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OraSure Technologies, Inc. (NASDAQ:OSUR)

Q3 2013 Earnings Conference Call

November 6, 2013 05:00 PM ET

Executives

Judy Clarke - IR

Doug Michels - President & CEO

Ron Spair - COO and CFO

Kathy Weber - SVP & GM, Consumer Products

Analysts

Jeff Frelick - Canaccord Genuity

Nick Nolan - Citi

Shaun Rodriguez - Cowen and Company

Brandon Couillard - Jefferies

Peter Lawson - Mizuho Securities

Nicholas Jansen - Raymond James

Operator

Good day ladies and gentlemen and welcome to the OraSure Technologies Inc. Third Quarter 2013 Earning Conference Call. At this time, all participants are in a listen-only mode. Later we’ll have a question-and-answer session and instructions will follow at that time. (Operator Instructions). And as a reminder today’s conference is being recorded for replay purposes. I would now like to turn the conference over to your host for today. Ms. Judy, ma’am you may begin.

Judy Clarke

Good afternoon everyone and welcome to OraSure Technologies 2013 third quarter financial results conference call and simultaneous webcast. As a reminder, today’s conference is being recorded. All lines have been placed on mute to prevent any background noise. After the speaker’s remarks, there will be a question-and-answer period. (Operator Instructions)

OraSure Technologies issued a press release at approximately 4:00 PM Eastern Time regarding its 2013 third quarter results and certain other matters. The press release is available to you on our website at www.orasure.com or by calling 610-882-1820. If you go to our website, the press release can be found by opening the Investor Relations page and clicking on the link for press releases. This call is also available real time on our website and will be archived there for seven days. Alternatively, you can listen to an archive of this call until midnight November 13, 2013, by calling 855-859-2056 for domestic or 404-537-3406 for international. The access code is 87563319.

With us today are Doug Michels, President and Chief Executive Officer; Ron Spair, Chief Operating Officer and Chief Financial Officer and Kathy Weber, Senior Vice President and General Manager Consumer Products. Doug and Ron will begin with opening statements, which will be followed with a question-and-answer session.

Before I turn the call over to Doug, you should know that this call may contain certain forward-looking statements, including statements with respect to revenues, expenses, profitability, earnings or loss per share, and other financial performance, product development, performance, shipments and markets, and regulatory filings and approvals. Actual results could be significantly different. Factors that could affect results are discussed more fully in the company’s SEC filings including its registration statements, its annual report on Form 10-K for the year ended December 31, 2012, its quarterly reports on Form 10-Q, and its other SEC filings.

Although forward-looking statements help to provide complete information about future prospects, listeners should keep in mind that forward-looking statements may not be reliable. The company undertakes no obligation to update any forward-looking statements to reflect the events or circumstances after this call.

With that, I would like to turn the call over to Doug Michels.

Doug Michels

Okay, thank you, Judy. And good afternoon everyone and welcome to our call. The company delivered strong overall results for the third quarter. Consolidated net revenues reached record high growing 12% over the third quarter of 2012. The principal drivers of this growth were a 48% increase in DNA Genotek revenues and a 20% increase in our infectious disease business.

Our molecular collection systems business continues to deliver record results driven by higher sales to commercial customers. Our infectious disease revenue has also increased nicely driven by sales of our OraQuick In-Home HIV Test and higher international sales of OraQuick HCV Test. During the third quarter we also launched the new promotional campaign for our OraQuick In-Home HIV Test and I will provide additional insight into how this campaign is progressing and certain other business items later in the call. So with that, let me turn the call over to Ron for a more detailed financial review.

Ron Spair

Okay. Thanks, Doug and good afternoon everyone. Our third quarter 2013 consolidated revenues were $24.7 million compared to $22.1 million reported in 2012. Our consolidated product revenues increased 13% as a result of the record sales from our molecular collection systems segment and higher sales of our infectious disease testing products. These increases were partially offset by lower sales of our substance abuse testing, cryosurgical systems and insurance risk assessment products.

Our molecular collection systems revenues primarily representing sales of the Oragene product line increased to $5 million in the third quarter of 2013 compared to $3.4 million in 2012. This 48% increase was the result of higher sales in the commercial marketplace.

Our infectious disease testing revenues were $12.9 million in the third quarter of 2013 compared to $10.7 million in the third quarter of 2012. The overall 20% increase was primarily a result of $1.8 million in net sales of our OraQuick In-Home HIV Tests which we began selling in the fourth quarter of 2012. Q3 sales of our professional HIV and HCV tests in the international markets also increased.

During the current quarter, gross sales of our OraQuick In-Home HIV Test were $1.9 million which were offset by $172,000 in customer allowances including cooperative advertising, cash discounts and other allowances. Net sales of this product included approximately $217,000 of direct sales of our OraQuick In-Home HIV Test to public health customers. In addition to the increase in net revenues from our OraQuick In-Home HIV Test, sales of our OraQuick HIV and HCV professional products in the international market increased 31% and 283% respectively. International sales of our professional HIV tests in the third quarter of 2013 increased to $1.2 million from $884,000 in the same period last year, primarily due to sales in support of a significant testing program in Africa.

International sales of our HCV tests in Q3 increased to $924,000 from $241,000 in the prior year due to the first installment of product shipped under an order from a multinational humanitarian organization. These sales increases in the international market were partially offset by a decline in domestic HIV revenues which were down 434,000 or 5% due to competition from other rapid and automated laboratory-based HIV tests, reductions in government funding and the timing of customer purchases.

Third quarter 2013 cryo revenues decreased 13% to $3.6 million from $4.2 million in the third quarter of 2012, primarily as a result of lower professional sales in the domestic marketplace and lower OTC sales. Professional domestic cryo sales decreased 11% compared to the third quarter of 2012, due to variability in distributor order patterns. OTC sales decreased 18% to $1.4 million in the third quarter of 2013 from $1.7 million in the third quarter of 2012. This decrease was primarily the result of the timing of orders placed by our Latin American distributor as well as a net decrease in sales to our European distributor.

Our substance abuse testing revenues decreased to $2.1 million in the third quarter of 2013 from $2.3 million in the third quarter of 2012 primarily as a result of lower Intercept sales. This decreased resulted primarily from reductions in purchases by our UK distributor who began selling its own competing oral specimen collection device.

Turning to our gross margin, our overall margin for Q3 was 61% compared to 63% reported for the third quarter of 2012. The lower 2013 margin was primarily a result of higher royalties paid on sales of our OraQuick products and an unfavorable change in product mix partially offset by an improvement in overhead absorption and a decline in scrap and spoilage costs.

Our consolidated operating expenses for the third quarter of 2013 remained relatively flat at $17 million compared to $16.8 million in the third quarter of 2012. Increases in sales and marketing expenses and G&A expenses were partially offset by lower R&D expenses.

Sales and marketing expense increased $379,000 largely due to higher staffing costs partially offset by lower trade show expenses. Spending associated with advertising and promotional activities for our OraQuick In-Home HIV Test increased slightly to $1.9 million in the third quarter of 2013 compared to $1.8 million spent in the third quarter of 2012. G&A expenses increased $122,000 due to an increase in staffing related expenses partially offset by lower spending on legal and professional services. R&D expenses for the third quarter declined $324,000 due to lower staffing and supply costs. From a bottom line perspective we reported a net loss of $1.9 million or $0.03 per share for the third quarter of 2013 compared to a net loss of $2.4 million or $0.04 per share for the same period of 2012.

So turning briefly to our balance sheet and cash flow, our cash balance at September 30, 2013 was $82.6 million compared to $87.9 million at December 31, 2012. Cash provided by operating activities in the third quarter of 2013 was $6.1 million compared to $1.7 million used in operating activities in the third quarter of 2012.

Looking forward, we expect to spend $5.6 million on advertising and promotion activities in Q4 related to our OraQuick In-Home HIV product. A significant portion of this represents a shift in spending from the third quarter of 2013 to the fourth quarter and is one of the primary reasons why we exceeded our Q3 guidance for the bottom line.

As we have discussed in prior calls, our current revenue recognition practices of the OraQuick In-Home HIV product have us differing revenue recognition from the time of shipment to the retailer or distributor until the conformation of a sale by the retailer or distributor either in a store or over the internet. Under U.S. generally accepted accounting principals product revenue cannot be recognized unless the amount of future returns can be reasonably estimated.

Since the launch of the product in September of 2012, we have continued gathering information regarding retailer and distributor inventory levels and return practices. We expect to change to a more traditional revenue recognition policy under which revenue is recognized upon shipments of the retailers or distributors, once we believe we have a sufficient amount of this data to develop a reasonable estimate of the level of expected returns.

We anticipate that this change in accounting policy may occur in the fourth quarter of 2013 and assuming it does, could positively impact our revenues by approximately $2 million. We have included these additional revenues in corresponding gross margin contribution in our guidance for Q4, 2013. In light of foregoing, we are now projecting consolidated net revenues of approximately $27.5 to $28 million and a consolidated net loss per share of approximately $0.07 to $0.08 for the fourth quarter of 2013.

As we look out to the first quarter of 2014, we will likely be recognizing revenues for our HIV OTC product based on shipments to the distribution channel and of course we would not have a similar revenue recognition adjustment. Additionally, I would like to take this opportunity and remind everyone that the first quarter has historically been our weakest quarter for both our infectious disease and cryosurgery businesses. Therefore, we do anticipate a sequential decline in revenues from Q4, 2013 to Q1, 2014.

And with that, I will now turn the call back over to Doug.

Doug Michels

Okay. Thanks Ron. As mentioned on our last call, we intentionally reduced our marketing activities related to the OraQuick In-Home HIV Test during the third quarter, as we prepared for and ultimately launched our new promotional campaign. Consequently third quarter sales of this product declined about 12% compared to the second quarter.

During the third quarter, our OTC marketing team assessed what practices and strategies prove to be most effective during the first nine months of the launch and develop new marketing activities based on that analysis. This retooled campaign has already launched and elements will continue to be added through the first quarter of next year.

Importantly our OraQuick In-Home HIV Test maintains a strong rating at major retailers. For example, the product holds top ten positions in the categories in which it is merchandized at both Wallgreens and CVS. In addition, internet or dot com sales now represent 8% of total brand retail sales and grew 1% from the second quarter. Interest from public health customers and advocacy groups also remained strong. The sales of the product to these entities approximating $200,000 in Q3.

Our new marketing campaign entitled Life As We Know It was officially launched in late September in conjunction with Gay Men’s HIV Awareness Day. As previously communicated, this new campaign is designed to address several key elements of our analysis from the first nine months of product availability. Of most significance was the need to significantly increase brand awareness among key consumer target groups such as MSM or men who have sex with man and the African American women. Our new campaign focuses on the importance of urban high prevalence markets and incorporates influential and trusted spokes people from within the target communities we serve. The campaign also addresses some of the sensitivities involved with starting a conversation with consumers about HIV. Initially the campaign will be reaching out two groups among those at highest risk for HIV, gay men and African American women.

Our activities include programs with national reach such as television and a number of more focused efforts in critical local markets. Today 15 markets account for nearly half of our sales and we're planning local efforts in all of these markets. Importantly nine of these markets are additions to our earlier local marketing efforts which we piloted in the second quarter.

As part of the campaign we've teamed up with powerful and influential voices in these communities to reach consumers through testimonials through interactive panel discussions, through sharable discussion guides and informative videos. In addition to Magic Johnson we've engaged television host and bestselling author Ross Mathews, actor Darryl Stephens, television host Dr. Rachael Ross, author blogger and life coach Demetria Lucas, journalist Jacque Reid and Drag Queen star Jinkx Monsoon.

The campaign also uses leading media properties to communicate with these target communities, including logo TV and its online properties for the gay community, a network that reaches into over 52 million homes and BET Essence and Interactive One, all top rated media brands for African-Americans. The campaign also includes high profile consumer events as well as targeted broadcast, outdoor, digital and print advertising.

Although the campaign officially began on September 27th many of the campaign elements are planned to launch at various times during the fourth quarter. For example our press tour with Ross Mathews, and our TV partnership with Logo launched in late September, but additional elements followed in Q4. Similarly radio targeting African-American women launched in mid October and the majority of our out of home and print advertising intended to reach the MSM community launched during the last week of October.

For the month of October, we placed about 13% of the total campaign impressions expected in the fourth quarter with the balanced expected to hit in November and December. We will continue to add new elements through the first quarter of next year with the most notable first quarter addition being our TV partnership with BET a television network with strong delivery to the African-American community. We estimate that by the end of this year, when multiple elements are up and running our program will have reached over 60% of the MSM community and over 40% of African-American women.

As we've introduced various elements of the campaign, we've started to see some positive signs, we are driving highly interested consumers to our website with 64% of MSM consumer visiting the site since the September 2013 campaign launch stating that they intend to purchase. This is versus 45% of our Q3 visitors and 50% of female visitors indicating an intent to purchase versus 30% of Q3 visitors. Social media mentions of OraQuick are also up and have more doubled since the launch of the new campaign. Although our success will ultimately be measured by sales, these early signs indicate that our programs are reaching and are connecting with our targeted consumers.

As discussed on prior calls, the retail environment remains challenging, but here again I am pleased to report that we are making progress. We continue to improve store inventory levels with out of stocks now running below 5% even in our highest volume stores. This is a substantial improvement from earlier in the year. However significant barriers to consumer access at retail particularly in high prevalence markets continue to impact sales.

An audit conducted in the first quarter of this year revealed that 23% of stores nationally and 56% of stores in high prevalence areas have some type of barrier to access at retail. These include placing of the product in locked cases or behind the counter and other theft prevention devices.

We place high priority on addressing these issues at retail and recently completed a substantial retail project with representatives personally calling on over 5,000 stores to assess and improve retail conditions. The results from this project are still tabulated, but we believe we’ve been able to improve retail placement in over 30% of the stores visited in one large retail pharmacy chain alone. We will continue to work with the retail community at the head quarters level, as well as at the store level to ensure that all consumers have easy access to our product.

And finally we continued to advance our international activities and we are encouraged by positive signals from health authorities, advocacy organizations and retailers in key markets. I hope to have more to report on this in the near future.

Turning next to our OraQuick HCV Test, total HCV sales increased 72% for the current quarter compared to last year and were up sequentially over the second quarter. As Ron mentioned, a major contributor to this growth was a significant international NGO which placed large orders for both the third and fourth quarters.

There have also been positive developments on hepatitis front since our last call. As previously discussed, the New York State Legislature passed the law early this year that would require New York healthcare providers to offer hepatitis C testing as a routine part of healthcare provider to baby boomers. I am happy to report that this law has been signed by the Governor of New York and will take effect on January 01, 2014. We believe this law will be a model for other states and should help expand HCV testing in the future.

As indicated previously, we believe the expected approval of new and more effective therapeutic treatments for hepatitis C will not only provide significant benefits for patients suffering with the disease, but will also positively impact the amount of testing for hepatitis C. As you may know there have been some recent developments in this area as well.

Earlier this month the Antiviral Drugs Advisory Committee to the FDA voted unanimously that available data supports approval of the use of Gilead Sciences, sofosbuvir in combination with ribavirin for the treatment of hepatitis C in adults with genotype two and genotype three infection. The committee also unanimously supported approval of sofosbuvir in combination with pegylated interferon and ribavirin for treatment of hepatitis C and treatment in adult patients with genotype one and genotype four infection.

The committee also recommended approval of simeprevir which is made by a Johnson & Johnson affiliate for using combination with pegylated interferon and ribavirin for the treatment of hepatitis C genotype 1 in adults with compensated liver disease. And a final development was the FDA's recent decision to grant what is known as breakthrough therapy designation for an oral combination drug regiment being developed by Merck for the treatment HCV genotype 1 infected patients. This designation is significant and that is used by the FDA to help expedite drug development for the treatment of the serious disease when preliminary clinical evidence indicates that the drug may demonstrate substantial improvement over existing therapies.

And finally the National Medical Association or the NMA has just officially released the consensus panel paper about hepatitis C in the African-American Community. As you probably know the NMA is the largest and oldest association representing the interest of over 50,000 African-American physicians. Among the other things this paper recommends the broader use of rapid HCV testing to better serve the African-American Community primarily because rapid testing greatly increases the probability that positive test results are actually received by the affected patients.

So in view of the strong growth in our HCV sales coupled with the many continuing positive developments in this area, we believe there is much to be optimistic about for our OraQuick HCV test.

And the last area I wanted to address is our Molecular Collection System business. The third quarter was another record quarter by DNA Genotek. The company continued its strong growth trend by generating a 48% revenue increase over the same quarter in 2012. Large [repeat] customers in the commercial market were key to driving this growth, although sales to academic customers worldwide were also up over Q3 of 2012.

In addition to servicing the growing needs of its commercial customers in the US market, the customer also signed our new commercial customers outside the United States. And we expect to see continued revenue growth by DNA Genotek in Q4 of this year, as well into 2014. To meet this expected growth, DNA Genotek began a manufacturing capacity expansion in the middle of 2013. This expansion which is expected to triple the company’s current production capacity is well underway and projected to be fully operational in the first quarter of next year.

So as we finish the year I believe there is much to build upon and much to be very excited about. Our new marketing campaign for the OraQuick In-Home HIV test is moving into full swing and should begin contributing to higher revenues. There continues to be many positive developments that we believe will help expand our rapid HCV testing business. And we are also very pleased that DNA Genotek continues to deliver against the high expectations we set when we first acquired that business. We look forward to a strong finish in 2013. And we also look forward to updating you on our progress in future calls.

So with that I'll now open the floor to your questions. Operator, you can proceed.

Question-and-Answer Session

Operator

(Operator Instructions). Our first question comes from Jeff Frelick from Canaccord. Your line is open.

Jeff Frelick - Canaccord Genuity

Good afternoon folks. Could you give us a sense of maybe Doug just your expectations for HCV testing in the New York State following the recent requirement law that was passed as we move into 2014? Does that start impacting that show up in kind of early ‘14 or what kind of things you have to build?

Doug Michels

It’s difficult to project how quickly that's going to build. The law that was passed recommends one-time testing for baby boomers which was estimated to be approximately 5.1 million in New York State alone. Census data shows New York has the third largest baby boomer population in the country. And obviously we’re working on multiple fronts to drive education of healthcare workers on a value of rapid testing we’re going to certainly leverage our strong position in public health. And obviously we've got a influenced physician behavior so that's all the process.

But we’re very excited about this and we’re hearing from other states and jurisdictions that they are interested in possibly considering the same kind of legislation. So we can use the HIV model going back several years when that law was first passed. And we did see a gradual uptick of that law in the State of New York. In the first year, we saw overall HIV testing increased about 10% that included both rapid and laboratory-based testing.

Jeff Frelick - Canaccord Genuity

Okay. And then just my follow-up, maybe for Ron, you talked about the change in revenue recognition. And so at the retail level, are inventories getting low and we should expect to see some replenishment of inventory there in the fourth quarter?

Ron Spair

So, Jeff we are, we have been replenishing inventory all along here and what we are seeing is that the replenishments are now approximating the consumption although there are some retailers that have pockets of inventory that may be a little bit higher than ideal and that may affect some of the purchasing particularly in the early part of 2014 as we move to this sell-in model. So I think again that’s another excellent point that we should all keep in mind as we’re thinking about revenues for early 2014.

Jeff Frelick - Canaccord Genuity

Okay, thanks. I will jump back in queue.

Doug Michels

Yeah. Thanks Jeff.

Operator

Thank you. Our next question comes from Amit Bhalla from Citi. Your line is open.

Nick Nolan - Citi

Hi, good afternoon. This is Nick Nolan in for Amit today. Maybe first talking about the fourth quarter guidance, just to clarify you did mention this new accounting changes going could potentially out of the $2 million in revenue. Is that revenue number that you gave it’s probably about a little over $2 million - $2.5 million higher than where consensus or where we would have thought it would be. Is that all due to this accounting change or is it some acceleration in the HCV front and also in the DNA Genotek that’s also in that assumption?

Ron Spair

Nick there is definitely, the major part of it is related to the revenue recognition change. And so if you go back and you think about where consensus estimates are going into the call in and around the $25.3 million mark you are talking about here now an increase of $2 million approximately or so for the revenue recognition change which brings you up to the lower-end of our guidance number. That said, there are some movements around within the other parts of the business. As Doug indicated, we are expecting DNA Genotek to have sequentially up revenues. We are again expecting HCV to be up. So there are some movements around and in the various other components which gets you to the guidance range of $27.5 million to $28 million. But to your point, a large chunk of that is related to the revenue recognition change.

Nick Nolan - Citi

Okay. And then one more on the HIV front and the advertising spend and the ads, it seems like the third quarter spend was little less than our expectations coming in. What was your assumption of why wouldn’t to make the HIV spend more fourth quarter backlog. What were some of the initial, what were some of the things that you came about and thought it’d be best to push that to backlog into the fourth quarter?

Doug Michels

So I am going to refer to Kathy on that.

Kathy Weber

Hi Nick. It was the readiness of the whole campaign and as you’ve probably seen and heard us talk about, there are multiple elements to the campaign or celebrity endorsers, there is digital programming, there is radio and it’s very much a content driven strategy. We were capturing content that’s really relevant and sharable by consumers. And to get that all launched in an organized fashion, we decided really the best strategy was to launch at the very end of the month of September, the very end of the third quarter around National HIV Gay Men’s Awareness Day.

And we picked that because we know that anchoring our launches and our programs to these key dates around HIV and AIDS really works well for us. So that was the decision to make sure everything was ready, the creative was ready, we had a good approach to roll out the different elements and we could anchor it on that date. So we took some of the media that we had originally planned for September and moved it into the fourth quarter.

Nick Nolan - Citi

Okay, great. I will get back in the queue.

Doug Michels

Thanks Nick.

Operator

Thank you. Our next question comes from Shaun Rodriguez from Cowen and Company. Your line is open.

Shaun Rodriguez - Cowen and Company

Hi guys, good afternoon. Thanks for taking the question.

Doug Michels

Hi Shaun.

Ron Spair

Hey Shaun.

Shaun Rodriguez - Cowen and Company

So O-US HCV was much bigger than we expected and we already expected a pretty big sequential jump there because the NGO you called out. So is the degree of the, because the degree of the sequential was more than I thought would be coming from that NGO at least initially did they end up doing more than expected right out of the gate or is the delta just reflecting more of a broad-based demand there?

Doug Michels

No, their delivery in Q3 was consistent with our expectations. I think we'll see that marginally a little bit in Q4 and we expect substantial growth in the domestic number in Q4. If you kind of look year-to-date even though Q3 was skewed more towards international as a result of this contribution from the NGO, actually year-to-date most of our revenues continue to be driven out of the domestic market about 55% versus 45% international. And so we expect good performance out of the domestic business and we expect a good portion of that international business to repeat in Q4 as well.

Shaun Rodriguez - Cowen and Company

Okay. And actually related to that last point, O-US HIV was I think a bigger quarter than, it's probably the biggest quarter you had in several years. So I think you related it to some African program. Is there any relation between that program and the international NGO that's been supporting on the HCV side or is this completely independent?

Doug Michels

No, it is completely independent. And to your point, our HIV international business through the first nine months is up approximately 7.3%, domestic is down approximately 5% overall total consolidated at least on the OraQuick front is down little shy of 4% consistent with how we thought about the business coming into 2013 that there would be relatively flattish up or down in the low single-digit percentage range. We're pleased with the performance really across each one of the different segments based on our original projections for the year.

Shaun Rodriguez - Cowen and Company

And then one last one before I jump into queue, can you just provide an update on business development discussions with potential HCV therapeutics partners?

Doug Michels

Well I appreciate you asking the question, it’s been asked on numerous calls obviously and we continue to be engaged with potential partners. Obviously it’s clear to us and I believe clear to the likes of the Gilead’s and the J&J’s and AbbVie’s that there is potential benefit in working together to expand diagnosis and the benefits of a rapid test enable patients to receive their result and enables physicians to direct them to the next level of care as quickly as possible.

So those discussions continue, I don’t have anything formal to announce at this point in time. But we will continue to engage with those potential partners and at such time that we've got more to say about it you can be sure we will.

Operator

Our next question comes from Brandon Couillard from Jefferies. Your line is open.

Brandon Couillard - Jefferies

Doug, the October data out at Nielsen suggested modest decline in the OTC HIV of sell-through in October, could you remind us what the typical lag time is between awareness and end users actually pulling the trigger, divide the test? And then secondly, I know it maybe early but a preliminary view on how we should expect the OTC HIV marketing budget to trend next year would be helpful?

Doug Michels

Yeah. I’ll flip the majority of this over to Kathy, but I do want to reemphasize that this campaign kicked off in late September and in October and elements of the campaign continue to deploy and actually they are going to continue to deploy through the fourth quarter and into the first quarter of 2014.

We believe the new campaign will have a significant impact and of course we’re going to continue to monitor every component of that and everything that we possibly can to evaluate effectiveness. But I will, like I said, put that to Kathy to talk about her views on the timing of the impact and how these things roll out.

Kathy Weber

Brandon, it really depends on the type of the consumer, so we've done a lot of work understanding when you make someone aware when they decide to purchase the product and it’s different. So the MSM consumers much more aware of HIV testing, comfortable with testing behavior and our product is really a supplement largely to a behavior that already exists.

So the MSM consumer, we expect once we make them aware, they will purchase relatively short term with the one exception that they have just tested them only a few months the next test and just trying to what Doug was saying most of the impressions against the MSM target really started to hit at the end of October. We have a very focused out-of-home plan. We have a print advertising plan. We have a public relations plan really targeting the MSM consumer and a lot of that, really the bulk it hit very, very late in October and then we roll out November, December.

So we should see that awareness still and the pickup from the MSM consumer start. The African-American consumer is a little bit different. There is less acceptance of the behavior. There is more stigma in the community and reluctance to talk about it. So our marketing approach is very different and we actually just launched. If you go to our website today, you will see some of the new campaign materials targeting the African-American consumer, but we expect that there will be a little more of a lag there. When we reach her with our messaging, we need to talk to her a few times to get her to adopt the product.

So that will also as those elements of the campaign rollout ultimately result in purchase but it will take a little longer for her.

Doug Michels

And Brandon I think you asked about spend levels and what I will say to that is obviously we are committed to supporting the campaign at the level that Ron described in the fourth quarter and future spending decisions will obviously depend on how the campaign is going and what kind of results are being realized and based on that you can be sure that we are going to make adjustments as appropriate. So I don’t want to make a commitment now to what those future spending levels are going to be. We are very enthusiastic about this campaign. We are eager to see its impact and we will be monitoring those results very carefully.

Brandon Couillard - Jefferies

Thanks. And then quick two part follow- up for Ron, what drove the positive operating cash flow experience in the third quarter? And then just to make sure I understand this correct, the revenue recognition change for OTC HIV is effectively a one-time catch up in nature, is that how we should think about that?

Ron Spair

Yeah, certainly, let’s view the latter one first, and certainly think about the revenue recognition change as a one-timer and we are expecting that to positively contribute to total revenues of somewhere in the neighborhood of $2 million plus or minus and obviously the gross margin effect and the operating income effect from that. And then we will move over to the selling model which I think hope some more familiar with for our consumer products based initiative. And as I mentioned earlier to previous question, we will see some volatility there in the early part of the year as a result of moving to this methodology, which could affect our revenues because of the fact that they are pockets of inventory in some of the distribution centers, in some of the retailers that when need to be work through before consumption nears selling perfectly. But we expect to get there, this maybe a little bit of a less predictable start than what we see now with the precise consumption data that is being tracked.

Now with respect to your earlier part question, where the first part on driving positive cash flow, clearly the DNA Genotek contributed a significant portion proportionally anyway to the operating income driving about to $2.7 million or so of positive cash flow from operations and also technologies drove the rest of it. We saw good performance on receivables as well as slight reduction in inventory, so it’s just a good performance across the board.

Brandon Couillard - Jefferies

Thank you.

Operator

(Operator Instructions). Our next question comes from Peter Lawson from Mizuho Securities. Your line is open.

Peter Lawson - Mizuho Securities

Just before the (inaudible) in the DNA Genotek business, what was the capacity utilization?

Doug Michels

I missed the first part of that, Peter I'm sorry.

Peter Lawson - Mizuho Securities

Just the capacity utilization in the DNA Genotek business, what was the pre build out?

Doug Michels

Well, the actual build out, if I'm interpreting your question correctly, that additional capacity won't be available until the early part of 2014 here or coming up right. So that's the additional manufacturing equipment which is going to effectively triple our existing capacity. Right now I can assure you that we have sufficient capacity to meet all the demands that are being placed on us, both commercially and academically at DNA Genotek. We just want to certainly anticipate the future growth and provide for that.

Peter Lawson - Mizuho Securities

And so you are below kind of 50% utilization of…

Doug Michels

Of the existing, I know we’re north of that, we're well north of that.

Peter Lawson - Mizuho Securities

Got you. And just if you give an update around the DNA Genotek businesses, I knew new customers signed up and have the 23andMe and Ancestry customers?

Doug Michels

Yeah, actually our commercial customers including 23andMe and Ancestry were strong contributors to third quarter revenues as well as if you just look at our top 25 customers, they represent in excess of 50% of total revenue contribution. But as we mentioned we are capturing new customers in the commercial space on the international front and we remain very enthusiastic about the opportunities in the academic research space despite the challenges in funding on a global level. We've seen nice growth actually in some of our rest of world activities in the academic research space and we're eagerly looking to get the product licensed or approve for sale in some additional geographies like Russia which we believe represents significant opportunity for the company. So really across all segments the business is performing quite well.

Peter Lawson - Mizuho Securities

Great. Thank you so much.

Operator

Our next question comes from Nicholas Jansen from Raymond James. Your line is open.

Nicholas Jansen - Raymond James

I think Doug you may be mentioned in your discussions about HCV domestically perhaps bouncing back in the fourth quarter nicely and I just wanted to get your feedback on why that’s the case, you've seen in the last couple of quarters be a little bit more choppy on that end. So maybe how much visibility do you have in terms of a bounce back in the fourth quarter? And then secondly on the international HCV front, how sustainable do you think you have one NGO buying now, but what your pipeline look for others to kind of think about the contribution for next year on the international front?

Doug Michels

Right. So on the domestic front, we see a number of drivers to increased revenues. Certainly the fact that the birth cohort screening opportunities we believe are going to be realized. Those recommendations take effect in January, but we believe different providers both physicians as well as on the public health front are beginning to prepare for that. We are very focused on integration opportunities with our HIV leadership position.

SAMHSA Grantees, the Substance Abuse and Mental Health Services Grantees awards for their HCV screening programs were actually made in September and all of those awards were for rapid hepatitis C testing and the CDC grants for this year are expected to be made in the fourth quarter. So take all of those things together and you can see why we’re bullish on our domestic business in the fourth quarter into 2014 and we have pretty good visibility on those opportunities and their contribution to the fourth quarter.

Nicholas Jansen - Raymond James

And then just on the international front, the pipeline with other NGOs?

Doug Michels

Yeah. So on the international front, obviously this NGO that we captured this year, we expect is going to continue to be a customer. We are seeing increased interest in hepatitis C testing driven largely by the enthusiasm over the new therapies around the world and we’re pursuing a number of different opportunities across multiple geographies.

Nicholas Jansen - Raymond James

And then Ron maybe regarding your comments with regards to the first quarter of ‘14, I acknowledged the 4Q revenue guidance includes kind of say 2 million to one-time or then historically 1Q declines by $1 million to $2 million sequentially, anything else that we should be thinking about there in terms of maybe framing the magnitude of the sequential decline that you might be trying to get out to the street?

Ron Spair

I think you touched on the relevant points. One is that the one-time nature of the adjustment that we put through for the revenue recognition change. So if you start with the basis of the 25.3 that you had for consensus estimate for the fourth quarter and then you look at a sequential decline as you move into the first quarter of 2014 which we have seen historically be in the range of couple million dollars or so you start to get into what might be a reasonable neighborhood for revenues for the first quarter of 2014, particularly when we still had to gain some visibility as to exactly how that revenue recognition policy change is going to affect the first quarter as we spoke about. So that’s pretty much the color I would share with you here at this point in time Nick.

Doug Michels

And I think you can go back and look at the quarterly splits and the revenue make up going back 2012 and the early part of this year and you can see primarily in the infectious disease and CRIO space like Ron talked about previously that those businesses tend to be lower in the first quarter and that would be our expectation for Q1 of ‘14.

Nicholas Jansen - Raymond James

Okay. Maybe if I can squeeze one more in on gross margins, I think they were a little bit better than what we were anticipating and certainly a good performance relative to the year to-date trends. Remind us how we should be thinking about that going forward and maybe just the opportunities longer term with HCV growth and with the earlier royalties going away in ‘15?

Doug Michels

That’s a big one, the latter one that you mentioned Nick and that obviously will roll off in February of 2015 and we certainly are looking forward to that. I do believe that continued growth in DNA Genotek as well as continued uptick in HCV will be positive contributors to our gross margin as well as more efficient effect of manufacturing operations and we do scrap and spoilage which we have been enjoying as of late. So, all positive contributors to our margin. That said obviously the mix issue continues to be there and to be present, particularly as you sell more of our prior OTC products, that definitely has a disastrous effect on gross margins in the quarter and which we load that up.

Nicholas Jansen - Raymond James

Thanks guys. Nice quarter.

Operator

Thank you. There are being no further questions. I will turn the conference back to Mr. Doug Michels for closing remarks.

Doug Michels

Okay. Once again, I want to thank everybody for being on the call this afternoon, look forward to a strong finish to 2013 and look forward to speaking to you again next quarter. Have a good afternoon everybody.

Operator

Ladies and gentlemen, thank you for your participation in today’s conference. This does conclude the program and you may all disconnect at this time.

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