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Executives

Michael K. McGarrity – President and Chief Executive Officer

J. Roger Moody Jr. – Vice President of Finance, Treasurer and Chief Financial Officer

Analysts

Bill B. Bonello – Craig-Hallum Capital Group

David Clair – Piper Jaffray

Matt V. Dolan – ROTH Capital Partners LLC

Nanosphere, Inc. (NSPH) Q4 2012 Earnings Call February 13, 2013 5:00 PM ET

Operator

Good day, ladies and gentlemen, and welcome to the Nanosphere Fourth Quarter and Full Year 2012 Earnings Conference Call. My name is Jeff and I will be your coordinator for today. At this time all participants are in listen-only mode. Later we will facilitate a question-and-answer session (Operator Instructions). As a reminder this conference is being recorded for replay purposes.

Before we begin, Nanosphere would like to state that certain statements made during this conference call which are not based on historical facts may be deemed to constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 because these forward-looking statements involve known and unknown risks and uncertainties, these are important factors that could cause actual results, events or developments to differ materially from those impressed or implied by these forward-looking statements. Such factors include those described from time to time in Nanosphere's filings with the United States Securities and Exchange Commission. Please note that Nanosphere undertakes no duty to update this information.

I would now like turn the presentation over to your host for today Mr. Michael McGarrity, President and Chief Executive Officer. You have the floor sir.

Michael K. McGarrity

Thanks Jeff, and thanks to all of you for joining us for our Q4 and full-year results call for 2012. With me today is Roger Moody, Chief Financial Officer of the company. I would like to begin my comments with the organizational announcement released as part of our earnings report. On behalf of all of our Nanosphere employees, I would like to wish Bill Moffitt and thank him for his years of dedicated service with the company. Also on behalf of our employees and customers, I want to emphasize her excitement as we embark on the next chapter of growth as a company.

Over the years our employees have worked tirelessly, to take the core technology and unlock its potential. That potential ranges from aiding and diagnosis and treatment of a variety of disease states ranging from high risk genetic disorders to complex sepsis syndromes to acute coronary syndrome, heart failure and cancer. While this broad focus might have compromised our ability to execute and deliver results, we have now defined a clear path to growth in microbiology fueled by our expanding menu of tests. Evidence of this focus is our Q4 results in which we had 56 new customer placements and nearly doubled revenue from Q3 to $1.6 million. We now have installed or are in the process of installing Verigene Systems and microbiology laboratories across the US, running our Respiratory Virus Assays, our Gram-Positive Blood Culture Assay, our C. difficile assays or a combination of our expanding menu.

Our blood culture customer validations are progressing well. My experience in the field with our sales reps and customers, in addition to our team's significant clinical study work validates this progress. And I thought it would be helpful to provide color on this aspect of our revenue ramp.

Our customers can generally be grouped into three categories, the first set of customers in which our microbiology director is able to drive the process in the utilization from the validation data generated by the laboratory. The second set of customers that require validation data to be presented to additional organizational disciplines, like pharmacy, infectious disease, and critical care. Finally, customers that are conducting perspective type validations and their patient population with some interventional and economic outcome analysis.

These three categories lead to our normal distribution of time utilization and revenue. And while the last group tends to take the longest competitively, they generate compelling data to be shared with future adopters of our tests. This data illustrates benefits ranging from antibiotics stewardship guided by our unique resistance markers preserving efficacy of critical last line therapies.

Earlier rollout of non-life-threatening contaminants allowing for associated P/S collection of therapy and discharge. And mobility and mortality benefits for multiple disease states independent of coexisting conditions. All of these leading to significant economic benefits to be realized by our hospital and a group of hospitals. We have a number of abstracts and publications pending from these validations that will provide a stream of additional data, to drive adoption of our test.

We have stated that our expected time to validation and utilization will be approximately 90 days. As we built history, we see that timelines can extend beyond that based on experience I just noted. A positive indicator of our progress is that we have customers executing long-term standing purchase agreements for our blood culture Assay.

All of these speaks for the standard changing aspect of what we are delivering to our customers, while it is an overused term we are clearly changing the paradigm of diagnosing and treating blood stream infections, it should also be noted that the sensitivity and specificity of our gram-positive blood culture test has been exceptional compared to gold standard method comparisons. While this is what we expected to see as evidenced by the thousands of samples running through validations and multicenter regulatory studies, our customers are clearly positive about the results they are seeing in real-world application.

In fact we have had multiple customers begin to document cases where critical clinical actionable information provided by our test had a direct and measurable result on patient outcomes. As an example, one of our sales reps recently related clinical result that reported an extremely opportunistic and deadly enterococcus faecium infection. That was risk resistant to Vancomycin, the standard initial prophylactic therapy. The treating physician immediately escalated therapy to restricted last line (linezolid) [ph] with positive outcome. One of our customer contacts in that institution estimated this rapid diagnostic and intervention to have saved up to eight days to discharge, if not the life of the patient. We will continue to share such examples of the significant value we are providing patients and clinicians.

Before I turn the call over to Roger I would like to highlight a webinar that we have recently sponsored and titled, Each Our Counts optimizing therapy for blood stream infections with rapid molecular testing. Participating in the educational session key opinion leaders from the Cleveland Clinic, Medical College of Wisconsin and the Ohio State University Medical Center all who have published examples of my above reference validation experience with the value of rapid identification and resistance. While these are large academic medical centers. It should be noted that we are seeing the same excitement and recognition of value by regional and community centers.

I would invite all of you to visit our website, where you may access an archive this webinar.

I would now like to turn the call over to Roger Moody.

J. Roger Moody Jr.

Thanks Mike. Let me be the first to welcome you publicly in your new role as CEO. This morning I will summarize Nanosphere’s fourth quarter and full year 2012 financial results. For additional information, please refer to our related news release and 8-K both of which are available on our website www.nanosphere.us

Before reviewing the numbers, I will summarize our progress. First, as Mike mentioned gram positive customer validations are progressing well and we are seeing the first phase of revenue growth.

Next we experienced a steady rise in respiratory virus assay sales throughout the quarter. In December respiratory virus sales accelerated as the flu season kicked in. Finally our expanding US microbiology customer base and test menu positioned Nanosphere for sustainable revenue growth.

Now I will take you through the fourth quarter and full-year 2012 results. Placements in the fourth quarter were 56, as compared to 50 in the third quarter and our guidance of 60. The shortfall was driven primarily by ongoing softness in European markets. Full year 2012 placements, we were 166, as compared to 63 in 2011.

Cumulative placements at year end were 272, 155 of which were US microbiology customers. Revenue in the fourth quarter was $1.6 million compared to $800,000 in the fourth quarter of 2011 and $900,000 in the third quarter of 2012. This increase was driven predominantly by instrument and cartridge sales to new US microbiology customers.

Fourth quarter 2012 total revenue increased sequentially by 81%, US microbiology test revenue tripled sequentially, driven by our gram-positive and respiratory virus assays. Full year 2012 revenue was $5.1 million, double the $2.5 million in 2011. Gross profit in 2012 was $1.5 million as compared to $700,000 in prior year, driven by increased sales.

Gross margin percentages increased slightly year-over-year. The benefit from our in-house substrate as well as other cost reduction programs will be realized in 2013 and beyond.

As of December 2012, we completed the validation studies for the in-house substrates on our new assays including gram-negative and enteric, as well as two of our cardiovascular tests. Validations studies for the rest of our assays are in progress or expected to be completed this year. Use of these substrate in all assays promises to increase consumable gross margins by approximately 7% upon validation and an additional 3% as we reduce the cost of our internal substrates.

R&D expense during 2012 was $17.6 million down from $20 million in 2011. This reduction was driven by a shift in resources from development into manufacturing and customer support. Additionally we reduce spending on development materials including fewer outsourced coated substrates.

Sales, general and administrative expenses increased to $16.9 million in 2012 from $16.2 million in 2011. The increased expense was driven by expansion of our sales and customer support teams and was partially offset by a reduction in equity compensation expense. Net loss for 2012 was $32.9 million and $0.67 per share as compared to $35.4 million and $0.94 per share in 2011.

Cash used in operations during 2012 was negative $31.7 million, $4.8 million of which was the buildup of inventory including equipment at customers pending validations.

Fourth quarter 2012 total cash flow was negative $8.8 million of which $1.5 million resulted from increases in inventory. Net proceeds from the underwritten public offering, we completed in the third quarter of 2012 were $27 million. We finished 2012 with $33.1 million in cash. Our capital resources are sufficient to last at least the next 12 months. We are currently evaluating debt financing structures that should provide the company with a reasonable cushion to operate through positive cash flow.

Now, I will turn to our guidance for 2013. We are initiating revenue guidance at a range of $13 million to $15 million for this year. Also we estimate 200 to 250 placements in 2013. Previous first-quarter guidance for placements was 80 to 100, slower than anticipated growth in international markets and the timing of projected regulatory approvals of our gram-negative and enteric assays makes 45 to 55 placements more likely in the first quarter.

We recently filed our gram-negative assay for CE Mark. This test has a compelling value proposition in Europe. While we appreciate the value gram-negative brings to the European market, we excluded any significant contribution from Europe in our guidance due to the strong economic headwinds. The momentum we have established in our U.S. microbiology business should drive most of our 2013 new customer placements and revenue.

Summing up, we are pleased to see the early signs of revenue growth. Most importantly, the feedback from our customers who are adopting our platform and validating our tests, suggest that we are building a solid recurring revenue stream that as we grow will yield attractive margins and cash flow.

Now let me turn call back over to Mike.

Michael K. McGarrity

Thanks Roger. I would like to emphasis how committed we are to consistent execution and results. We have extraordinarily talented and dedicated employees, a rapid growing and loyal customer base, and a value proposition that is known. The guidance Roger provided for 2013 is based on a number of experiential and informed assumptions.

One, our U.S. customer ramp and visibility to a solid pipeline of customers for current menu and those who are waiting our gram-negative and enteric panels. Two, these menu additions require a complex and comprehensive clinical study plan to navigate the regulatory process. Three, we commenced these studies in Q4 and have a team of experienced clinical and regulatory affairs talent directing these efforts. Four, we have built a commercial, technical, and customer support team dedicated to providing exceptional service for which we are building a reputation. Five, initiating progress in Europe has clearly taken longer than we anticipated due to the macroeconomic environment. However, we remain committed to building a business through our distribution partners and believe we will see progress at 2013. Six, in Asia Pacific, we are continuing to move through the required approvals for regulatory and reimbursement and we will have more to update in the next couple of quarters.

Finally, while it is clear that our near-term drivers of placements will be U.S. base, all of this leads to a confidence in our guidance of $13 million to $15 million in revenue and 200 to 250 placements. We individually and collectively are committed to execution of our plan, delivering results and value to our customers, patients and shareholders.

Finally, I would like to thank our shareholders, employees and Board of Directors for their commitment to our growth as a company. Thank you for your support.

Now I will turn the call back over to Jeff for questions.

Question-and-answer session

Operator

Thank you. (Operator Instructions) Our first question comes from the line of Bill Bonello, with Craig-Hallum. Please proceed.

Bill B. Bonello – Craig-Hallum Capital Group

Hi, good afternoon guys. Thanks for taking my questions. I guess a couple – the first thing is, I'm just curious if you can be anymore granular in sort of what's going on with the uptake of the gram-positive and the respiratory assays? I know last quarter you gave some numbers about the percent validated and validating et cetera, that was a little vague but I don't know if you can give us anything like the actual number of customers that are using the assays or the actual revenues for those assays or something to give us a gauge of how things are going so far.

Michael K. McGarrity

Yes Bill I'd be happy to, I highlighted that we feel very good about our progress in validation of our blood culture assay. I’ll just make a couple of quick points. Roger commented on our microbiology US-base of about 150 customers, one point to remember is that in July when we received our FDA clearance, that's really when we started the validation process, because we had to get customers to go forward and validate the full gram-positive blood culture assay. We have about 1/3 of those through the process, so we feel as if the process from a timeline stand point as well as the successful adoption and implementation of the test is going well. We are not at the point where we are breaking our test menu revenue from a test standpoint between RV and Blood Culture, but I would say that we feel like we have momentum coming out of Q4 into Q1 that resembles the momentum from Q3 to Q4 and into Q1. So $900,000 to $1.6 million and going into Q1 we feel good about that progress.

Bill B. Bonello – Craig-Hallum Capital Group

Okay. And just to be sure, when you see you have about a third that are through the process, does it mean about one-third of those 150 are using either respiratory gram-positive or both?

Michael K. McGarrity

Yeah, the majority of them are using gram-positive. The majority of our microbiology customers are using gram-positive and then a subset of those are using respiratory as well. You can think of all the respiratory customers we had is validated at this point in the season and the Blood Culture are moving through the processes we have discussed.

Bill B. Bonello – Craig-Hallum Capital Group

Okay, okay. That’s helpful. And then just on the U.S. you talked about the weakness, that being slightly light in placements being largely international. Can you give us any detail on sort of what the progression in the U.S. from Q3 to Q4 was?

Michael K. McGarrity

Yeah. Our contribution in placements from Europe and international in total has dropped and it’s come down to approximately 15% where earlier in the year, in fact in the second quarter was more than half as we talked about in the third quarter, it comes down to about 20%. So we’ve seen a continue erosion in the contribution we are getting outside the U.S. and that’s why we’ve taken the opportunity to really focus our guidance on what we have the most visibility into.

Bill B. Bonello – Craig-Hallum Capital Group

Okay. And then just the last question, I’ll let other people hop in, but just give us a sense of the visibility you have into that 45 to 55 placements at this point in the quarter. I mean do those tend to fall into the last month of the quarter or just help us get comfortable with that?

Michael K. McGarrity

Yeah Bill, I would say that the guidance we’re are providing both from the revenue and a placement standpoint is guidance that we don't want to happen, we expect to happen, we're going to continue to drive upside to those projections both revenue and placements in the key areas of our business, international, our US placement rate, our validation timelines, our regulatory timelines. So we are obviously directing our guidance to what we expect to happen based on our experience and our contact with our customer base and field.

Bill B. Bonello – Craig-Hallum Capital Group

Makes sense. All right thank you.

Operator

Our next question comes from the line of Bill Quirk with Piper Jaffray. Please proceed.

David Clair – Piper Jaffray

Yes, good afternoon everybody, it's actually David Clair, in for Bill. Maybe we can just talk a little bit about the pipeline here, are we still looking for enteric maybe in the first half of '13 and any additional color on assay launches that we should be expecting in 2013, would be pretty helpful.

Michael K. McGarrity

Dave our projections for our enteric and gram-negative assays is submission to the US FDA in mid-year and as Roger mentioned that's a combination of our Q1 reset from the previous guidance that was out. It was really driven by those two factors where initially in the first quarter and second quarter, as Roger commented we had a significant weight of 30% to 35% or more weighted to Europe. In the international we’ve seen that decline. And the second factor is just real visibility and we feel a well informed projection of where we think will be from the submission stand point and we look to those to be midyear submissions to the FDA.

David Clair – Piper Jaffray

Okay and then Roger, how should we be thinking about operating expenses, cash burn in 2013 and can you give us the share count in the quarter as well?

J. Roger Moody Jr.

Sure. The operating expenses as you saw have remained roughly flat with a slight drop as we shifted resources from development over into manufacturing and therefore you’re seeing that spend in cost of goods as opposed to in expenses. We’ll see more of that as we go into 2013 and we expect that the gross profit contribution in 2013 will outstrip any increases in sale marketing and general SG&A which is driven by expansion of our sales force and customer service groups. The share count outstanding is 56 million shares.

David Clair – Piper Jaffray

And what was the – I am just trying to back into the, I guess I can do it, but what was the average in the quarter?

J. Roger Moody Jr.

The average share count in the quarter, hold on one second, I will get back to you. Let me get back to you on what the weighted average was.

David Clair – Piper Jaffray

Okay, and then anything you can tell us about?

J. Roger Moody Jr.

There were no changes, so the average was the same as the 56 million shares in the quarter.

David Clair – Piper Jaffray

Okay. And then any color you can give us on cash burn expectations for 2013?

J. Roger Moody Jr.

Sure. I would expect it to come down throughout the year quarter-to-quarter driven by increases to gross profit. I would also expect that the inventory build up that we saw in the third and fourth quarters will not continue to rise. In fact, I think we’ll start to see that come down as we continue to grow because we won’t have this well backlog of new placements that came from gram positive will get some more of a steady state and I would expect that the inventory levels will normalize out, so there will a smaller cash consumption in 2013 than 2012.

David Clair – Piper Jaffray

Okay, thank you.

Operator

Our next question comes from the line of Matt Dolan with Roth Capital Partners. Please proceed.

Matt V. Dolan – ROTH Capital Partners LLC

Hey guys, good afternoon. I wanted to maybe start on the management change. Obviously, the company’s history there have been some delays and now you are starting to assuming right here try little bit in terms of commercial placements and starting to see a revenue ramp, so walk us through the (inaudible) timing of the change today and then Mike maybe could touch on how you see the strategy changing going forward? I know you mentioned maybe focusing a little bit on the commercial opportunity, but anything else you could add to that would be appreciated.

Michael K. McGarrity

Sure Matt, I think you hit on it right. I think that this reflects where we are as a company that our clear focus and path forward is to be a customer facing commercial focused organization. And I have spend virtually all of my time building that focus with our sales reps, our customers, our market in and around our competition and I think that it’s probably a normal progression of a company particularly like ours where you spend a significant amount of time harnessing the technology, embodying it, validating it and getting it to the performance we have today, which is outstanding and then taking the next turn, this is okay, now we are going to make that 180 degree focus turn to the customers and our commercial business opportunity and that’s where we are and that is the entire focus of our efforts going forward from our development groups, our regulatory groups. And I think we have the right people in place to drive that and then continue to build on our commercial arbitration.

Matt V. Dolan – ROTH Capital Partners LLC

Okay, great. And then on the placement and the revenue guidance kind of a two part question, Roger did you say that you were – what are you excluding in terms of your assumption out of Europe and just trying to understand how conservative that number is. And then the second part is, we saw the benefit of gram-positive in placements in 2012, should we anticipate that enteric and gram-negative have a similar effect as we kind of think about the progression of the placements throughout this year?

J. Roger Moody Jr.

Sure, so what I said we excluded was anything that we don't have great visibility into which is any significant placements from international. I will let Mike answer your question about the catalyst that enteric and gram-negative create on the placements.

Michael K. McGarrity

Yes, Matt. Our gram-positive blood culture assay is still driving significant pipeline. I think it might be helpful to look at our pipeline kind of three ways, I think in our placement pipeline coming in the coming quarters we have kind of again three types of customers. We have those that are potentially some of them we need for gram-negative just so they can implement, validate and begin to report both gram-positive and gram-negative. Second we have some that are actually doing a lot of the work that I prefer to in our validation efforts as far as getting the process in place to reportable result process in place and getting all the clinicians on board prior to starting their validation, which we believe will actually serve to contract our validation timelines as we go forward.

And the third and this is why the data that we're generating is so important, are waiting for kind of some reference performance of how did people validate and implement one of the best practices on how do they bring that data into their institution. So we think we have a process to address those we have a pipeline that we are continuing to focus on moving forward and you have to answer your question is obviously gram-negative and enteric provide a catalyst not only in Europe but in the US for our placements and we are very excited about that. Our customer target base is aware of our process and progress there and I think that that will serve as the catalyst.

Matt V. Dolan – ROTH Capital Partners LLC

Okay and then the last one is on the consumable side, I don't know if you could give us any more detail there but for those sites that are validated and up and running, you've talked about 50 gram per and 200 per side or per unit to breakeven and start generating some cash. Do you have any updates on where you are and what you're seeing in the field relative to those consumable target.

Michael K. McGarrity

We don't have any change in our view of what each assay will be worth by customer per year. We continue to believe in the assumptions that we made and we've talked about in the past, I would say it's probably too early to have enough data to bi-focate or to show the kind of test revenue per validated customer but as we accumulate that data we will begin to release more of it but what we’ve seen thus far our customers are coming in and using the depth as we expected and as they had suggested that they would when we added that data through the – in the sales pipeline process.

Matt V. Dolan – ROTH Capital Partners LLC

Thank you.

Operator

Ladies and gentlemen that concludes the time we have for questions. I'd now like to turn the presentation back over to Mr. Michael McGarrity for closing remarks.

Michael K. McGarrity

Thanks Jeff. Again I would just like to thank all of you for your interest in and support of Nanosphere, and we look very much forward to reporting on our progress going forward herein in 2013. So thank you very much for joining us today.

Operator

Ladies and gentlemen that concludes today's conference. Thank you for your participation. You may now disconnect. Have a wonderful day.

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