IRIS International, Inc. Q3 2008 Earnings Call Transcript

IRIS International, Inc. (IRIS)

Q3 2008 Earnings Call Transcript

October 29, 2008 4:30 pm ET

Executives

César Garcia – Chairman, President and CEO

Tom Adams – Chief Technology Officer

Peter Donato – VP, CFO and Secretary

Analysts

Steven Crowley – Craig-Hallum Capital Group

Ernest Andberg – Feltl & Company

James Sidoti – Sidoti & Company

Presentation

Operator

Good afternoon, and welcome, ladies and gentlemen, to the IRIS International Incorporated conference call for a discussion of the company's 2008 third quarter financial results. Moderating today's call are César Garcia, President and Chief Executive Officer, and Peter Donato, Corporate Vice President and Chief Financial Officer.

At this time, I would like to inform you that this conference is being recorded and that all participants are in a listen-only mode. A PowerPoint presentation is available for those participating via webcast. At the request of the Company, we will open up the conference call for questions and answers after the presentation. The Company requests that the question-and-answer session be limited to one question and one follow-up per caller.

Before we begin, it is necessary to read the following forward-looking statement. This presentation contains forward-looking statements made in reliance upon the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements include, but are not limited to, the Company's views on future financial performance, market growth, capital requirements, new product introductions and acquisitions, and are generally identified by phrases such as thinks, anticipates, believes, estimates, expects, intends, plans, and similar words.

Forward-looking statements are not guarantees of future performance, are inherently subject to uncertainties and other factors which could cause actual results to differ materially from the forward-looking statements. These statements are based upon, among other things, assumptions made by and information currently available to management, including management's own knowledge and assessment of the Company's industry, R&D initiatives, competition, and capital requirements.

Other factors and uncertainties that could affect the Company's forward-looking statements include, among other things, the following. Identification of feasible new product initiatives; management of R&D efforts and the resulting successful development of new products and product platforms; acceptance by customers of the Company's products; integration of acquired businesses; substantial expansion of international sales; reliance on key suppliers; the potential need for changes in long-term strategy in response to future developments; future advancements in diagnostic testing methods and procedures; potential changes in the government regulations and healthcare policies, both of which could adversely affect the economics of the diagnostic testing procedures automated by the Company's products; rapid technological change in the microelectronics and software industries; and competitive factors, including pricing pressures and the introduction by others of new products with similar or better functionality than our products.

These and other risks are more fully described in the Company's filings with the Securities & Exchange Commission, including the Company's most recently filed Annual Report on Form 10-K and quarterly report on Form 10-Q, which should be read in conjunction here with for a further discussion of important factors that could cause actual results to differ materially from those in the forward-looking statements. The Company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

At this time, I would like to turn the call over to Mr. Garcia, President and Chief Executive Officer of IRIS International. Please go ahead, Mr. Garcia.

César Garcia

Thank you, Corin. Good afternoon. We welcome you all to the IRIS International third quarter 2008 conference call. We are pleased with our financial results for the third quarter and the solid performance of the Company in this time of global economic turmoil. The demand for our product has been very good and we have not suffered a significant impact as a result of the credit crisis and the general pessimism that permeates today’s economy.

A strong demand for laboratory automation and consolidation in the international market, factors that should help us to continue increasing our market penetration. Our business is good and that is exemplified by our record revenue, our year-over-year growth, and the strength of our balance sheet

Moving on to Slide number 4, you can see that we have significant accomplishments in the third quarter. Among others, we achieved a revenue in the third quarter, where consolidated revenue grew 14% in spite of the global economic turmoil. We shipped 110 units in a seasonally slow quarter, exceeding 2008 200 analyzers shipped over the last five years.

We initiated commercial shipments of the iChem VELOCITY, our new automated urine chemistry analyzer to major European markets. It is very rewarding to report our year-to-date consumables and service have grown to 595 of IVD revenue from 54% in the first three quarters of 2007.

Finally, we have a successful review of our NADiA PSA Pre-IDE application with the FDA.

I am also pleased to introduce the name NADiA ProsVue, which is the new commercial name that we will use to differentiate our ultra-sensitive NADiA PSA assays from the routine PSA screening assays offered by other competitors.

In more detail, our IVD revenue grew 15% in comparison to Q3 2007 and we experienced growth in every segment of the business. Our instrument revenue increased 11%. Our consumables and service grew 17%, and our sample processing business increased 9% in spite that in the third quarter of 2007 we have seen significant pent up demand with the introduction of a new product, the Express 4 Centrifuge.

In spite of all of these accomplishments our consolidated revenue for the quarter was approximately $1 million lower than our internal target. Part of that can be attributable to the VELOCITY, which was delayed by approximately a quarter and that represented about $600,000 in revenue in the third quarter of 2008. As well, we have reported previously that our international demand is lumpy. We did not book about $400,000 in international consumables and parts that were expected in the third quarter.

It is important to mention that during the first two quarters of 2008, we achieved record revenues and sequential revenue on a quarter-to-quarter basis. So, on year-to-date basis, we are significantly higher than where we were in 2007.

(inaudible) sales pipeline remains good and we anticipate a record fourth quarter 2008. Go into more details, I want to (inaudible) highlight the different elements of the iChem VELOCITY launch and in the third quarter we shipped over 30 units, mostly to European countries. Over 60% of the units shipped were part of the iRICELL sale, something that we anticipated and is part of our business plan to have a pull-through with the launch of the automated chemistry analyzer.

We are also carrying a backlog into the fourth quarter of 2008. As I mentioned before, the VELOCITY has only been launched in Europe and now we are beginning the launch of the product into the Asia Pacific rim and Latin America. As we progress with the release of the VELOCITY, we expect significant pull-through of the iChem test strips beginning early in the second quarter of 2009. As you know, international units, we have a lag between the shipment of the units and the generation of consumables of about six months.

As a result of the many changes and the many improvements that we made on the iChem VELOCITY over the last six months, the Company has submitted a new 510(k) application, which we expect to clear late this year or early in the first quarter of 2009. Prior registrations are in process at many distributor as a requirement of prior to sell.

And finally, we have negotiated a gradual concession from the AUTION MAX to the VELOCITY analyzer with our Japanese distribution partner, ARKRAY.

One key element of the IRIS strategy is the R&D pipeline and we have made significant investment and I want to, on a qualitative basis, show you the productivity of our R&D initiatives. On the iChem VELOCITY we transform a (inaudible) into a full line of full line of urine chemistry products with state-of-the-art technology that enables us to compete in a $350 million market.

Moving on to NADiA ProsVue, we recently identified NADiA ProsVue, formally NADiA PSA, as a proof-of-concept application. As a result of our efforts, we have improved the product performance, the improved performance has translated into stronger clinical claims, increasing the addressable market from approximately $60 million per year to at least $200 million per year. As well we have carried our learnings from our NADiA ProsVue assay and we are much more confident today our ability to release NADiA HIV and NADiA Her-2/neu. So, in essence, we are forecasting a first commercial product release within three years of the acquisition of Leucadia Technologies.

As well, we continue to work with potential licensing agreements and the interest hasn’t declined for obviously many of the potential partners are awaiting for the 510(k) approval.

Moving on to the next generation morphology system, most of our emphasis in over the last year has been concentrated on our hematology application. And I am happy to report that we have implemented two conceptual prototypes of a nine-part part white cell differential using the Company’s proprietary technologies. At this point in time, we are testing those prototypes, we are experimenting with a different number of concepts and we expect to finally sign direction [ph] within the first half of 2009.

In conclusion, the new pipeline should begin to have a material effect in revenues and earnings in 2009.

Despite these major accomplishments, we have not been totally immune to major macroeconomic effects and the currency volatility, and a small impact on revenue resulting from some delayed purchases. We have also experienced some favorable business changes, which in the short term may have a small negative effect on earnings, but in the long run are good for us.

For example, our customers have accelerated the adoption of our iQ200 flagship product in the domestic market, rendering our legacy systems obsolete and practically extinguished by the end of this year. That’s about a year sooner than we have originally anticipated, creating a planned inventory obsolescence and reducing our service revenue because every new system enjoys a one-year warranty. As well, we have improved the quality of the iQ200 system and the execution of our service, thus reducing the need for spare parts.

These are the right things to do if we are going to take care of our loyal customers. Although it has a temporary adverse effect, we win in the long run.

I want move on to Slide number 8 and highlight some critical factors that should be considered when you evaluate the Company performance in 2008. The first one and probably the most significant of all is that we are experiencing a significant unfavorable foreign currency effect. Most of that is related to anticipated purchases of ARKRAY inventory, both in instruments and consumable and we purchased inventory early in the year when the yen was stronger. Therefore, it created a significant currency variance. And so the third quarter we estimate the currency variance in total to be about $875,000 with a full year projection that will be approaching $1 million, obviously a factor out of the control of the Company.

The second significant change from our previous update is that we have increased our inventory reserve for legacy systems. We booked $150,000 in the third quarter and we will book $150,000 in the fourth quarter for a total of $300,000 in increased inventory reserves to cover the obsolescence of the legacy inventory. There is a potential that some of those units will continue to be used in 2009, but at this point in time we are taking a more conservative approach.

Finally, although we have a solid pipeline as a contingency IRIS is ready to selectively finance more domestic equipment purchases for those are customers that are credit-worthy, but for some reason or another they may not qualify for credit. But even with that we are still projecting to end our cash position at $33 million – at least $33 million by December 31^st, 2008.

The last line in my presentation is typically presented by the Chief Financial Officer of the Company. But I decided to cover this today myself because I want you to understand that I am behind the numbers and at the same time I want to give you an operational flavor to what the numbers mean.

Our original guidance for the full year was $98 million. That guidance was issued early in the year when we reported 2009 numbers. Today we announced that we are reducing the guidance to $94 million, about $1.5 million is related to the delay of the VELOCITY. Unfortunate with the product delay it delayed the product registrations and that’s really the main cause for the decline under VELOCITY for the full year.

As I also mentioned the quality improvements in service and the quality improvements in the iQ200 in general also contributed to a lower reduction in spare parts and that represents about $1 million reduction in revenue.

And finally, considering the experience that we had in the third quarter of this year and the anticipation that we have for the fourth quarter we are reducing the iQ200 volume in revenue terms by $1.5 million. (inaudible) bridges the gap from ‘98 to ’94. As you can see, about 60% of the reduction is out of the control of the Company. It’s a result of number, better quality, better execution, but also the economic situations in the market.

On an EPS basis, our original guidance was $0.48. This unfavorable FX, the first one as a result of the share repurchase on a full year weighted average computation, we get to gain $0.01 per share as a result of the share buyback. The revenue decrease represent about $0.04 decline on the guidance. The unfavorable currency, which we disclosed, represents about $0.04 lower in the guidance. The legacy inventory represents about $0.01. So, we have been proactive and we have been managing expenses and as a result of our conservative spending in the year, we have identified about $0.03 savings in our operating expenses.

So, as you see from this analysis, we are going from $0.48 to $0.43. About $0.07 of the reductions is not related to the Company performance, it’s mostly related to the currency variance, the legacy inventory, and about half of the volume figure are reduction. At this point in time, it is our concern with the general economic conditions. So keep in mind as the Company continues to achieve record revenue, we are trying to be a little more conservative considering what is happening out there.

Dr. Tom Adams will follow me now with a brief status of our NADiA ProsVue product followed by Peter’s presentation of our financial results. I believe that after the presentations you will be convinced that IRIS is doing very well and the outlook for this Company is excellent. Tom?

Tom Adams

Thank you, César. Good afternoon. Today I am going to cover very briefly the status of our NADiA ProsVue technology and the steps we have made with the FDA in terms of its intended use. The NADiA technology is an ultra-sensitive protein detection platform, which we have initially applied to detection of PSA following radical prostatectomy for the treatment of prostate cancer. This assay operates in a range from femtograms per ml into picograms per ml whereas normal current PSA assays actually operate in ranges that are at least 20 times and in general from picograms per ml into nanograms per ml.

So, it’s not the same thing as the current tests that’s out there for screening for prostate cancer. It’s actually a test which has been designed to have a very broad dynamic range. They can measure PSA concentrations that can't be usually measured with any other test. The – our assay is a minimum of 20 times better in sensitivity than the next best test and in general about 100 times more sensitive than the rest.

Recent experiments with automation have shown that we are also able to substantially decrease the sensitivity to even lower levels by automating certain parts of the assay. So that speaks well to the future for this technology.

In terms of – on Slide 12 NADiA ProsVue clinical value, the NADiA ProsVue is intended for use in – to identify post-radical prostatectomy patients that have a low risk of prostate cancer recurrence. This gives actually (inaudible) benefits to the patients for identifying those patients with low risk because if you know that a patient has had a successful surgery well then you can avoid unnecessary medical treatment such as radiation, chemotherapy, and hormonal ablation. You can also avoid aggressive surgical approaches that are applied in some cases where the lymph nodes are removed from some patients that have very high Gleason score.

It also provides a better quality of life for the patient because knowledge is equivalent to peace of mind, so the patient does not have to worry about relapse and subsequent therapy that has substantial morbidity and would lead to lower side effects with – than with follow-on cancer treatment.

So, it will also result in lower diagnostic spending both in vivo and in vitro and elimination of unnecessary, ineffective diagnostic procedures. So, again the primary benefit is to avoid unnecessary therapy.

On Slide 13, I briefly cover our regulatory strategy. This summer we had a very successful meeting with the FDA in terms of the review of or Pre-IDE. The Pre-IDE is a clinical protocol that we proposed to the FDA to validate the product claims. We reached in principle an agreement on product claims and clinical circuits [ph] that will be used and in general the FDA feedback was in line with our plans and expectations.

Our next steps are final submission of the clinical protocol. There is just a couple of details to wrap up there. And then we are going to be then doing a fairly large clinical study at two to three different sites. We already have a negotiated agreement with University of Washington and we are in negotiations with two other leading medical centers and the activity there is to get IRB, that’s Institutional Review Board clearance from these medical centers, and establish the financial terms of the collaboration.

We plan then on submitting, following the completion of these clinical studies, a 510(k) with expected clearance depending upon what the FDA does by the middle of 2009.

So, with that I will turn this back to Peter Donato, who is going to cover the financial summary. Peter?

Peter Donato

Thank you, Tom. I am on Slide 15, the segment revenue slide. The consolidated revenue for the quarter was $23.4 million, up from $20.6 million last year, or 14%, in what is traditionally a slower seasonal period for us.

The IVD segment revenue increased 15% to just under $20 million from $17.3 million last year. IVD instrument revenue increased 11% quarter-over-quarter to $8.3 million, up from $7.5 million, with increased units shipped at 110 this year versus 102 a year ago. The unit growth was entirely international and contained both iRICELLs and iChem VELOCITYs, representing about $1 million in incremental revenue.

IVD consumables and service revenue increased to a record $11.5 million, a 17% increase over 2007’s $9.8 million. This was driven by volume in our consumable product line as a result of increases in our installed base and service contracts on instruments coming off their initial warranties.

Revenue in our sample processing division increased to a third quarter record of $3.6 million, up from $3.2 million a year ago, an increase of 9%. As César indicated, this increase is primarily attributable to strong demand for our new Express 4 product line.

Moving on to the year-to-date slide, you can see that consolidated revenue was a record $68.8 million through the first nine months of this year, up from just under $62.5 million last year, or 10%.

While the IVD segment revenue increased nearly $5 million, or 9% to $58.4 million, up from $53.4 million last year. IVD instrument revenue decreased slightly year-over-year to $24.1 million from $24.6 million one year ago, a decrease of 2% and seven units. Please keep in mind last year’s Q1 contained a large one-time order. IVD consumables and service revenue increased to $34.3 million, a 19% increase over 2007’s $28.8 million, all volume driven.

Revenue in our sample processing division increased to just under $10.5 million for the nine months period, up from $9 million a year ago, an increase of 16%.

I am on Slide 16, the gross profit quarter-to-date. Consolidated gross profit was $11.8 million this year, up $1 million from $10.8 million last year, but our margins declined to 50% from 52%.

The IVD segment gross profit also increased to $10.1 million, up from just over $9 million, again with margins decreasing slightly to 51% from 53%. IVD instrument gross profit was flat on a dollar basis quarter-over-quarter at $3.5 million. However, the margins decreased to 42% from 47% a year ago. This year’s margins was negatively impacted by startup costs associated with VELOCITY, unfavorable write-offs of legacy instrument parts and the impact of unfavorable foreign currency on instruments purchased from ARKRAY denominated in Japanese yen.

IVD consumables and service gross profit increased to $6.8 million, up from 2007’s $5.6 million, with margins at about 57% for both periods. This year’s increases in volume and improvements in utilization of our German facility were offset by unfavorable foreign currency.

Gross profits at our sample processing division were flat on a dollar basis at $1.7 million, with margins decreasing to 49% from 51%. The decrease is attributable to product mix as our new Express 4 has slightly lower margins at this point than previous ISP products.

Slide 17, gross profit year-to-date. Consolidated gross profit was $35.7 million for the first nine months of this year, up from $31.5 million last year as margins increased to 52% from 51%. The IVD segment gross profit increased to over $30.5 million from $27 million a year ago with year-to-date margins improving to 52% from just under 51% last year.

IVD instrument gross profit decreased to $11 million from $11.6 million last year. This decreased the margin by a point to 46% from 47% a year ago. Again, this year’s margins were negatively impacted by foreign currency and VELOCITY startup costs.

IVD consumables and service gross profit increased to $19.6 million, up from 2007’s $15.4 million, taking the margin up to 57% from 53% for the same period a year ago. The margins are consistent with our near-term goal to reach 60% margin in this segment of our business.

Gross profit in our sample processing division increased to $5.2 million for the nine month period, up from $4.6 million a year ago, with margins remaining around 50%.

Moving on to Slide 19, our operating expenses. Marketing and selling expenses increased quarter-over-quarter from $3.6 million, or 17% of sales to $4.2 million, or 18% of sales. This increase was almost entirely attributable to increased personnel and related costs.

G&A expenses were $2.7 million for both this year and last, but they fell on a percentage basis to 12% of sales this year.

R&D spending increased to $2.8 million from $2.4 million last year, but remain close to 12% on a percentage basis. The dollar increase is primarily attributable to the continued development of our product pipeline that César mentioned with specific emphasis on our molecular diagnostic platform.

Slide 20 is our P&L quarter-to-date. As usual, I will not go line-by-line but I will call out some of the highlights. As you can see, we have double-digit increases in sales quarter-over-quarter with record quarterly revenue in both consumables and service as well as sample processing. It also contains – the quarter also contains the launch of VELOCITY and $1 million of incremental revenue.

Lastly, we had the ability to maintain our earnings per share even with our continued R&D spend, the VELOCITY launch cost, adverse foreign exchange condition.

Slide 21 is the P&L year-to-date and again the highlights include record year-to-date revenue at $68.8 million, margin improvements on a year-to-date basis, and strong EPS improvements.

Moving on to the balance sheet, as you can see, our cash exceeded $30 million and, as César said, should reach $33 million or more by year-end. This is with minimal exposure to auction rate securities. This also includes $5.7 million in cash used during our recent stock repurchase program and nearly $3 million in expected cash payments for taxes.

We have a strong accounts receivable performance with balances declining by $1.2 million this quarter. This gives us the ability to fund new deals internally, if necessary. We continue to drive down our inventory as a result of the successful launch of VELOCITY and other inventory initiatives.

Lastly, we have a debt-free balance sheet with open and available lines of credit.

I will not spend a lot of time on the final slide, which is the revised guidance, but I will reiterate a few points that César talked about earlier. Our revenue will be revised downward to $94 million. About half of this shortfall is behind us with the other half expected in the fourth quarter. Correspondingly, EPS will revise downward to be at least $0.43 per share. Again, this is due to the revenue shortfalls, the strong unfavorable foreign currency headwinds that we are facing, legacy inventory adjustments, which should be partially offset by our operating expense reductions and benefiting from the reduced share count due to the earlier share buyback program. Our R&D spending will remain flat in the 12% range and as always funded entirely from operations. Thank you.

César Garcia

Corin, we can move into the Q&A session.

Question-and-Answer Session

Operator

Thank you. (Operator instructions) We will take our first question from Steven Crowley with Craig-Hallum Capital Group.

Steven Crowley – Craig-Hallum Capital Group

Good afternoon, gentlemen.

César Garcia

Good afternoon, Steve.

Steven Crowley – Craig-Hallum Capital Group

A double – a two-part single question on your VELOCITY backlog situation. You broke up in the call when you – at least on my phone when you talked about the dollar amount of backlog that you exited the quarter with and may be you could just give us a little more color on the product registration issue or issues you dealt with in Q3 and where you are in that process now.

César Garcia

Honestly, I did not cover the dollar backlog. I think that we are not going to disclose that at this point in time but a significant – the issue with their registrations is that we release a product, the product that needs to be registered in each local market. So we release in units they are being used by the distributor to complete the registration process. For his – until the registrations are approved the distributors cannot ship units to end users. That’s all mostly for Latin America and the Asia Pacific rim. In Europe we are basically now in the selling process.

Steven Crowley – Craig-Hallum Capital Group

Okay. So, you are still working through the final stages of those registration issues in Latin America and Asia Pacific as we speak?

César Garcia

That’s correct.

Steven Crowley – Craig-Hallum Capital Group

Okay. Then my second question follow-up is related to the discussions we were having at the AACC conference around urinary tract infection – hospital-acquired urinary tract inventions. Do you sense a growing awareness by the customer base programs that are bring formulated for next year that might include more urinalysis or is this still very much in the concept stage? What do you see going on with the customers there?

César Garcia

I think the customers are waking up to the need to implement some automation to do this. I think that we also are making it more visible and one of the things we are working in a significant product upgrade that will be released in 2009 that will better address the need of the UTI market. And those are kind of a combination of initiatives, making them more aware, and giving them a product that more specifically targets their needs. And we still remain convinced that this has got – that’s going to generate significant pull-through on consumables and at the same time that it will help to justify automation in laboratories that are being marginal for automation at this point in time.

Steven Crowley – Craig-Hallum Capital Group

Okay. Well, thanks for taking the questions. I will hop back in the queue because I have plenty more.

César Garcia

Thank you.

Operator

Now, we’ll move on to Ernie Andberg with Feltl and Company.

Ernest Andberg – Feltl & Company

Good afternoon, César.

César Garcia

Hi Ernie.

Ernest Andberg – Feltl & Company

Hey, the fourth quarter has historically been a pretty strong seasonal quarter and if I use your nine months to-date and a minimum $93 million worth of revenues–

César Garcia

94.

Ernest Andberg – Feltl & Company

Pardon.

César Garcia

94.

Ernest Andberg – Feltl & Company

–94, it’s saying a modest increase in the fourth quarter this year. Can you discuss why just a modest increase as a opposed to the big jump that you normally see seasonally?

César Garcia

Well we are forecasting a 15% increase quarter-over-quarter. I think that that’s significant. Part of the issue that we do have is we do have still have a little concern with what is happening in the economy. I think that we have been achieving record revenue and increasing 15% year-over-year in this economy is excellent because it is abut two and a half times the growth rate of more mature IVD companies. Well I don’t think that these are the times to project 20%-25% increase in revenue when every one is going in the other direction. But we do have a significant increase, a minimum it will be a 15% increase quarter-over-quarter. If you – just a simple math, we are projecting at least a $25 million quarter, which is the highest in the Company history and like I said a 15% increase over last year.

Ernest Andberg – Feltl & Company

What is the status of the revised 510(k) at the FDA as best you can describe it because–

César Garcia

Remember we had an original 510(k) that was submitted and received comments. Okay?

Ernest Andberg – Feltl & Company

Yes.

César Garcia

What we opted to do was to submit a completely new 510(k) because we don’t want the 510(k) to expire on us. We wanted to be basically be proactive. So we submitted a new 510(k). The benefit of this 510(k) is that we know all the questions and we addressed them. So I–

Ernest Andberg – Feltl & Company

When was that submitted?

César Garcia

It was submitted this week. Okay? So basically we are in a – at the present pace, we should get this approved because as I said we went through one round, it should be approved by the end of this year, early next year, but in spite of this remember that we have continued to supply with ARKRAY because we are going to carry inventory into 2009 and we work with ARKRAY a gradual transition between AX-4280 to the VELOCITY.

Operator

And we’ll move on to James Sidoti with Sidoti and Company.

James Sidoti – Sidoti & Company

Good afternoon, César, can you hear me?

César Garcia

Yes, I can hear you fine, Jim.

James Sidoti – Sidoti & Company

Okay. A question on the NADiA submission. If you submit that in the first part of next year, are there any cost associated with that trial or is that relatively inexpensive to do?

César Garcia

No, insignificant cost. It’s about I think – Tom will probably tell us – I think it’s about $200,000-$250,000 in cost for that. That being kind of factored into our plan.

James Sidoti – Sidoti & Company

And that will be the first two quarters of 2009?

César Garcia

Most of that will be in the first quarter of 2009.

James Sidoti – Sidoti & Company

Mostly in the first quarter and then it’s about $250,000?

César Garcia

Tom, is that a good number.

Tom Adams

Well, we don’t have a negotiated deal yet, so it’s – I really can't–

César Garcia

Tell the number that we are using for planning purposes—

Tom Adams

That’s the number we’ve used for planning.

James Sidoti – Sidoti & Company

Okay. Alright. And then, the trial you said you said you expect that to be done within the first six months of the year?

Tom Adams

In the first quarter.

James Sidoti – Sidoti & Company

In the first quarter and then submit in the second quarter, so you think some time in the third quarter of 2009 NADiA will be available?

Tom Adams

Well, this – all the technical aspects of the – and performance characteristics of the test have already been reviewed by the FDA, so it’s just the clinical claims we believe will be review this time around.

James Sidoti – Sidoti & Company

So, you think that’s a good timeframe now–

Tom Adams

Yes, I think so.

James Sidoti – Sidoti & Company

And then is there anything holding you back from nailing down your distribution contract ahead of that approval? Or your distribution strategy ahead of that approval?

César Garcia

No, we are working with – on that we are making significant progress. Obviously I don’t think that people will sign below the dotted line until you got 510(k) approval or that – we are pursuing these very aggressively and we are very pleases with the way things are going so far.

Operator

(Operator instructions) We’ll move on to Debjit Chattopadhyay with Boenning & Scattergood. And caller, your line is open.

César Garcia

Debjit? Move to the next caller. I don’t think that he is there.

Operator

Great. And moving on for a follow-up question from Steven Crowley.

Steven Crowley – Craig-Hallum Capital Group

Couple of follow-ups, actually. In terms of the NADiA trial, you referenced, Tom Adams, a large trial. Can you give us a bit more in terms of details – in terms of are we talking 300 samples, 500 samples, is it still a retrospective trial? It sounds like the fuse is short enough for that would be the logical assumption on our part.

Tom Adams

Yes, we’ve – it’s going to 300 to 400 patients all retrospective.

Steven Crowley – Craig-Hallum Capital Group

Okay. And therefore the time to complete the – start to complete the trial should be relatively quick or did you say a couple of months once you start?

Tom Adams

Yes, that’s right, once the full thing is – it would only take us about two months to complete the testing.

Steven Crowley – Craig-Hallum Capital Group

And I am sorry to ask you this again, but you said your plan would be to submit the application to the FDA in Q2 of ’09.

Tom Adams

That’s what our current timelines suggest, yes.

Steven Crowley – Craig-Hallum Capital Group

Okay. Now in terms of – switching gears to the business side of the equation, again, the volatility you guys experienced on the consumable line – in consumable and service line, was it entirely due to spare parts that fall into that line or where there – was that relative weakness internationally that should be rectified in the fourth quarter much like we saw last year?

César Garcia

Okay. Steve, in reality there was no reduction in terms of the consumable. The consumable is essentially flat. We anticipated to book more consumables because as you see in the first two quarters we have achieved significant sequential growth on the consumable base line. And what happened was we were expecting to get another $400,000-$500,000, which we didn’t get. Most of that I think is related to the lumpy demand that we get from the international market. And we expect to record most of that in the fourth quarter. So that’s really the bulk of it.

The other issue that we have, as I mentioned, we have improved the quality of the iQ200 and we cured a chronic problem that we have, which represented about $1 million-$1.5 million in terms of revenue from spare parts. And because of that we are not basically selling those components any more at the pace that we were selling them before. It is a good thing to do, but in the short term it creates a negative effect in revenue and earnings.

Steven Crowley – Craig-Hallum Capital Group

A question for Peter. In terms of the foreign currency issue, what kind of impact did you forecast in your Q4 guidance? Your exposure has been to the yen. The yen has actually been strengthening recently ex the day to day variability this week–

Peter Donato

We’ve taken in about $875,000 year-to-date, Steve. We are anticipating just over $100,000 in the quarter in the fourth quarter, about $1 million total for the year.

Steven Crowley – Craig-Hallum Capital Group

I am confused though about your exposure. The yen has gone considerably up here. You are carrying inventory–

Peter Donato

Yes, we can offline, Steve. We are contractually required to pay ARKRAY a higher amount.

César Garcia

The currency exchange is primarily the yen, but remember we also have international operations, which also contribute a little bit. Do you follow that?

Steven Crowley – Craig-Hallum Capital Group

In Q3, did you feel like there was an economic impact because of the financial crisis in you results. I think answer is not in Q3, but you are being cautious and conservative about the potential for that impact in Q4.

César Garcia

Yes, I think that most of the impact – if you look in terms of the payable [ph] that we presented the impact of the crisis is very small, it’s about $1.5 million for the whole year. Okay? Of that $1.5 million for the whole year, most of that is in the fourth quarter. Okay? And that’s basically – I think that’s the way to correct that I said above. 50% is domestic, 50% is international of the $1.5 million.

Steven Crowley – Craig-Hallum Capital Group

Okay.

César Garcia

Okay.

Steven Crowley – Craig-Hallum Capital Group

Thank you.

Operator

(Operator instructions) We have a follow-up question from James Sidoti with Sidoti and Company.

James Sidoti – Sidoti & Company

Well, just a quick follow-up to Pete. Pete, why did you need to take the $150,000 charge for the inventory reserve?

Peter Donato

Yes, we had to take a look at our demand, Jim, on those legacy, and as César said, we are about a year ahead of schedule on that, so the demand just couldn’t justify. It is basically an excess charge.

James Sidoti – Sidoti & Company

I guess I am still confused. You are on a schedule in that–

Peter Donato

These are parts for our legacy systems, the pre-iQ200–

James Sidoti – Sidoti & Company

Okay. So this is –

Peter Donato

They had a – that replacement cycle.

James Sidoti – Sidoti & Company

I understand. So this inventory that you have on hand that you don’t think you will necessary be–

Peter Donato

Yes, we don’t think we’ll use. It’s purely an excess (inaudible), it’s not quite obsolete yet until we get rid of all the legacy in the field.

César Garcia

Jim, the plan was that we will counter-support the legacy systems through December 31^st, 2009 and we have contracts, supply agreement, which we have to commit in anticipation for some of the spare parts and the consumable. So when the – and these are long-terms commitments because they are basically obsolete components. So when the products begin to die faster than you expect you have to look back in terms of the amount of inventory that you have and you have to basically increase your reserves. And that’s what we are doing.

James Sidoti – Sidoti & Company

So, this has nothing to do with VELOCITY, this is the legacy–

César Garcia

Nothing to do with VELOCITY. All of these is legacies, all the–

James Sidoti – Sidoti & Company

Your legacy microscopy systems.

Peter Donato

That’s right.

César Garcia

No, these are all the old legacy (inaudible) 500.

James Sidoti – Sidoti & Company

Understand. Okay, thank you.

César Garcia

Okay.

Operator

We’ll take another follow-up question from Ernie Andberg.

Ernest Andberg – Feltl & Company

Peter, I don’t want to beat too hard on the call here on the ARKRAY. Are you saying to us that you had made commitments to acquire inventory that when you acquired it you were – you needed to pay more, $875,000–

Peter Donato

That’s right.

Ernest Andberg – Feltl & Company

–year-to-date to ARKRAY than you expected?

Peter Donato

That’s right. And we were locked into the yen at about 100 and our contract significantly more than that.

Ernest Andberg – Feltl & Company

Okay. Right, thank you.

Operator

And we have no further questions at this time. I will turn the call back over to Mr. Garcia.

César Garcia

Thank you very much, Corin. Well, this concludes our conference call today. I want to thank you all for participating and as I said before we expect a very good closing in the year with record revenues in the fourth quarter and we will keep you posted as we progress in our milestones. Thank you very much and have a good day.

Operator

Ladies and gentlemen, if you wish to access the replay for this call you may do so by dialing 1-888-203-1112. International callers should dial 719-457-0820 and use access code number 4672241 to access the playback. This concludes our conference call. You may now disconnect.

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