Executives
Ron Zwanziger – Chairman, Chief Executive Officer, and President
David Teitel – Chief Financial Officer and Principal Accounting Officer
Doug Guarino – Director of Corporate Relations
Analysts
Greg Simpson – Stifel Nicholas and Company, Inc.
Jonathan Goldberg – Merrill Lynch
Peter Bye – Jeffries and Company
[Jeffrey Freelick] – Lazard Capital Markets
Inverness Medical Innovations, Inc. (IMA) Q3 2008 Earnings Call October 29, 2008 10:00 AM ET
Operator
Good morning. My name is Barbara and I'll be facilitating the audio portion of today's interactive broadcast. (Operator instructions) At this time, I would like to turn the event over to Doug Guarino. Sir, you may begin.
Doug Guarino
Thank you Barbara and good morning and welcome to the Inverness Medical Innovations conference call to discuss our results for the quarter ended September 30, 2008. We are joined today by Ron Zwanziger, Chairman and CEO, and David Teitel, CFO.
Before we get to that discussion though, I would first like to draw your attention to the fact that certain matters discussed in this conference call will constitute forward-looking statements, within the meaning of the US Securities law. These statements reflect our current views in respect to future events, or financial performance and are based on management’s current assumptions and information currently available. Actual results and the timing of certain events could differ materially from those projected or contemplated by the forward looking statements due to numerous factors including without limitation, our ability to successfully integrate our acquisitions and to recognizing expected benefits of restructuring and new business activities; the performance of businesses acquired, our ability to consummate the health management joint venture alternative arrangements that we are exploring, the impact of the recent crises in the global financial markets including the credit markets, our plans and operations and those of our suppliers and customers; our exposure to changes in interest rates in foreign currency exchange rates; our ability to successfully develop and commercialize products, the market acceptance of our products, continued acceptance of healthy management services by payers, providers, and patients; the content and timing of decisions by regulatory authorities, both in the United States and abroad; the effect of pending and future legal proceedings in our financial performance; and the risks and uncertainties described in our periodic reports filed with the securities and exchange commission, including our form 10K for the year ended December 31, 2007. Our company undertakes no obligation to update forward looking statements. Our company undertakes no obligation to update forward-looking statements.
Additionally, please note that during this call, we may discuss non-GAAP financial measures. For each non-GAAP financial measure discussed, a presentation of the most directly comparable GAAP financial measure and a reconciliation of the differences between the non-GAAP financial measure discussed, and the most directly comparable GAAP financial measure is available on the company’s web site at Invernessmedical.com.
With that, let me turn the call over to Inverness Medical Chairman and CEO, Ron Zwanziger, Ron.
Ron Zwanziger
Thanks, Doug and good morning everyone. During Q3, we experienced another quarter of sustained financial improvement with adjusted cash EPS up 59% over Q3 of 2007, representing our ninth consecutive quarter of year-on-year improvement. The financial result that we achieved in the third quarter are based on sustainable long-term factors and we therefore expect to continue our significant year over year profitability growth for the foreseeable future.
Q3 however was not without its challenges. Toward the end of the quarter a variety of issues in Europe reduced our overall reported results by approximately $0.05 per share on an adjusted cash basis. Approximately half the impact was related to shipment delayed out of the quarter most of which was shipped at the time. The balance is due to a number of issues including foreign exchange and production introductions in some companies that need to be addressed.
On the other hand, the U.S. professional market experienced a particularly good quarter and we believe that the momentum should continue even through a recession. For example, the outpatient cardiovascular business continues to see positive momentum from both the (inaudible 00:04:47) product lines with BioStar experiencing a record number of new accounts closing into the physician office market. Additionally, Cholestech business remains solid with expanding new business opportunities into the growing retail health market.
Also important in terms of our ability to sustain these successes is the fact we're experiencing both revenue and cost benefits from increasingly strong relationship with our key distribution partners in the U.S. as we find new ways to drive our combined business and optimize the supply chain.
Despite the problem in Europe at the end of Q3, our overall organic growth rate in the quarter for professional diagnostics was 11.1% continuing the path and approach we've been experiencing over the past several quarters.
The integration of our health management business now operating as Alere continues ahead of schedule. Even in the current economic climate, our health management customers remain committed to improving the clinical outcomes of their employees and members, especially when these programs allow them to cut their overall cost of care. As a result of our unique capability to offering high touch, low cost technology-driven solutions, we've just renewed and extended the contracts with our largest health claim client and our largest employer client. We're also in discussion with several of our clients about expanding their business to include our unique product offerings. We're now pleased to report that the attrition of legacy Matria has slowed considerably and we're beginning to gain more new clients than we're losing, both in the employer and health plans.
We believe that this momentum will continue based on the fact that our pipeline for requests for proposal and sales leads are strong and we are unrivaled in the quality of our staff that we have been pursuing these opportunities.
Additionally, as previously discussed, we're in negotiation with several of our health plan clients to add home based PTI in our monitoring programs using Inverness Diagnostics. In fact, the number of clients with whom we are engaged in discussions expanded during the quarter and we're optimistic that we'll sign multiple contracts in this area over the next several months, making an important milestone in the convergence of diagnostics and health management.
Furthermore, several insurance companies have recently agreed to automatically cover INR monitoring based on physician prescriptions, eliminating the need to obtain reimbursement approval on a case by case basis.
Overall, we believe that home INR monitoring is a major opportunity which we're uniquely positioned to capitalize on. I'll come back to this in more detail later in the call.
Q3 was financially strong with record EBITDA during the third quarter of $100 million excluding restructuring charges and this has enabled us to continue making several smaller strategic investments around the world. For example, as part of our strategy, to increase our direct sales presence in countries outside the U.S., we acquired two foreign distributors in Austria and Brazil in September and October. Respectively, both of these companies were privately held distributors for a number of manufacturers including Inverness, to the professional diagnostic market. In each case, we selected a company and a management team that we know well and which we're confident will support Inverness expansion over the next several years.
Also in September, we completed the acquisition of two companies located in South Africa. The first specializes in the development and manufacture of malaria lateral flow tests, an attractive addition to our wide range of rapid diagnostics. The second is a diagnostic product distributor which will provide marketing and sales resources to Inverness' new subsidiary in Johannesburg. These two acquisitions collectively represent the creation of Inverness' first direct manufacturing and distribution breaks in Africa to help in the launch of both a determine combo antigen/antibody rapid diagnostic HIV test and the CD4 test being launched next year.
Additionally, in August, we acquired a smaller overseas health management business with revenues of less than $2 million per year on a trailing basis.
Before I hand the call over to Dave, let me just mention that while the financing transaction around the health management business is obviously much less likely at the moment, we're exploring options which may enable us to enhance its value.
And now let me turn the call over to Dave for a discussion of our reported financial results for the second quarter.
David Teitel
Thanks Ron and good morning everyone. Adjusted net revenue for the third quarter of 2008 was $438.8 million, up 85% as compared to $237.6 million for third quarter 2007. Adjusted gross margins for the quarter were $240.9 or 54.9% of revenue in Q3 2008, compared to $124.2 million, or 52.3% of revenue in Q3 2007.
Adjust operating income was $85.5 million in Q3 of 2008, compared to $42.4 million in Q3 2007. Adjusted cash earnings per diluted share for Q3 of 2008 was $0.43, compared to $0.29 for Q3 2007. Comparing our third quarter results to Q2 2008, revenues of $438.8 million earned in Q3 exceeded Q2 revenues of $401.1 million.
Changes in exchange rates during the third quarter reduced reported revenues by $2.3 million compared to Q2 2008 rates. Q3 2008 benefited from a full quarter of ownership of Matria which contributed $75.2 million of revenue in Q3 2008 compared to $44.5 million of revenue for the partial quarter results included in Q2 2008. Adjusted gross margin for the percentage of revenue decreased from 56% in Q2 2008 to 55% in Q3 2008.
General and administrative expense increased to $132 million in Q3 of 2008, from $121.9 million in Q2. Matria, by virtue of a full quarter of ownership, attributed 13.2 million of the increase. Excluding this increase, as G&A expenses were $118.8 million in the quarter, or $3.1 million lower than the Q2 results.
Adjusted R&D spending of $23.3 million reflects a $1.2 million decrease in R&D expense from Q2 levels. As a precaution in response to the financial crisis, we're placing increased emphasis on expense control at the moment.
By business segment, product and service revenues from our professional diagnostic segment were $252.6 million in Q3 of 2008, compared to $172.2 million in Q3 of 2007. Acquisitions accounted for $59.5 million of this increase. The currency adjusted organic growth rate of the professional segment, excluding acquisitions was approximately 11.1%.
Considering the full quarter results for each entity, net product revenues for Biosite, Cholestech, and Hemosense grew by a combined 9.1% during the third quarter of 2008, compared to the same quarter a year ago.
Professional diagnostic revenues grew sequentially from $250.4 million in Q2. Adjusted gross margins from our professional diagnostic segment were 62.5% in Q3 of 2008, compared to 62% in Q3 of 2007 and 63% in Q2 of 2008.
Revenues from our health management segment were $124.1 million in Q3 of 2008 including $75.2 million of revenues from Matria that I noted earlier. Revenue from Alere and Paradigm grew by approximately 14% compared to their pre-acquisition revenues earned in 2007. Matria's results declined slightly from $77.4 million in Q2 and were down 16% from Q3 2007. This year over year decrease was offset by a 36% increase in revenues from our (inaudible 00:12:56) subsidiary, which contributed revenues of $7.3 million in Q3 of 2008.
Adjusted gross margins from our health management segment were 55.7% in Q3 of 2008 compared to 53.6% in Q2 of 2008. The decrease was principally related to lower margins from our QAS subsidiary associated with the placement of coagulation meters under Medicare reimbursement programs. While QAS recent progress in the placement of meters bodes well for future revenue and profitability growth, there is a two to three month lag from the additional identification of patients for the first billable revenue associated with this placement. As a result, the time requirements for training and the completion of the requisite number of tests by home users, during which costs are incurred in the training of these patients.
Product and services revenues from our consumer diagnostic business segment were $34.7 million in Q3 of 2008 compared to $30.3 million in Q3 of 2007 For the 2008 period, these revenues include $26.9 million of manufacturing and service revenues for product and services supplied from a joint venture.
Looking at the results at the joint venture level, products sold by the joint venture were $51 million in Q3 2008 compared to $48.7 for the year ago period. Adjusted gross margins from our consumer diagnostic segment were 23.0% in Q3 of 2008 compared to 18.5% in Q3 of 2007 and 23.6% in Q2 of 2008.
Revenues from our nutritional business were $21.6 million Q3 of 2008, up 4.4% from revenues of $20.7 million in Q3 of 2007. Adjusted gross margins from our nutritional segment were 80.5% in Q3 of 2008, compared to 12.6% in Q3 of 2007, and 10.3% in Q2 of 2008.
Adjusted research and development expense was $23.3 million, or approximately 5.3% of revenues, up from $19 million in the comparable quarter last year, reflecting our recent acquisition for continuing investment in our cardiology related research, and down slightly from $24.5 million in Q2 of 2008. We expect R&D expense to continue at approximately 6% of net revenues.
At $85.5 million, our adjusted operating income reflects a $43.1 million increase over third quarter of 2007. Overall, we expect improvements in adjusted operating profits against comparable prior year quarter to continue in Q4 and throughout 2009.
Adjusted interest and other expense was $24.5 million in Q3 of 2008, compared to $26.9 in Q3 of 2007. Included in this line is adjusted interest expense, net interest income of $22.8 million in 2008, compared to $27.6 million in 2007.
Also included in other expense during Q3 of 2008 was a $3.1 million charge for realized and unrealized exchange losses associated with changes in exchange rates during the quarter.
Equity variance of unconsolidated subsidiaries in Q3 of 2008 include $2.8 million related to our share of earnings from the joint venture with DNG. In Q3, our tax rate was approximately 33% of taxed income. After tax rates ranged from 30% to 35% for Q4 in 2009. With respect to our acquisition of Matria, based on the integration work that we have completed to date, we expect to realize synergies of $20 million to $25 million from the combination of Alere and Matria. Of this amount, our acquisitions to date have resulted in annualized savings of $17.4 million, with realized synergies of approximately $4.3 million compared to approximately $1.1 realized during Q2.
In terms of other integration programs, both significant integration initiatives remain on track. During the first quarter, (inaudible 00:17:14) transfer of manufacturing and subsequently closed some of our highest cost plants. These plants will affect Biostart, Cholestech and Hemosense in the U.S. and (inaudible 00:17:22) and will run through the end of 2009. BioStart production at the end of Q2 and Hemosense is on track to wind up production during Q4 with respect to our debt and related exposure to changes in the interest rate.
As of the end of the third quarter, we had floating rate that associated with our senior credit facility of $1.355 billion. Of this amount, 963 relates to our first lien debt which bears interest at LIBOR plus 200, prime plus 100. $142 million relates to our revolver which bears interest at LIBOR plus 1.5 or prime plus 70, and $250 million relates to our second lien debt, which bears interest at LIBOR plus 425 or prime plus 325.
Against these balances we purchased an interest rate hedge in August 2007, covering a notional $350 million at a three month LIBOR rate of 4.85% through September 2010. For the first month of the fourth quarter, we purchased one month LIBOR contracts for the non-hedge portion of our debt at LIBOR rates of approximately 3.4%. These contracts lapse toward the third week in October at which point we rolled over the balances into prime loans at a rate of 4.5%. With recent declines in LIBOR rates, we anticipate switching back to LIBOR in the next few days.
With a significant strengthening of the dollar against the euro and pound since the end of the quarter, we expect our reported revenues and gross margins to be adversely impacted by these recent changes, although the amount of such impact will vary with rates over the remainder of the quarter.
This trend will be offset by corresponding benefits from our locations with incur costs principally incurring these other new U.S. dollars, reducing the overall impact in net income. With that, let me turn the call back over to Ron.
Ron Zwanziger
Thanks, Dave. During the third quarter, we announced or launched five new products, the consumer JV Conception Guide Indicator, the Determinant Combo Antigen/Antibody HIV Point of Care Test, the TB (inaudible 00:19:28) Test for HIV-positive individuals, the Binax Now Avian Flu Test and the second generation (inaudible 00:19:34) Ratio Coagulation Monitor. Several of these products are novel diagnostics, the first to be introduced by any company and have been in development for a number of years.
Additionally, earlier this month, we announced that the first product of (inaudible 00:19:49) platform will be a portable CD4 cell enumeration analyzer which will be introduced in the international HIV conference in Senegal in early December.
For individuals who've been confirmed as being HIV positive, testing for CD4 or key healthy cells is a critical baseline measurement that gauges the state of their immune system and is also measured at regular intervals during the course of HIV therapy. We believe that this device has the potential to revolutionize the management of HIV positive individuals in the near term by delivering CD4 quantification at the point of care where it is needed most and where few tools are available.
However, the greater long term value of the CLONDIAG platform lines in its multi assay capability and not opportunity to further develop it into the first molecular platform capable of deployment to a broad customer base directly in the physician office and eventually in the home.
Progress on our NGAL program continues with several multi center clinical trials underway, spanning various potential applications. The NGAL test will become available on the triage platform for use in Europe within the next few weeks and will begin sales on a limited basis shortly thereafter.
While it is too soon to know how effectively NGAL will ultimately be an early mark of the kidney injury, there have been a number of positive indications for its potential.
The Sterling CHF device is nearing completion. It has already begun preclinical trials for the professional market and should begin clinical trials in a home setting early in 2009, which will focus on determining the appropriate BNB testing frequency for heart failure patients in the home.
As a home monitoring device, this proprietary blood market based testing system will provide patient data to our health management monitoring systems in real time dramatically improving quality of life while lowering cost to the healthcare system. We expect to have it commercially available for the professional setting in 2009.
Clearly, our R&D programs are proceeding well and we're confident that we'll continue to meet our previously stated goals of multiple product launches in various disease categories every year for the next several years, resulting in a steady increase in our rate of organic growth.
As a brief update on some of the Q3 introductions just mentioned, the conception guide indicator rollout is on schedule in Europe with launches so far having occurred in the UK, Ireland, and Spain with a number of additional countries planned before the end of this year. The U.S. introduction is expected to occur in 2009 pending FDA clearance.
All of these launches are being supported by Proctor & Gamble sales and marketing infrastructure. However, even before advertising commenced in the UK, same store sales figures were up 30% with similar positive indicators coming out of Spain. Supported by these promising early results, we believe that the conception guide indicator can drive significantly higher sales for the joint venture for many years to come.
The determine HIV one and two antigen/antibody combos test has undergone multi center clinical trials throughout the second and third quarters and we're very pleased with the performance data which shows sensitivity and specificity comparable to the fourth generation lab based enzyme immune acetates which are traditional use for blood backing screening. This novel diagnostic is the first rapid format test which enabled the identification of acute HIV infections prior to the development of antibodies. It is important to note that those who are acutely infected with HIV are responsible for a high percentage of new infections and without early indication of this population it would be difficult to control the HIV epidemic.
Considering the performance that we've seen in trials, we feel that this test should set a new standard of care for rapid HIV testing and we're scaling up manufacturing for the product in two production facilities at this time.
In terms of near term drivers of revenue and earnings, home coagulation monitoring represents one of our most immediate and meaningful opportunities. In fact, home INR testing is one of the most exciting markets that we've seen in years in terms of professional consumer interest for a new offering. Currently, QAS revenue is trending at a 50% increase versus prior year although we've yet to benefit from the full revenue impact of recent positive changes in coverage for home anti-coagulation testing.
Referral of patients by prescription from physicians have increased from an average of 700 per month in the second half of 2007, to over 1,800 per month on average for Q3 of 2008. Between Alere management offering to pay us for home coagulation monitoring and QAS' offers directly to physicians and patients, we expect to lead the way in this dynamic growth area of home diagnostics, as well as position ourselves for additional success as technologies being developed by us or others create new opportunities in home monitoring.
Despite the probability of a serious recession for most of 2009, we feel that '09 earnings will be strong and significantly higher than 2008. This is because the vast majority of our revenues are unlikely to be affected by a recession. Currency adjusted organic growth from both existing and new products should continue to increase from the overall 2008 growth rate, which would drive improvement in gross margins. Manufacturing consolidations in California and China should also continue to improve gross margins as well as two contractual changes with a long term business partner. Tremendous potentials in INR should result in QAS turning profitable toward the end of 2009 and continued success with the Alere integration should also contribute to our earnings growth.
Considering these and other profitable drivers that we expect to come into play in the near term and consistent with what we have said previously about significant year over year earnings growth, at this point, we expect to achieve approximately $2.00 per share in adjusted cash earnings in 2008, excluding the litigation settlement that we recorded in Q2 and year over year increase at 57%. Furthermore, we expect to achieve a minimum of 25% earnings growth in 2009, compared to our 2008 estimate.
And now let me open up the call to questions. Operator.
Question-and-Answer Session
Operator
Thank you. (Operator instructions). Our first question is coming from Tarik Habib of DHCM. Sir, your line is live.
Ron Zwanziger
Operator, why don't you go to the next person.
Operator
Our next question is coming from Eric Schneider from UBS.
Eric Schneider - UBS
Good morning, gentlemen. Couple of question. First off, given where the share price is, what are the limits in your credit agreement or anything else that prevents you from doing share repurchase? How long do they survive if they are in the credit agreement?
Ron Zwanziger
That's exactly the point. They are in the credit agreement. We have a prohibition on using cash to repurchase that share. Excess cash has to go to repayment of the loan. Particularly as you've pointed out, given our share prices, it's obviously a disappointment not being able to do that.
Eric Schneider - UBS
Okay. Then you talked a bit about home INR. Finners (ph 00:27:10) is now scheduled as a late breaking trial in AHA. How much could positive results there affect the momentum and give a swag at least at the top line impact in that and how soon you'd see it. And secondarily about that market, what proportion of the population is now covered through the most simple insurance schemes in terms of reimbursement?
Ron Zwanziger
That's a good question. I'll start with the latter one actually because we have found that essentially most people are covered because most insurance companies when you negotiate with them one on one will agree to reimburse with a physician prescription after some negotiation. You may have noticed my remarks in our prepared remarks that we pointed out that several insurance companies have now agreed not to have to go through that and they're covering automatically, which is a big benefit and we think that that will continue.
Now, as for the first part of your question in regard to thinners, clearly, a good result will be helpful. My suspicion is that a lot of people already know that the results are reasonably good anyway we think that might well have been behind the Medicare change that took place earlier in the year and we're now, as we said, we're seeing much higher prescriptions in the last quarter. We had a very large number and we think that may well be due to that reimbursement thing. So the two things are probably linked.
So yes, there has been improvement but I think to some extent it's already out there and we're certainly very much geared organizationally to take advantage of that.
Eric Schneider - UBS
To just follow up quickly, do you have a sense what proportion of the population is covered where you don't have to negotiate to get reimbursement?
Ron Zwanziger
No, I don't want to give you a guess. I think there are about five or six insurance companies so far so it's not that big a percentage. But we're talking to insurance companies and adding them.
Eric Schneider - UBS
Okay. And you noted in the prepared remarks the potential for impact in currency both top line and gross margin. Can you give an estimate of where that would be either from where current levels are, the average level we've seen so far in the current?
Ron Zwanziger
The problem is it's fluctuating. The exchange rates are fluctuating so wildly it's hard to give any sensible estimate. But I'll let Dave have a go at this question.
David Teitel
Sure. From a revenue standpoint, we had roughly $90 million of foreign denominated revenues in Q3 so that's the piece from a revenue standpoint that's subject to changes in the current environment. From an earnings standpoint, we export about $20 million of products from the U.S., principally the Biosite, Cholestech products as well as Hemosense principally to the European markets and obviously been exposed to about a 15% change in currency from the end of the quarter to now.
We import from China roughly $25 million of product into the U.S. and Europe, principally into the U.S. which exchange rates haven't changed all that dramatically. And we export from Japan about $5 million a quarter of product principally into Africa but those sales principally take place in dollars. So with the recent strengthening of the dollar, we did see an impact a little bit.
So from a gross margin standpoint, if we stayed exactly the same as they are today, though I don't know exactly at the moment where they are today -- they're moving so rapidly -- it would be a $3 million or $4 million impact on gross margin. Offsetting that, we do incur a fair number of our expenses in foreign currencies, about $30 million of SG&A as well as about $9 million of R&D expense in foreign currencies, and that would be offset, changed in the other direction. So that would negate about half of that gross margin impact.
Lastly, on the consumer diagnostic side, from the joint venture, we manufacture a substantial portion of the product in our facility in the U.K. which gets imported into the U.S., so that won't show up on the gross margin line but we will see a benefit to that product as the products become cheaper to buy in dollars.
So the challenge in giving you a precise number, there are a lot of moving parts and exchange rates haven't moved sort of uniformly. They're up and down a bit and they're moving fairly dramatically (inaudible 00:32:04) the exposures.
Eric Schneider - UBS
Thank you. I appreciate the detail.
Ron Zwanziger
If I could just input my own view on these exchange rates. I think the net impact given past quarters and past fluctuations including what we're seeing now, since we have a reasonable amount of internal hedge, it's hard to imagine how it would affect us by more than two or three cents one way or the other.
Eric Schneider - UBS
Okay. I appreciate the detail. Thanks a lot, guys.
Operator
Our next question is coming from Zarak Khurshid from Caris.
Zarak Khurshid – Caris and Company
Hi. Thanks for taking my questions. Good morning guys. Could you break out perhaps the Biosite growth rate as well as Hemosense in the quarter.
David Teitel
The combined rate we gave you was 9.1%. Biosite individually was about 9%. Hemosense was a little bit higher than that. Cholestech, which is the last piece of that, was relatively flat quarter over quarter.
Zarak Khurshid – Caris and Company
Okay, great. And then just to clarify on the earnings front. Did you say $2 for '08 and then 25% growth for '09?
Ron Zwanziger
Yes, at approximately $2 for '08 and a 25% increase the next year.
Zarak Khurshid – Caris and Company
Fantastic. And then just curious about kind of some of the cashflow metrics. Do you have any sense for cashflow in the quarter, operating cashflow and CapEx?
David Teitel
We do and we actually posted it on our website. Free cashflow for the quarter was about a little over $9 million. That number was adversely impacted by the litigation settlement that we took in Q2 and paid in Q3. So there's a $13 million payment that offsets what otherwise would've fallen through free cashflow in the quarter. So if you add that back, it's about $22 million of free cashflow on the quarter and that's net of $17 million CapEx in the quarter.
Zarak Khurshid – Caris and Company
Okay, great. Thank you guys.
Operator
Our next question is coming from Bruce Cranna from Leerink Swann.
Bruce Cranna – Leerink Swann, Llc
Good morning. It's Lehman Swan. How are you guys doing?
Ron Zwanziger
Good, Bruce. Go ahead.
Bruce Cranna – Leerink Swann, Llc
Dave, I'm sorry. First of all, in totaling up the product piece, it's $427 million and about $11 million in license revenue. Is that right?
David Teitel
No, it's $433 million of product revenue so let me run through it again quickly for you. That's fine but the product piece is $433 million out of the $438 million.
Bruce Cranna – Leerink Swann, Llc
That's right. License is $5.7 million. Okay. And then I'm curious in the consumer business in general -- maybe not in general. Maybe I'm thinking specifically with pregnancy. Have you guys seen any mixed shift at all given I guess presumed greater consumer sensitivity. So have you seen, sort of a trend towards lower ASPs in that business?
David Teitel
No. We actually haven’t, if anything perhaps a little bit the reverse of what you might think, because as we mentioned in our call the initial response to the consumption guiding indicator prior to the commencement of advertising, and with word-of-mouth, internet, word-of-mouth that sort of thing. It actually starting a shift and in fact the response were seeing for the particular product is more pronounced in this early stage and that maybe not too much to into it, but it is more pronounced than when we originally launched the digital pregnancy test itself a couple years ago.
So, with that background and with the switch to digital in general in most market continuing, it sort of perverse but it seems to be the swing towards the better product is at the moment is still fine. That’s what it would have hits me.
Bruce Cranna – Leerink Swann, Llc
Okay, and Ron, you mentioned some product introduction as used in Europe. I think you said that–I lost you a little bit there, what were the specifics?
Ron Zwanziger
We have several product introduction delays, which sort of affected us. One was InRatio where we expected to have the product earlier and it didn’t get enough have been out and that’s being whipped up on and we’ve also had some introduction delays difficulties with collect taken a couple of countries, we’ve had some opposition from doctors not wanting us to do too much of it and so we’re working through those issues and those kind of arose. So, we’re working through those.
Bruce Cranna – Leerink Swann, Llc
Okay and this is probably a tough question and answer, but I’m just looking at SG&A line, I consistently seeing the miss that you guys, I know, you added some on the quarter cause you have a full quarter Matria, but still if I had 13 million or something incremental from Matria sequentially, I’m still not getting that sort of–but I thought, I guess that’ll explain all the increase, so what I’m wondering is when do we see some leverage in the SG&A line of some material nature?
David Teitel
Well, if you back out the increase for the Matria, of course, it does go down by about $3 million quarter-over-quarter.
Bruce Cranna – Leerink Swann, Llc
On the GAAP-basis.
David Teitel
On the GAAP-basis there’s a lot of amortization flowing through those numbers, so much for that irrelevant measure. If you look on the cash basis such as the way we think about it and manage the business, there’s an absolute $3 million decrease quarter-over-quarter when you take out the Matria increase, which does reflect some of the spending controls and in particular the increased synergies in the (inaudible 00:38:10) or combination.
Bruce Cranna – Leerink Swann, Llc
Okay, so, I mean do you think we can any acceleration there?
David Teitel
While we continue to closely monitor our expenses and expected revenue growth, we’ll grow faster than other sudden changes and expenses.
Ron Zwanziger
There should be leveraged we assume.
Bruce Cranna – Leerink Swann, Llc
And then lastly, Ron you mentioned a couple of new distributors, I think you’ve checked your button, it sounded like Austria or maybe Brazil?
Ron Zwanziger
Yes, a couple of small ones. Yes.
Bruce Cranna – Leerink Swann, Llc
How much you’ve spent on those still?
David Teitel
It was combined about $12 million.
Bruce Cranna – Leerink Swann, Llc
I’m sorry 12?
David Teitel
Twelve, yes.
Bruce Cranna – Leerink Swann, Llc
In just lastly on Matria and sort of the health management business, is there any sort of typical or new cycle in that business. I know you mentioned, you resigned a big client, but is that at all seasonal you see sort of January, speak where normal season there or there were throughout the year?
David Teitel
Well, no. I mean, it is throughout the year, but the vast majorities here are January-related. We’re passed the renewal dates, I missed the contracts, I mean the contracts have already renewed. So, were actually sort of feeling pretty good about where we stand. We’re getting feedback from customers in relation to the turnaround that’s going on. We expect that the Q1 of ‘09 revenues actually will be just a tad higher than our Q3 for Matria, I mean, beg your pardon, for health management will be a tad higher than the Q3 revenues. And given the fact we know what the contracts that we’re already have and because we have the outlook, we’re anticipating growth in Q2 over Q1 and we’ll overall see a increased in revenues for ’09 over ’08 although preferably more rate for the health management business.
Bruce Cranna – Leerink Swann, Llc
Okay, thank you.
Operator
Our next question is coming from Greg Simpson from Stifel Nicolaus.
Greg Simpson – Stifel Nicolaus
Okay thanks, good morning guys. David, if I could dig into the those end of quarter events a little bit, can you–you talked about the earnings in back and maybe give us some quantification if you said it I apologize, but on the revenue impact and then also is there any way to give us a sense of how that impacted the growth margin number?
David Teitel
Sure, the revenue impact was particularly Europe in the professional business. Revenues were down about $9 million from where we expected them to be. Of that 2 million is sort of effects, which affects the whole P&L and it’s not really the driver of earnings, but is a piece of the debt finds. Of the rest – about half of the rest related to product interest was pushed out into the fourth quarter and the rest of the issue that weren’t talked about from a margin impact standpoint, you see that show up in our professional margins in the quarter where the European sales tend to have a slightly higher than average overall margin and missing in a bit did impact the margin which went from 63% in Q2 to 62.5% in Q3.
Greg Simpson – Stifel Nicolaus
Okay. I mean, it’s fair to ask then what that margin where you have seen sequential improvement had it not been for these issues.
David Teitel
It would have at least been flatter slightly up, yes.
Greg Simpson – Stifel Nicolaus
Okay. Can you guys go into, I want to ask about the guidance in the second, but can you go into the cost savings, integration cost savings that are included in your assumptions, or just kind of review those that are included in your assumptions for 2009.
David Teitel
Sure, you know we do expect margin benefits from combination of HemoSense and Cholestech into our Biosite facility as I mentioned HemoSense will effectively cease production at the end of Q4 and Cholestech about mid-year, we should be manufacturing most of that product at Biosite, both of which will produce better overhead absorption and improved profitability in the Biosite location. So that is baked into our assumptions for next year as well as we close down the Legacy facilities at Cholestech and HemoSense, we will see G&A benefits that we’ve been baked into our assumptions for next year.
Greg Simpson – Stifel Nicolaus
Okay. And then, Ron, on the guidance–but first of all, I’ll speak for everybody which whoever you guys can moved in this direction. Let me ask you about the guidance in your specific commentary, can you talk about a minimum of 25% earnings growth in 2009 and you guys, how to see your standard discussion as that you look for significant your re-earnings growth at least the next five years with no hockey sticks. So first of all, is there’s any we can read into this in terms of the long term earnings growth rate and then secondly with respect to the specific comment of minimum 25% growth in ’09. My conversations with you guys as suggested, you know, certain you guys are even more optimistic about ’09. I’m just curious if we can maybe put brackets around the minimum and maximum earnings growth that we might be looking at in no time.
Ron Zwanziger
Well, I mean, first of all in terms of the general comment, we remain-- we’re very bullish about the company in general. I think the way the products are coming through are indeed on the way they’re getting accepted, its voting very well and that sort of the noble ones that we have in the market place that being accepted and the work being done in integrating Alere is going very well and that you can tell from the Biosite numbers, things are going very well.
So, if you back away from that and look at long term growth, earnings growth, I think we’re more comfortable today than we were given a few months ago about our comment that we expect significant earnings growth for the next several years. And so, that firmly remains in place.
As to commenting about ’09, I mean we thought that given the general anxiety–unbelievable excite in the market place, we’re on ’08 is of earnings growth and I’m very confident about it. The reason we failed at the way we did is because there somebody unknown out there, you know the depth of the recession, we do have truly speaking about 10% of our revenues could be affected or so depending on how you count it– could in theory be affected by deep recession. So it’s a very small percentage of our business.
So you’ve got a number of unknowns. You have to make assumptions about interest rates when you give an estimate like this, and you have to make assumptions about foreign exchange. So there’s so many assumptions that go into it. So what we wanted to do is to give a baseline of what we think is a minimally achievable.
You may have noted in our call that we commented about moderating expenses. We’ve taken some steps to be a bit careful with expense increases as we see how the general practice unravels. So we’ve taken a number of precautions to make sure we can at least hit the minimum earnings growth that we had commented on.
Greg Simpson – Stifel Nicholas and Company, Inc.
Okay. So the right way– I’m not trying to put words in your mouth but as long as you’re giving guidance, I may as well just jump all over this– is the way we should interpret this based on what you’ve just said– based on my work with my model I had assumed assuming the recession interest rates LIBOR, all those issues to me it has looks like a 250, 255 kind of number, looks like, and I hesitate to use the phrase, worst case scenario.
But taking all those factors into account that is where I come out. It seems based on what you just said that’s essentially what you’re saying. That’s a minimum target assuming the impact of all that stuff and if things break a little better for you, you’d expect to be above that?
Ron Zwanziger
Yes. I should–I don’t know if I said it, but I did mean to say that these comments are independent of acquisitions. The view we expressed here is an organic growth-based view.
Greg Simpson – Stifel Nicholas and Company, Inc.
Right. I don’t think you did say it, and that actually is helpful. Okay. And I’ll get back in line. Thanks very much.
Operator
Our next question is coming from Jonathan Goldberg from Merrill Lynch.
Jonathan Goldberg – Merrill Lynch
Hi, good morning. Thanks for taking the call. So, Ron, I think the answer to my question which was– the 25% growth in ’09 does not assume any more acquisitions, that’s just to clarify, right?
Ron Zwanziger
Right. It’s just as we are; yes.
Jonathan Goldberg – Merrill Lynch
Yes. Okay. and then Ron, can you maybe just talk about your relative as to when you bought Matria and how it’s performing now? I think you said it was down another 15%. And what you need–you have Alere, Paradigm, I think you said grew 14 % and maybe– what it is that you need to do to turn around Matria to perform, or even if you can or if there are just different dynamics to the pieces. What you need to do to turn it around.
I know you mentioned some positive things that you thought were occurring towards the end of the quarter, but maybe are there best practices, are there things from the Alere and Paradigm that you can transfer over? Maybe you could just talk about that.
Ron Zwanziger
Well first of all just to correct your words, we’re not down another 16%. We are relative to the previous year. But we’re essentially almost flat with Q2, and as I said, we’ve dealt with most of the negatives at the moment. And as I said we expect revenues in Q1 to be about the same or just a tad higher than for our overall health management business. But so, I think we’ve pretty much we’ve bottomed out.
Now in terms of the best practices that you’ve asked, remember that when we went into this we were very clear that our whole approach to health management is its focusing on proper outcomes, focusing on effective outcomes and therefore dealing with more specific situations and specific chronic diseases. And that approach is very much the one that we are taking as part of the overall integration.
And it’s going well, and I think it’s been well-received by customers who understand that if you can deal with certain groups of patients who have certain issues you can demonstrate outcomes and you can really work with the targeted group to get sort of savings which makes a difference to the insurance companies and of course makes a difference to the patients. And I think that was our original reason for going into it and today we’re probably feeling even more confident about this than when we went into it because we’re seeing far more ways of the merging of rapid diagnostics and health management to take advantage of our combined platform.
Jonathan Goldberg – Merrill Lynch
But just relative specifically to Matria, did that deteriorate more quickly than you would have thought or was it about in line with what you thought?
Ron Zwanziger
Well, I think it was certainly in line from– it’s very much in line from when we spoke in Q2, there’s been really no change in our expectations around it.
Jonathan Goldberg – Merrill Lynch
Okay. And then Dave, could you just walk around I think you said on the prepared remarks EBITDA of about 100 million and a CapEx of about 17, so kind of a quick and dirty EBITDA minus CapEx is around 83 million, and then your pre-cash flow I think you said was 9 million, can you maybe talk, I know you have some restructuring charges and the other one time charge you mentioned, but it still sounds like a pretty big belt, there. Could you just talk about some of the other major differences there?
David Teitel
Well, sure. So there would be a bit of a working capital build in the quarter which is probably the individually biggest difference, principally in receivables and inventories. On the receivables side, just the way Q3 is structured with July tending to be a relatively slow month in many parts of the world, August being particularly slow, September comes back a bit which means a lot of the sales are late in the quarter and show up the receivables as opposed to collected. And that impacted the receivable balance.
From an inventory standpoint in particular the Biosite inventory is up a bit. Two factors there: one, as we prepare to take back the Beckman piece of the Biosite business we’ve built our own inventory so we can service those customers directly moving forward.
And secondly we did see a bit of a reduction in the level of inventory that Fisher was holding in the quarter which impacted our sales and inventory levels in the quarter. But the end user business remains relatively strong. So those two things are individually the biggest difference between what you might expect from free cash flow and what came through during the quarter.
Jonathan Goldberg – Merrill Lynch
Okay. And then this last question. With some of your distributors that you use in the U.S. in the physician office lab or even more point of chair applications, what are you hearing from them in terms of current dynamics, maybe how they need– if their financing deals or some of their customers or maybe any qualitative update there
Ron Zwanziger
Well we specifically mentioned in our prepared remarks that we’ve been doing particularly well with the Matria distributors. And we’re not seeing or hearing of any issues. I think the business is actually a bit business in the U.S. is good; the outlook is good, the quarter started well. I think we’re feeling very good, actually.
Jonathan Goldberg – Merrill Lynch
Okay. Thanks a lot.
Ron Zwanziger
Any other questions?
Operator
Our next question is coming from Peter Bye from Jeffries and Company
Peter Bye – Jeffries and Company
Okay, thanks, guys, appreciate it. Ron, your comments about acquisitions and guidance without it and stuff and you’ve made some comments to the credit markets and access to capital that you’re sort of happy maybe to play with what you have because there’s a lot on the plate. Do you still view that as the same, that if credit environments stay as they are now you won’t make any major acquisitions, or you don’t want to take anything off the table?
Ron Zwanziger
Well, firstly Peter, I didn’t say I was happy about it.
Peter Bye – Jeffries and Company
Oh, well, okay.
Ron Zwanziger
I’m extremely upset at the fact that the banks have screwed up the credit market so badly that they’re not lending money despite the government intervention at sensible rates. So I’m not, and you can’t possibly describe me as happy.
The reality, however, is that we don’t need to make acquisitions of any scale, although there are some that we’d like to do. But the practical reality is that share prices I’m sure you’re more than aware is chronically depressed and interest rates are very high. So at the moment what we’re doing is focusing on key, small acquisitions that we can utilize our cash flow. And our cash flow is good and we expect it to continue to improve over time. So we are sticking with our existing cash flow.
Perhaps we’ll do some acquisitions over time with seller financing; we’re seeing a number of sellers I think would like to get in with us and so there might be some seller financing. But basically while the credit markets are closed on a sensible basis– having said that there are people still willing to offer us financing; but they’re crazy. And equity is close, so for the time being we’re not doing anything of any consequence.
Peter Bye – Jeffries and Company
Great. And maybe a question for Dave on Ron’s guidance, it looks like a pretty big acceleration on EBIT expansion if anybody’s can sense this revenue out there is correct. Are you getting that gross margin back this quarter, or is it just more SG&A leverage that you showed this quarter or a combination of both? Or could you proportion it for us at all, where it’s coming from on that ebit expansion?
David Teitel
Yes, as I said earlier it’s a combination of both, we do expect margins to improve over the course of next year as well as some SG&A leverage with controlling expenses and taking advantage of some of the plant closures. And their impact on SG&A over the course of the next year. So I think we’ve gone a long way in terms of providing additional guidance I’m not sure we want to go on a line by line basis.
Peter Bye – Jeffries and Company
Sure; sure, I know you have. And just– do you expect a convergence back to free cash flow and EBITDA minus CapEx? Is this a one-off on the inventory’s DSOs or will it take a little while to take through? What should we expect, there?
David Teitel
You should expect improvement from what you saw in Q3 in Q4 as some of the working capital does reverse itself a bit in the quarter.
Peter Bye – Jeffries and Company
Great. And just one last one, just throwing a net. Any thoughts, Ron, on J&J’s acquisition of HealthMedia and their comments coming off their comment earlier this year on this sort of segment, and then actually going out there and what they acquired; your thoughts there and any thoughts on did it really surprise but just– you know, any comments you have. Any color.
Ron Zwanziger
Sure. Well, first I’ll comment on the issue of the gross margin. We have said repeatedly about our expectations of expanding gross margins, and I think everything we’re seeing in terms of both cost reductions at the plant that we’ve referred to again today as well as the new product introductions in terms of the value of those, I think that we remain very confident about our ability to expand gross margins year on year. And I think you’ll see that not only this year but I think you’ll see it next year and the following year.
As to J&J moves, I certainly wasn’t surprised. I mean, the comments they made earlier in the year were crystal clear. And it’s interesting that their move was in the wellness market. And that it was focused. It’s not dissimilar to the kind of things that we do.
And so they clearly are looking at the market and seeing tremendous opportunity in health management and in helping determining outcomes. Because that’s what they’re doing. It’s interesting that they chosen wellness as the place to start.
Peter Bye – Jeffries and Company
Well, that was sort of where we scratched our head. And that seems to be the most difficult spot to show an ROI on and it’s also the one that seems to be the most at risk on the front or that’s what we think. So maybe just expand on– I don’t want you to speak for them, but why do you think they chose wellness?
Ron Zwanziger
Well, I can’t possibly speak for them. I tend to agree with you; wellness is a little awkward to start with. I think it’s more susceptible, but in reality if you think long term–very long term– it’s also one of the better outcomes, if you’re willing to measure in outcomes measured in years. So it’s not inconsistent. I mean, frankly, it’s not inconsistent for a company like J&J that’s going to be around for years.
Peter Bye – Jeffries and Company
Right. I got you. Thanks a lot. I appreciate it.
Operator
Your next question is coming from Jeffrey Freelick (ph 00:58:29) from Lazard Capital.
[Jeffrey Freelick] – Lazard Capital Markets
Yes, thanks. The first question’s for Dave. With respect to gross margin, you spoke about the quarter ending product delays and the impact there. Anything else? Anything unusually high in COGS? Maybe fuel costs or startups, new systems, anything like that?
David Teitel
Nothing other than again in the health management business where we already talked about QIS we are incurring costs to grow that business that show up in the gross margin line.
[Jeffrey Freelick] – Lazard Capital Markets
Okay. And then also, can you comment on flu sales to the physician distributors. Typically they’re still stocking orders into the flu season. Do you typically see distributors buying more product late 3Q, is it typically in early 4Q?
Ron Zwanziger
Typically what happens is, you get initial stocking in Q3 but it’s really in September of Q3, and we certainly had our more than fair share of that. And then most of the stocking then takes place in October and November, with repeat orders depending on the season coming in December and Q1.
[Jeffrey Freelick] – Lazard Capital Markets
Okay. And then how’s pricing looking, shaping up for infectious disease rapid tests?
Ron Zwanziger
I don’t think there’s really anything to comment on. I didn’t literally check before the call. If there were any changes I should be aware of. But if there were any I should have been aware if there were any changes. Why’d you ask the question? I’m not aware of any changes.
[Jeffrey Freelick] – Lazard Capital Markets
Just curious if prices are remaining stable in the marketplace.
Ron Zwanziger
Right.
[Jeffrey Freelick] – Lazard Capital Markets
Okay, thank you.
Ron Zwanziger
Okay, well, with that, I will perhaps provide some closing comments, here. We remain on track to deliver strong financial results for many years to come without a necessity of further significant acquisitions. Over the next several years we expect to steadily increase organic revenue growth rates, which will help drive revenues to considerably more than $3 billion. This revenue growth will be accompanied by overall gross margin expansion from the mid 50’s today to approximately 50% by 2012.
Throughout this time period an investor should expect steady significant annual growth in adjusted cash basis EPS. With a continued focus on scalable, technology-oriented health management programs, successful development of breakthrough home diagnostic devices and the achievement of industry-leading quality and customer service levels, we believe we have the opportunity to generate outstanding results for both our customers and our investors.
Additionally with a number of new products and programs that have recently launched or will be launched in the next few months, combined with a broad momentum in our core business, we believe that 2009 will be a breakout year in terms of establishing the merits of our long term strategy of using technology to enable individuals to look after themselves at home, thereby both on improving their health and reducing the cost of the health care system. As always I’d like to thank you for continued support and interest. Thank you very much and have a good day.
Operator
Thank you. This does conclude today’s conference call.
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