Senior Vice President of Worldwide Commercial Operations.

Analysts

Dan Leonard - First Analysis

Bill Quirk - Piper Jaffray

Quintin Lai - Robert W. Baird

Peter Lawson - Thomas Weisel Partners

Zarak Khurshid - Caris and Company

Brian Weinstein - William Blair

Bruce Jackson - RBC Capital Market

Derik De Bruin - UBS

Scott Gleason - Stephens Incorporated

Cepheid (CPHD) Q3 2008 Earnings Call October 28, 2008 5:00 PM ET

Operator

Good day ladies and gentlemen and welcome to the Cepheid's Third Quarter 2008 Earnings Conference Call. My name is Jerry and I will be your operator for today. At this time all participants are in listen-only mode. We will conduct a question-and-answer session towards the end of this conference. (Operator Instructions). As a reminder this conference is being recorded for reply purposes.

I would now like to turn the call over to Ms. Jacquie Ross, Senior Director of Investor Relation. Please proceed.

Jacquie Ross - Senior Director of Investor Relation

Thank you Jerry and welcome to Cepheid's Fiscal 2008 Third Quarter Conference Call.

On the call today are John Bishop, Chief Executive Officer, and Andrew Miller, Chief Financial Officer. In addition, Rob Koska, Senior Vice President of Worldwide Commercial Operations and Dr. David Persing, Chief Medical and Technology Officer are joining us for the Q&A portion of the call.

Today's conference call is being broadcast live to an audio web cast and a replay of the call will be available later today at www.cepheid.com.

During this call Cepheid will make forward-looking statements including guidance of the future operating results. Because such statements deal with future events, actual results may differ materially from those projected in the forward-looking statements.

Additional information concerning factors that could cause actual results to differ materially from those in the forward-looking statements can be found in Cepheid's annual report on Form 10-K, Form 10-Q and other filings with the U.S. Securities and Exchange Commission in addition to today's press release. The forward-looking statements including guidance provided during this call are about only as of today's date October 28, 2008, and Cepheid assumes no obligation to publically update these forward-looking statements.

During the call, Cepheid will discuss non-GAAP financial measures. These non-GAAP measures are not prepared in accordance with Generally Accepted Accounting Principals. A reconciliation of the non-GAAP financial measures to the most directly comparable GAAP measures can be found in today's press release made available on our website again at www.cepheid.com.

Finally, and as a reminder this conference call is being recorded.

With that I would like to turn the call over to John Bishop.

John Bishop – Chief Executive Officer

Good afternoon everyone and thank you for joining us. Our total product sales of $42.4 million and total revenue of $44.9 million for the third quarter were new quarterly records for the company. While we are seeing growth with our GeneXpert system and all our Xpert test product, the primary driver for sales is our continued momentum in the rapidly developing Healthcare Associated Infection or HAI market. With very strong North American system placements and record Xpert MRSA test sales our core clinical business grew 71%, although that was a very strong third quarter 2007 and 34% over last quarter.

We stated during our last conference call that we expected that the 37 GeneXpert systems placed in North America during the second quarter to represent a trough for the year, and that indeed support to be the case. With the benefit of the refinements we made to our US sales process we placed 68 GeneXpert systems bringing our cumulative North American total to 402, it is also interest to note that as a proportion of North American placements our record 74% of the systems were GeneXpert 16 cabinets in various configurations, positioning customers to take greater advantage of our expanded menu of test. International placements representing Europe and rest of the world or ROW were 47 bringing our cumulative international placements to 446.

Please note that we intend to report Europe and ROW placements as one category going forward until such time is a separate breakout as meaningful. Globally, our cumulative GeneXpert system placements were 848 as of September 30, 2008. In terms of modules placed, the third quarter marked another new record for saphead with a total of 879 modules. This number includes 650 modules placed in North America and 220 placed internationally.

Customer adoption of the GeneXpert systems continues to be strong as the systems ease of use and efficient operation is expanding the universe of labs during molecular testing in addition to providing existing molecular laboratories with improved work flow. We are also seeing strong interest in the Infinity 48 system following a sense reduction during the American Association of Clinical Chemistry Meeting in July. We continue to expect to initiate of the Infinity System by the end of the year.

To date the primary driver of our GeneXpert systems placements has been the record growth of the MRSA surveillance market. As a remainder, Xpert MRSA test revenue was just under $4 million in the third quarter of 2007. Now just one year later, we are pleased to report MRSA test revenue of approximately $14 million in the third quarter.

As we have previously stated, there are three significant components to the developing HAI market worldwide, surveillance, diagnostics, and presurgical testing. Up to this point the primary market driver has been the guardian of active surveillance as a necessity within the hospital setting. Presently multiple factors are driving the growing movement toward active surveillance.

First, the growing body of data clearly high light the benefit of active surveillance and reducing the incidence acquired infection. A couple of recent examples include a 60% reduction in MRSA infection rates at the New England Baptist hospital and a 79% reduction in the VAE tower healthcare system. Second, legislation continues to trend toward mandating reporting of HAI’s as well as some cases the requirement of active surveillance testing programs. The latest such action in the US was the passage of builds in California requiring both reporting and specific testing of high risk admissions starting in January 2009. I will notice it is also developing in selected international markets.

The third factor specifically impacting hospitals in the US is the CMS initiative that became effective October 1. This ruling discontinued reimbursement for patient extended care related to certain hospital acquired conditions deemed to be preventable. The stated conditions include a number of infections of which MRSA is a leading causative agent. While the majority of active surveillance testing program continue to be directed toward high risk stations, institutions are in many cases trending to a broader definition of high risk and in other cases moving toward all admissions testing. In the US BA hospitals have been moving aggressively toward all admissions testing which translates to an opportunity of approximately 780, 000 test annually. In support of should have they VAE has continued to purchase additional GeneXpert systems and modules.

During the third quarter for example, we placed an additional 18 systems and 96 and on modules in the VAs, five of the system placements were in new VA accounts.

To date, Cepheid has approximately 90% of the VA, MRSA molecular surveillance business. Additionally the count of VA is expected become one of our first Infinity 48 customers later on the year. That said, based upon our success within the VA and as it becomes a smaller contributor within a rapidly expanding MRSA business we will not be breaking out additional detailed information we’re wording in this account in future quarters. The primary driver of third quarter growth in North American system placements was non-VA accounts where we placed 50 GeneXpert System.

As previously noted 74% of the North American systems placements were for various configuration of the GeneXpert 16 system which positions accounts well to take full advantage of our rapidly-developing menu of Xpert test.

Looking forward in the US we are increasingly turning our attention toward transitioning accounts that already cultured based MRSA surveillance programs in place. Based upon ATEC and cash surveys we estimate that this segment comprises approximately 28% of the US market today versus approximately 7% who have already implemented molecular MRSA testing. Therefore we will be focusing on institutions that have ready committed to surveillance programs. This is a pool that is growing as more institution implement active surveillance programs for the first time.

As an example during the third quarter, we transition three hospitals totalling almost 1000 beds and as Pennsylvania University Health System from culture based MRSA testing of high risk patients, two on-demand testing with the GeneXpert System. This institution had implied an innocent until proven guilty model whereby all patients were assumed to be negative for MRSA during the 30 hours or so we took to receive culture based results.

Over time however, clinicians concluded that this vendor of our opportunity for the spread of MRSA was simply too long and exposing other patients to at avoidable and potentially costly infection. A shorter time the result was also the driving force behind the Birmingham Childrens hospital selection of the GeneXpert System.

In our press release issued Monday this British Institution stated that obtaining an accurate and timely result for MRSA is absolutely key at the admission point The hospital also noted that the patients who have undergone several medical procedures that carried a risk of introducing MRSA during the two or three days that takes to receive the culture result. It is vital stated consulted microbiologist Dr. Jim Grey to present MRSA from entering the ICU as it is extremely serious and potentially feeble for children who are already critically ill. These examples highlight the growing recognition of molecular base testing as the basis for best practice surveillance programs. And within molecular testing we have clearly established ourselves as the leader running an overwhelming majority of new molecular accounts.

Additionally, we have been enjoying success and converting accounts from our molecular competitor. Unlike the GeneXpert System are molecular our competitors platform demands significant hangs on time in terms of complex sample prep and fails to deliver on time results due to the need for Bats testing.

One of our VA ramps during the quarter for example, converted from the competing molecular platform to the GeneXpert System when their frustration associated with the utilization and true cost per test became the apparent.

However, as noted surveillance is only one segment of the developing HAI market with the recent FDA clearance of our Xpert MRSA and SA skin and soft tissue or SSTI, hence our MRSA, SA blood culture as always we refer to it BC product, we are now well positioned to enter the diagnostic segment of the market. Both our Xpert SSTI and BC MRSA SA test are designed with the priorities and needs of the frontline practitioner mind.

In the case of blood culture for example, the ability to identify MRSA or Scaphoid from a positive blood culture bottle within an hour offers the potential for more targeted therapeutic approach and a critical situation.

With about 750,000 severe sepsis patient in the US annually, the test is targeted and as targeting a subset of 400,000 or so that are ground positive and are thus have risk for MRSA or SA caused sepsis. Clinicians are telling us that identifying are indeed excluding MRSA or SA some 18 to 48 hours faster than culture is very compelling preposition and that significantly enhances patient outcomes and reduces length of stay. And we are also receiving positive feedback on the Xpert SSTI test which offers an on-demand alternative to the Cepheid treatment of up to 12 million skin and soft tissue infection presented at doctors offices and emergency rooms each year in the US.

With identification or exclusion or MRSA and Scaphoid is under an hour, our Xpert SSTI test provides immediate information useful to the clinical in determination of appropriate therapeutic alternatives. For this product we expect the clinical will be the key influence for test demand.

Looking forward, we are particularly excited about our C-diff test which is currently in beta trials. In many parts of the worlds C-diff is attracting attention than MRSA as a deadly HAI, and we believe that Cepheid’s test will offer patient and clinicians dependable test results in under an hour. Initial beta trial data suggest very high levels of sensitivity and specificity. Our C-diff were also uniquely caught out for highly 027 stream providing clinicians and hospitals with critical on-demand information to enable improved antibiotic stewardship, patient management and more effective confession control of program.

We continue to expect to release the product in Europe via CE mark before the end of the year and to submit a 510-K to the FDA during the first quarter of 2009. Our VRE is also currently in clinical trials in the US and while a CE mark product was released in Europe in early October. This test identified Genes most commonly associated with Vancomycin resistant enterococci. We also expect to file a 510-K for this rest with the FDA in the first quarter of 2009. We expect to further extend our leadership in the healthcare associated infection market during 2009 with an MRSA SA nasal test for presurgical testing. By the end of 2009 we expect our US menu of Xpert test to include up to seven HAI test design to reduce the incidence of HAI’s and to support clinicians in accurate timely diagnosis and targeted treatment decisions. Beyond the HAI market we have a number of products and developments in womens healthcare, critical infection diseases, genetics and oncology. We continue to expect FDA clearance of our first genetic product for Factor II and V testing before the end of the year and we expect to release CE marked product for detection of multi drug resistant tuberculosis in Europe in the second quarter of 2009.

Now I would like to hand you over to Andy for a detailed discussion of the financial results. Andy.

Andrew Miller - Chief Financial Officer

Thank you, John.

Total revenue of 44.9 million was up 24% from the same quarter a year ago and up 7% sequentially with strong growth in our core clinical segment more than offsetting the expected decline in our non-core clinical and biothreat business. Of total revenue product sales comprised 42.4 million and other revenue consisting of contracts grants and research was 2.5 million.

Core clinical sales of 28 million increased 71% year-over-year and 34% sequentially, driven by strong GeneXpert placement and record MRSA test sales. The core clinical business now represents two-thirds of our product sales and is clearly the primary area of strategic focus for the company.

As we discussed in some detail last quarter, revenue associated with our legacy clinical partner business declined from 5 million last quarter to 1.6 million and now represents less than 4% of our product sales a decrease from 15% of total product sales in 2007.

Biothreat sales declined from 9.4 million last quarter to 8.6 million in line with the expectations we shared with you last quarter. Third quarter biothreat sales represented 20% of our total product sales which compares to 35% for the full year 2007. Again highlighting our progress in the clinical market driven by the rapidly expanding HAI opportunity.

Finally our industrial business reported seasonally strong revenue of 4.2 million up slightly from the 3.7 million last quarter and relatively flat with the same quarter a year ago. This business represents 10% of our total product sales.

To recap then, total product sales of 42.4 million grew 9% sequentially and 25% year-over-year with strong growth in our core clinical business comfortably offsetting the anticipated $4 million decline in the legacy non-core businesses.

In terms of geography, North American product sales excluding biothreat products for the US Postal Service were approximately 27 million an increase of 35% sequentially and 47% from the same quarter a year ago.

International product sales of 6.5 million were up slightly from a year ago with new rest of world sales marginally offsetting the declines in our non-core legacy clinical partner business in Europe.

Gross margin on product sales improved to 44% on a GAAP basis. On a non-GAAP basis gross margin on product sales was 46% improving sequentially as expected.

R&D at 11.6 million on a GAAP basis were 10.1 million on a non-GAAP basis, reflected higher costs associated with our aggressive program of Beta and clinical trials. As we have previously discussed R&D may fluctuate according to our scheduled program as such trials. Current trials include C-diff and VRE resulting which we expect to submit to the FDA in early 2009.

Sales and marketing at 7.9 million on a GAAP basis were 7 million on a non-GAAP basis were up about a half a million dollars sequentially reflecting higher costs in the quarter associated with the American Association of Clinical Chemistry meeting higher commissions and additional headcount to support tactical marketing programs.

At 5.5 million on a GAAP basis and 4.4 million on a non-GAAP basis G&A was flat with last quarter. With higher total revenue and improved gross margin operating loss narrowed to 6.2 million on a GAAP and 2 million on a non-GAAP basis. With the strengthening of the US dollar during the quarter we recorded a $1.1 million currency loss partially offset by interest income of 200,000. GAAP net loss was 6.5 million or $0.11 per share. Non-GAAP net loss was 2.3 million or 4 cents per share.

Turning to the balance sheet, cash, cash equivalent and investments were 45.4 million an increase roughly flat from June 30, 2008. Year to date cash flow from operations was positive 3.5 million. Note that we have been advised by UBS that we are eligible to participate in its auction rate securities purchase offer and no cost loan program which it had filed with the SEC. As a result if we participate our auction rate securities will be redeemable after a par value of 25 million in the middle of 2010 and in the interim we have the option to enter into an interest neutral loan agreement for up to 75% of the value. Our auction rate securities are currently classified in non-current investment in our balance sheet.

With that I would now like to turn to guidance. Taking our MRSA test sales guidance first. You will note that including our third quarter results year-to-date sales totaled approximately 33 million. While we always anticipated a steep ramp towards the end of the year a small component of the guidance was led to some progress in the United Kingdom's MRSA surveillance program which is targeting a lack of admission testing by the end of the first quarter of 2009.

As on of the handful of companies granted a hunting license for the business, Cepheid remains well positioned. As it remains possible that the NHS will start to move more aggressively towards meeting it’s mandate during the fourth quarter. However, with one month of the quarter behind us and given our understanding of the complexity of the surveillance adoption cycle we are opting for the more conservative path. We are therefore reducing our MRSA test sales guidance from 52 to 55 million for fiscal 2008 to 49 to 51 million which implies fourth quarter MRSA test sales in the range of 16 to 18 million. This revised guidance range at the midpoint represents 475% growth as compared to our fiscal 2007 MRSA test sales and clearly demonstrates the continued rapid growth in the market.

Some additional points I should look out to the fourth quarter and beyond. First, while the United States Postal Service is committed to a contractual minimum of 1 million test for their fiscal year ending September 30, of 2009 the most recent purchase order indicates the shipments will not be linear during that period. Taking this into account we now expect total biothreat revenue to approximate 5.5 million in our Q4 '08; 7.5 million for Q1 '09; 7.5 million for Q2 '09 and 3.5 million in Q3 '09.

Next we expect sales from our non-core clinical partner business to be approximately flat in Q4 '08 relative to Q3 '08. And on system placements we continue to expect second quarter North American placements of 37 to represent the trust.

Year to date we have placed 155 systems in North America for an average number of North American placement per quarter in the low 50s range. We expect this general level of placement to continue in the near term. Although given the nature of the business we would anticipate fluctuation around that level in any given quarter.

Moving to the business model, as one would expect with the new system the initial shipments of the Infinity 48 during the fourth quarter are likely to contribute lower gross margins than we are targeting in 2009 and beyond. With that in mind we expect gross margin performance on a non-GAAP basis to be roughly inline with our third quarter results. Finally on the business model, we continue to target the achievement of a non-GAAP profitability for fiscal 2009.

Moving back to guidance, with the refinements to our MRSA test sales expectations forecast for our biothreat business and the potential for strengthening US dollar we now expect products sales in the range of 164 and 166 million for fiscal 2008 implying fourth quarter product sales of approximately 41 to 43 million. Total revenue is expected to range from 174 to 176 million for fiscal 2008 implying fourth quarter total revenue of approximately 42 to 44 million.

Reflecting negative currency impact through the second half of 2008 coupled with lower than projected gross margins associated with our early shipments of the Infinity 48 we now expect full year GAAP net loss within the range of 22.5 to 23.5 million or $0.39 to $.41 per share. This implies fourth quarter GAAP net loss in the range of 6.7 to 7.7 million or $0.11 to $0.13 per share.

Excluding approximately 16 million related to stock compensation expense and 1 million related to the amortization of acquired intangibles, non-GAAP net loss for fiscal 2008 is expected in the range of 6.5 to 7.5 million or $0.11 to $0.13 per share. This implies fourth quarter non-GAAP net loss in the range of 2.4 to 3.4 million or $0.04 to $0.06 per share. We expect to share fiscal 2009 guidance with you during our fourth quarter earnings announcement.

Now let me turn the call back to John.

John Bishop – Chief Executive Officer

Thanks Andy. With just a couple of month left in 2008, we look forward to building on the recent US release of our Xpert SSTI and blood culture products and the European release of our VRE product and closing the year with some additional milestones. These include the anticipated shipment of Infinity 48. In addition to the US market release of our Xpert test and the European release of our Xpert C-diff test.

Looking out to next year, we expect 2009 will mark a new chapter for Cepheid as we build on strength in molecular MRSA testing, which now includes both surveillance and diagnostic test and to expand our leadership and the overall healthcare associated aftermarket more broadly. Our rapidly expanding Xpert test menu is expected to be the primary wealth driver in 2009 and beyond.

First new test can be served into existing GeneXpert System customer. We have already experienced the benefits of rapid on-demand testing. Our Xpert SSTI blood culture C-diff and multi-drug resistant TB test offer superior medical value-add to establish markets. And finally, as the menu continues to expand, investment in the GeneXpert System becomes an even more compelling proposition as customers are able to leverage their platform investment across multiple testing programs. And it’s not just customers who are recognizing the truly disruptive nature of Cepheid’s GeneXpert System for molecular diagnostic.

During the quarter, we were very pleased to welcome CDC epidemiologist, Dr. Fred Tenover, PCR Inventor Dr. Russell Buchie and renowned microbiologist Dr. Alex van Belkum to the Cepheid team. Our continued ability to attract experts and their caliber highlights the groundbreaking nature of our technology and the importance of the work we are doing here at Cepheid. By serving healthcare through the eyes of the clinician, seeking the optimum medical value-add with each test, Cepheid is defining the future of molecular testing.

I would now like to ask the operator to begin the Q&A.

Question-and-Answer Session

Operator

[Operator Instructions]. And your first question comes from the line of Bill Quirk with Piper Jaffray.

Bill Quirk

How are you doing?

John Bishop

Good Bill. How are you?

Bill Quirk

Good. Just I guess the first question is, we have come through about three quarters now relatively flat GeneXpert utilization. Can you tell us what you think is kind of drive that higher going forward, is it publication?

John Bishop

It’s going to be a bit of all of the above thing is a continuing increase in scientific publications, clearly is showing the benefits of surveillance testing. There is going to be some additional presentations at the upcoming Molecular Pathology meeting in Dallas later this week directed at that issue. So I think that’s going to continue certainly as the understanding of the CMS, gets fully more appreciated and understood that that’s going to drive incremental testing. The other thing that we are seeing that’s going to be leveraged well is to replay the total menu and the whole aspect of the diagnostic portion is really going to start to drive incremental demand. We are seeing good interest in the SSTI, the blood culture products. We are seeing a very heightened anticipation of the availability of the Cepheid product. A couple of those, we think that’s going to drive additional overall placements and it’s going to drive increased utilization of placements that are already installed.

Bill Quirk

Okay, great. And you guys kind of alluded in the call, it sounds like the really strong GeneXpert placement in the quarter. You mentioned there has been some kind of sales force change, some kind of new incentive or something. Can you give us a little bit more color there?

John Bishop

Actually it’s a new process. We actually spoke about that during our last call for the second quarter that what we realized was that in developing the accounts coming on now that essentially we passed the pioneer phase and we are into the second phase and that we needed to do a couple of things. One was to provide a model based upon what wa learned with the pioneers on how to establish a program, make that available for our institutions. And then in addition to give better drive basically understanding where the account was and their own determination of setting the surveillance program because what’s different that’s the reason why we are stressing also for next year the big -- we think a bit coming form the diagnostic test. What’s different for surveillance, it is not just the laboratory. You have to have all the barer protection, the hygiene, everyone’s got to be fully trained and on board with one together from the clinicians to the nurses to housekeeping. As a result, that takes time to develop and one of the things that we have done is literally developed a qualitative account evaluation program that our representatives work through and that program actually has helped the accounts to understand where are they relevant to the other components outside of just the laboratory. So when it comes time to initiate the program, place an order that everything is lined up and ready to go. So that program has been as you can see with the Q3 results very very effective.

Bill Quirk

Okay. And just a quick one on guidance. It looks like MRSA came down about 3 to 4 million. Is that fully due the UK or is there something else going in there?

Andrew Miller

Actually as we indicated with our guidance quite a long, the guidance is always comprised three pieces: North America, Europe, rest of the world coming on. So basically as we will be reporting on North American international looking at that. North America is tracking very very well. I know that there was a lot of discussion on if the VRE for example going to be moving to other missions, they did purchase incrementally, reduce the increased utilization and test volumes. So North America is tracking just fine. Primary initiatives here are internationally and again, we indicated during the guidance portion of the discussion is the UK in particular, we are doing well, we are well positioned there. It’s a question there of the availability of the funding. I mean you saw the press release that came out from the Birmingham, I can’t say enough about that, but frankly, very excited about that study because it proves multiple points with the Gene, the first step we are done that really used GeneXpert coupled with 16s placed in ICUs and Emergency admissions, general admissions and correlated all of that to the central laboratory. So we are well positioned over there, but the question is funds flow, we cant control that. So we have elected to be more conservative in our guidance and lower.

Bill Quirk

Okay. Then just one last one.

Operator

And your next question comes from the line of Dan Leonard with First Analysis. Please proceed.

Dan Leonard

Hi good afternoon.

Andrew Miller

Good afternoon Dan.

Dan Leonard

I see both of my questions are – I have both of them for Andy. Andy you alluded to this in your prepared remarks, but my question is, what is the minimum cash balance you are comfortable with?

Andrew Miller

So, we have right now about 45 million of cash in investment, 45.4 million, and that includes 25 million of auction rate securities at par value with the fair market value of 21 million. I pointed out that we year-to-date are actually cash flow positive from operation at 3.5 million. So we believe we have adequate cash an investments to operate the business, especially when you consider that we are planning on non-GAAP profitability next year. So the fact that you guys have now filed with the SEC on exactly when and how they are going to redeem the auction rate securities HIPPA confident. So the middle of 2010, June 2010 we can put them on UBS, and then the interim we are able to borrow against them at no interest for 75% of the value. So we feel our position well from operational prospective on cash.

Dan Leonard

Okay. And then my second question then is on your working capital. Do you achieve the cash flow performance you talked about, your accounts receivables days on hand have comedown pretty significantly, and at the same time I think your inventory, I imagine it would pickup if you have more product skews and you have Infinity 48. So how do I think about working capital going into the fourth quarter?

Andrew Miller

So, with the DSO of 36 days that’s pretty good performance, so, I wouldn’t be surprise of that moved up a little bit, but it clearly have room to make some improvements on inventory turns as we move forward. 3.1 is being impacted by frankly the high systems demand as well as the infinity launch. So there is an opportunity for us to still generate cash from working capital management as we move forward over the next three quarters.

Dan Leonard

Alright. Thank you very much.

Operator

And your next question comes from the line of Peter Lawson with Thomas Weisel Partners. Please proceed.

Peter Lawson

John, if you have seen any impact from the Credit Suisse hospitals in that spending in the US?

John Bishop

Thus far Peter we have not, I mean, as you see with the results on the third quarter certainly in the US that’s continue to be very strong and the other – looking forward right now we are not seeing any real impact on that. The other one that I would say, as we move into next year we are seeing very good interest in the Infinity 48, there maybe some level there because they will be looking at a $400,000 piece of equipment versus what we see with the rest of the GeneXpert product line.

Peter Lawson

And what’s the backlog like for the Infinity?

John Bishop

Well, I don’t initially give you a particular number at this point in time, but its looking a good, its actually were more positive there then what we originally planned going in. So as I mentioned we had a good response following AACC.

Peter Lawson

And, is there any likelihood that there is a twist over to reagent rentals and how big of part of business is that for you?

John Bishop

Well, right now reagent rentals is a very small portion of our business in the US marketplace faraway that vast majority of our product so actually sold as you agent reagent rental program. It’s possible that we could have a limited number of units on the reagent rental, that’s clearly not our focus in that regard, and then frankly as we are looking at capital. I know the question was on cash flows there and working capital. We have a banking arrangement, so reagent rental programs are not carried on our balance sheet. So, on the event that we were banking program carrying that and we wouldn’t carry it.

Peter Lawson

Okay, thank you John. Thank you.

John Bishop

Thank you Peter.

Operator

And your next question comes form the line of Quintin Lai with Robert W. Baird.

Quintin Lai

Hi good afternoon nice quarter.

John Bishop

Thank you Quinn.

Quintin Lai

John, could you talk a little bit about Europe, I mean, if Q3 turns to be seasonally softer because of the summer holidays, but as you look forward to Europe, can you give us an update outside of the UK what some of the countries are doing there culture with versus NAT and how you are doing versus the competition?

John Bishop

Sure, actually, I wanted to turn over and let Rob give you some of the details. As we have indicated there we have been doing very well in Europe and the Netherlands also Germany continues to be a very good country for us. And going into some of the other initiatives, Rob, you want to have the details here?

Rob Koska

Yeah, as John said, when we look at our top three countries of course, Germany, Italy and the UK are included in that. Interestingly enough from competitive situation we have turned our targets to culture and winning against culture in the European markets. We are not seeing that our other molecular competitor is gaining any market share. And interestingly enough we don’t see a lot of activity from them in UK market positioning us to be able to take advantage when the flood gates open and funding becomes readily available to implement at end of Q1 2009 mandate over there. So, overall it’s a robust situation and I think we are well prepared to be able to take advantage of it.

Quintin Lai

Thank you for that. And then now with the passage of the California Bill, what are you seeing from your customers, I guess, should we be thinking along the lines of that 28, 7% split between culture and NAT or would you think some of these are hospitals especially with the news like these NSL stars that are catching MRSA from their surgeries, that increased awareness we might even see more adoption to the NAT side?

John Bishop

So there is two parts to your question Quintin, and first I will ask Rob to address what you are seeing in the market relative to the legislative activity. I think the second part of your question really brings up more importantly a separate discussion of diagnostics what I was already talking about, because the NSL situations are real example where one needs a very accurate and rapid diagnosis immediately. To understand if you are dealing with MRSA we are dealing with Staph, because you know, I mean, some of this has actually been around for a while and was generally Staph infections and that is the overall higher rate of colonization, but now you’ve got the MRSA contributing to the complication there. So I think the SSTI product is going to play nicely in that regard, and yes, I think that its really going to help enable accounts to treat these patients excessive impact in the emergency department setting immediately with a rapid diagnosis, but on the surveillance side, let me turn it over to Rob to go through some of the details there?

Robert Koska

Yes Quintin, up until this week there was a lot of clarification that was necessary to be able to interpret the legislation as it was passed. I think we have moved beyond and institutions are understanding what that obligations are. To date what we have seen that we sent an increase in our final and a tremendous increase in interest in going molecular. One of the things that I can say about the GeneXpert as you look at our market segmentation is that we sell across all segments of the market and we uniquely qualified or uniquely positioned to be utilized in a thousand bed hospital all the way down to a 25 bed hospital. And so, I am sure that those smaller institutions want to move into clinic asset testing, we will be there with the GeneXpert to accomplish that.

Quintin Lai

Thank you.

Operator

And your next question comes from the line of Zarak Khurshid With Caris and Company. Please proceed.

Zarak Khurshid

Hi guys thanks for taking my questions, congratulations on the strong clinical business. First question, could you give us some color on the SmartCycler or what’s likely were minimal if not zero just a quick update on the kind of the Becton Dickinson relationship as it stands currently?

John Bishop

Sure, as you would expect, the SmartCycler were down certainly on the clinical side as we have ended essentially the BD relationship on SmartCycler purchases. So we indicated that, that certainly happened during Q2, so we then expect to see much in Q3s and we expected to see SmartCycler sales decrease. So, no surprise in that regard, the other side of it is the industrial. Industrial primarily right now, because we are really focusing on the clinical side is handles by our distributors in the US market. So there, we are pushing that market and its not getting quite the attention obviously that we are putting under GeneXpert. So, hence, the decrease versus what you’ve seen previously.

Zarak Khurshid

Okay. So the SmartCycler sales that go distributors those are categorized under the industrial segment and they don’t fall into the system sales breakout?

John Bishop

On the clinical side prominently yes, those are – we have some SmartCycler sales that can be sold clinically, now for someone using ASR products by way of example, but far the way there was a bulk of those that are distributed those are all industrial products.

Zarak Khurshid

Okay, great. That’s helpful. And then…

Operator

And your next question comes from the line of Derik De Bruin with UBS. Please proceed.

Derik De Bruin

Hi good afternoon.

John Bishop

Good afternoon Derik.

Derik De Bruin

What was the year-to-date top line impact from FX and I guess you have the loss recorded this quarter on the net interest line. Is that something we are actually going to see going forward as well or have you hunch that?

John Bishop

Yes, the top line impact was in the 100s of 1000s for the quarter negative impact. So its not that significant. We had a $1.1 million currency loss, we are not hedging currently, we are evaluating it something that we are looking at in the early part of next year, and we have factored some additional currency loss in Q4.

Derik De Bruin

Okay, great. And, I guess, can you just help me think a little bit about how the SSTI test and bulk order test, how those are going, basically are kind of a ramp up rate for those going forward and I guess you know, what being – I think there are any contribution this quarter, what your contribution for this test in the fourth quarter, just give me some idea on how you see the testing ruling out?

John Bishop

Okay, well I think the answer that Derik we are not going to get into clearly specific expectation on the bi-test basis. Its something that now has really grown has grown frankly beyond that so we are really going to be focusing as we go forward the future on the overall clinical product growth. And however, to get out of that a bit I think, it will be helpful to have Dave Persing address the clinical utility because I know, there has been some comments made in the market wherein in one case I think they were talking to a laboratory, you know, I cant get my head around the value preposition there and the issue there is one and talking with people there, not unnecessarily talking to the appropriate market driver, the real market drive for these products likely will be the clinicians. So in that regard, Dave you want to?

David Persing

Yeah, Derik, I would just say that there is a lot of enthusiasm about these products, we heard that over and over again kind of in the same meeting that we discussed back from last night. Fred Tenover and I were attended sessions together and he heard the same information from different sources. And, now the bottom-line is that these products are going to drive treatment decision in realtime and that’s going to save a lot of hassle for clinicians down the road, emergency rooms docs are looking at getting results back, quickly, actionable results within that hour to send the patient home on the correct therapy they get treatment pieces and information from that cultures they get a MRSA result, MSSA result and a negative result, and all three differently, and they know really with very high resolution how to manage those patients once they get that result and they are not having to chose down the patient after the fact try to give them a prescription over the phone or pharmacy pickup make that much easier for them to manage those cases.

The other enthusiasm is coming from the surgeons, they are really interested in having a rapid result in patients who were postsurgical and develop a slightly fever in the hospital, the work done for possible ruled infection having test available good to generate the first actionable information is very beneficial because they can get them on the right therapy as soon as possible, and the real eye opener for a lot of people is the realization that Vancomycin is not the antibiotic therapy for MSSA, its just simply isn’t, so there are much better treatment options then the so call broad range antibiotic approach if the patient does not have MRSA and they want the treatment option available in order to maximize treatment responses. The blood culture product appeals to the ICU docs, they were lightly being able to distinguish between MRSA, MSSA and probable coagulase negative staff in order to maximize their treatment options and also to be able to potentially manage the patient without antibiotic therapy if its coagulate negative contamination. So, bottom line is that there is – a lot of enthusiasm comes from outside of the laboratory for these products and they are going to converge e on the laboratory we think to really provide a lot of boost to these systems being installed.

Derik De Bruin

Okay. That’s helpful thank you very much. Just on one part question just on looking at the instrument number. So if you assume that the SmartCycler sales are negotiable and you kind of back out that, I think the 1.5 from BD, that’s quite that’s – about – you are getting about 100 and looking at 150 system that’s about a $100,000 per system as an ASP?

John Bishop

On the SmartCycler?

Derik De Bruin

No. What you are getting in terms of your product revenues?

John Bishop

Yeah, actually few assumption were little off. So the non-core clinical is D and we also do have some sales to Roache within there. So that’s in there as well. And of course, industrial a good piece of that is SmartCycler.

Derik De Bruin

Okay. That’s revenue going back as like what, what's the industrial number picked up this time? So what you are selling there and I guess ….

John Bishop

It more than half.

Derik De Bruin

More than half okay.

John Bishop

The other thing you can note, our GeneXpert-16 is a least price of 155 and with fully configured and we gave you some indication of the percentage of US placement that that was GeneXpert-16 cabinet. So I think we will be able to try to ran in these BD.

Derik De Bruin

That’s what I was having. Thank you.

John Bishop

Okay

Operator

And we have followup question Zarak Khurshid, with Caris & Company. Please proceed.

Zarak Khurshid

Great thanks.

John Bishop

Zarak, what happened?

Operator

(Multiple Speakers). You may proceed sir?

Zarak Khurshid

Can you hear me?

Unidentified Company Representative

Zarak your line is open.

Zarak Khurshid

Hello?

John Bishop

Yeah Zarak.

Unidentified Company Representative

We will comeback to Zarak later, next call please.

Operator

[Operator Instructions]. And your next question comers from the line of Scott Gleason, with Stephens Incorporated. Please proceed.

Scott Gleason

Hi John, thanks for taking my question and congratulation on strong quarter. First question with America is going to effect throughout the quarter, has the conversation with hospitals changed at all, have you guys seen any noticeable change in terms of the impact associated with those?

John Bishop

We will ask Rob that address that point directly. Scott, nothing nervous about this point as you would expect that there would be a light phase between when the customer is coming and actually understanding the impact your institutions by it. So we see some interest driven, tight conversations, but nothing that’s translated into incremental sales at this point.

Scott Gleason

Okay, great. And then if I look at the analyst specific regions in the deadline being met from the FDA. Can you guys talk about what the impact was this quarter and then what kind of impact you could see going forward next quarter?

John Bishop

Sure. As we indicated there, we have about five products that have been de-bundled, so some of the ASL products are sold internationally, so we are having international operations we can – we will keep those product essentially on the market ready to international so that is again part of -- the big volume sellers of the ASL products essentially de-bundle and they are continuing, yes. So right now, we haven’t see a huge impact with that. Certainly we expect a nominal stuck down with some accounts that like the idea that they have got to deal with a whole bunch of different regions versus one something that you said previously.

Scott Gleason

Okay, great John. And then just one last question. When we start thinking about next year and the contribution from new products, I guess, John you maybe provide a little directionality and what kind of growth you could see from the C-diff, VRE and then all for the diagnostic products for skin and soft tissue and the blood products?

John Bishop

Well, as Dave indicated, the key products for next year the once that just got released certainly the US market will be the SSTI and the blood culture products. Timing wise we are looking at second half of the year for the C-diff and the VRE products. I think what we are seeing right now that we are seeing very good interest in all of those products. The SSTI product can develop nicely. The question there is if you take a look at the 12 million patient visits annually that are in the US marketplace, what percentage of those are coming in through the emergency department versus through the general practitioner or nutrition. So I think it would be initially the smaller set likely coming into the emergency department and then spreading to the other and later on is you are going to have to send those test out. Although the other things we are very interested in looking at would be laboratory supporting good practices who have modern complexity and capability where we already have that. So those products can play a role. Then as you get into the second half of the year, I think probably with what we are seeing right now, the lead product the likely be the C-diff product given the fact that there appears to be pent-up demand for a rapid accurate product there and then following that would be the VRE product that should contribute on the surveillance side.

Scott Gleason

Okay, John. And then just one last question. When we look at the VA and the disposable sales in the US, can you maybe provide some commentary on where you think we are from a penetration standpoint right now and where that penetration level could go as we transition into 2009?

John Bishop

Yeah, as we indicated, we got approximately 90% of the VA at this point in time primarily focused. If you look at the VA is on testing, they are testing on admissions and they are going through additions. They are testing on discharge and they are testing on interdepartmental transfer. So the bulk where we are certainly the frontline is on the admissions. They have been doing a lot of culture testing for the discharges. So obviously you going into next year certainly and all will be admissions with us, with 90% of the business there, handling the admissions and then on the discharge as I mentioned those are mostly cultured can there with some of the accounts be interested in potentially ease-of-use going to the GeneXpert we are seeing some possibility there, but primary focus on the admissions testing.

Scott Gleason

Okay. Thanks.

John Bishop

Thank you,

Operator

And your next question from the line of Zarak Khurshid with Caris & Company, please proceed.

Zarak Khurshid

Great thanks for taking the followup question. It looks like the account qualifying for again really starting to pay dividend. Can you provide a little more color or commentary as to kind of – as the rate limiting step in the sales process, and then how might it is kind of we can microenvironment kind of change on this strategy in that program?

John Bishop

Well the single rate limiting step is being about the get out the players on the page and what we’ve really learned is that we have to go through accounts instead sales process where it is in fact illuminating to the customer as to the things that they didn’t think about in the implementation of a comprehensive program to be able to reduce MSA infections. And being able to coordinate and get all the place to the table is the single greatest catalyst to change at this point, and that's different to be where we were a year ago, where would have that single product champion that would drive it to those accounts. So that would be in the nutshell.

Zarak Khurshid

Okay. Great. And then it appeared initially the early adopters of GeneXpert have purchased perhaps a little more module capacity than they really need it out of the gate, can you guys comment on how those extra modules that were dormant may have changed in terms of their usage overtime, and then the new customers today, how are there buying patterns say different comparing to the early adopters?

John Bishop

Well, I don't think that the buying patterns is changed, I think that the account demographics have changed, whereas as I think awesome and other competitors were focused on the higher end or larger accounts, and they have not been able to move down in accounts size, but I think its pretty much uniform out there that people kind of ease into the water, they put the toes in and decide that they’re going to test a certain departments over ICU or once they show success there they move into broader and broader implementation of testing. And I still think to that's pretty much the approach that everybody is taking regardless of size.

Zarak Khurshid

Very helpful. Thank you.

Operator

And your next question comes from the line of Bruce Jackson with RBC Capital Markets, please proceed.

Bruce Jackson

Hi good afternoon. Can we get a little bit of an update on the US sales force for your stand in terms of reps and national accounts field service stuff like that?

John Bishop

Yeah, that’s pretty much unchanged from where we were at the beginning of the year. We have 24 accounts, 24 reps who have a direct responsibility to be able to call in accounts. You factor and the field technical service reps who do the training implementation and we utilized them to be able to do many expansion within accounts because our sales force of course is focused on being able to get new placements. National accounts program is unchanged and sales management is unchanged. So we are at roughly 43 individuals focused on the field that has not changed. Although we do anticipate a shift as remove into next year, now that we have a number of new products, the blood culture bottle product, the SSTI product, VRE see just coming to catch up, its time to really focus on that installed base and really ramp up utilization per account, and so, that's what we are going to be building ourselves things to be able to do as the first of the year.

Bruce Jackson

Okay and then in terms of the MRSA revenue what percentage of that was domestic and what was international?

John Bishop

We actually haven't broken that out, but I will say that significantly larger proportion of all of that is US North America.

Bruce Jackson

Okay and then having provide us with a rough estimate of how many modules are at the VA versus modules that are non-VA in the US?

John Bishop

We provided last quarter - That’s right, I think we have about 1300 VA modules in the US now….

Bruce Jackson

And that’s at the end of the third quarter?

John Bishop

Yeah.

Bruce Jackson

Okay. All right that’s it from me. Thank you.

John Bishop

Thank you.

Operator

And the last question comes from the line of Brian Weinstein with William Blair. Please proceed.

Brian Weinstein

Hi guys, how are you. To start is, what you guys mentioned in the UK about the complexities in getting funding maybe you could be a little bit more specific on what those complexities are and is there a chance that they don’t come through at all and that the program is delayed?

John Bishop

I do not believe that there is a chance of the program will be delayed, the deadline of course is the end of the March. What we anticipated based on the market input that we have et cetera is that there would be easing into this mandate and that a number of accounts would come on board throughout the year early enough to be able to prevent a last minute rush to be able to hit the mandate. And clearly what is occurring is that you know, people are waiting until the last minute. There has been some loaded funding available up until this point on a -- I don’t want to say grant phases, but on a specific need basis for some people to get started early. And there was just within the parliament there were questions that were leveled towards the implementation of the program and the house officials did reiterate that they are marching ahead expecting to be able to hit that dead line for elective admissions by March. And then be able to assume as possible bring on the emergency admission that they have. So we have a total opportunity of some 11,000 test that are available next year and then beyond you know, for the UK.

Company Representative

Multiple speakers

Brian Weinstein

All right. And are we going to see any change…..

John Bishop

Wrapping up a direct sales force that type of opportunity.

Brian Weinstein

Any thing of C-diff or VRE that we are going to see later on this week at the meeting in Dallas?

John Bishop

Yeah actually -- Dave why don’t you talk about what's going to be happening there at ……..

David Persing

Yeah, we will have a really good conference actually a pretty conference workshop that’s going to be held on Thursday from 1 to 3. it will have four presenters and two of them will be laboratory directors of Cepheid products and then that will be followed by Dr. Fred Tenover giving some background on the VRE and C-diff and then I will talking about the new products in the pipeline and also the Infinity system. And we will be giving some specifics on improvements of the VRE, C-diff and TB products at that time.

Brian Weinstein

Thanks. Great, I look forward to that. Thanks.

Operator

This concludes the question-and-answer portion of the conference. I would now like to turn the call over to Ms. Jacquie Ross. Please proceed ma'am.

Jacquie Ross

So that concludes today's conference call. A replay of the call will be available after 4:00 p.m. Pacific today on our website at www.cephied.com/investors or by dialing 617-801-6888, participant coded 68801630. The video replay will be available until next Tuesday the 4th of November. Thank you for joining us today.

Operator

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Good day.

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Source: Cepheid F3Q08 (Qtr End 09/30/08) Earnings Call Transcript
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