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Quidel Corporation

Q2 2010 Earnings Conference Call

July 29, 2010 05:00 pm ET

Executives

Doug Bryant – President and Chief Executive Officer

John Radak – Chief Financial Officer

Analysts

Zarak Khurshid - Wedbush Securities

Steven Crowley - Craig Hallum Capital Group

Scott Gleason - Stephens, Inc.

Operator

Good day ladies and gentlemen and welcome to the Quidel Corporation Second Quarter 2010 conference call.

At this time all participants are in a listen-only mode. Later, instructions will be given for the question-and-answer session. (Operator Instructions)

As a reminder this conference is being recorded for replay services. I’d now like to turn the call over to Mr. John Radak, please go ahead.

John M. Radak

This is John Radak, Chief Financial Officer, Quidel thank you for participating in today’s call. Joining me today is our President and Chief Executive Officer, Doug Bryant.

Today Quidel released financial results for it's three months ended June 30th, 2010. if you have not received this news release or if you would like to be added to the company’s distribution list, please call Reuben or Gerta at Quidel Corporation at 8586468023.

Please note that this conference will include forward-looking statements within the meaning of Federal Securities laws. It is possible that actual results and performance could differ materially from the stated expectations. For a discussion of risk factors please review Quidel’s annual report on form 10K and subsequent quarterly reports on form 10Q as filed with the SEC.

Furthermore this conference call contains time-sensitive information that is accurate only as of the dates of the live broadcast July 29th, 2010. Quidel undertakes no obligation to revise or update any statements to reflect events or circumstances after the date of this conference call except as required by law.

For today’s call I will report the financial results for the quarter on year-to-date and also provide details on the DHI acquisition synergies. Doug will provide color to our near-term and longer-term business growth prospects and give an update on a new product pipeline. We will then open up the call to your questions.

Total global revenues for the quarter were $25 million, an increase of 2% compared to the second quarter of 2009. There are several factors that affect revenue comparison for the two quarters. In 2009 there were $11.3 million of pandemic-related influenza revenues offset by weak strep and pregnancy shipments to US distributors as they lowered inventory levels of these products. In 2010 revenues were favorably impacted by $10.1 million from the acquisition of DHI, partially offset by a weak respiratory season and the timing of orders for our veterinary products.

Domestic revenues for Quidel were $21.2 million, an increase of 28% period over period, while international revenues came in at $3.8 million, a decrease of 53% from the second quarter of 2009.International revenues accounted for 15% of total revenues in the second quarter of 2010.

Global infectious disease revenues were$13.9 million versus $16.1 million in the second quarter of last year, a decrease of 14% driven by an absence of influenza sales partially offset by the additional revenues from DHI’s respiratory, urology and herpes product lines.

Strep sales grew 20% in the quarter largely due to more normalized distributor inventory levels in 2010.

Global revenues of our reproductive and women’s health category increased 37% in the second quarter of 2010 to $8.4 million. This increase was driven primarily by the inclusion of DHI’s Thyretain product line as well as robust growth in our other, immune and complement product lines. Pregnancy revenues also contributed to the growth in this category as a result of more normalized distributor inventory levels in 2010.

Gross margins in the second quarter of 2010 decreased to 50% as compared to 59% in the prior year. The decline in gross margin was driven by the following: first an unfavorable product mix shift due to the significant flu sales during 2009 associated with the pandemic, lower unit production volumes and related leverage of our manufacturing facility in 2010 and finally by the final $400,000 of amortization at the inventory per value write up associated with the DHI acquisition.

These unfavorable factors were partially off set by the addition of DHI’s gross margins which were higher than our Pregnancy and Strep products.

Operating expenses were $19.9 million compared to $13.5 million in the prior year. This includes $5.3 million of DHI’s operating expenses in the current period as well as $1.5 million of intangible asset amortization associated with the DHI acquisition.

Research and development costs were$6.3 million in line with our expectations. On a GAAP basis the loss per share in the quarter was $0.09 compared to earnings of $0.02 per diluted share in the same period of 2009. Those familiar with our company know that in a normal year Quidel historically reports a loss in its second quarter in the range of $0.05 to $0.12 per share so this quarter is not a typical.

On a pro-forma basis our loss per share was $0.03 per share compared to earnings per diluted share of $0.04 in the same quarter in 2009.

Stock-based compensation expense was $1.4 million for the quarter versus $0.9 million for the same period in 2009. During the second quarter Quidel repurchased approximately 400,000 of its common stock at an average price of $11.30 under the company’s previously announced share repurchase program. A total of $10.3 million remains available for stock repurchase under the current board-authorized program.

Let me briefly update you on our progress with the DHI integration synergies. We are still reaping the benefits of the DHI acquisition and the integration between Quidel and DHI has yielded significant synergies in the annualized amount of approximately $5.4 million.

Roughly half of these synergies are related to reducing costs. For example we have brought in-house our marketing communications activities, reduced budgeted head count additions, eliminated duplicated spending administrative areas and wound down some R&D projects to create significant savings around the company.

We also account synergies from increased operational efficiencies related to square our production efforts at DHI as well as benefits from our stronger purchasing power on direct materials and shipping costs.

Overall we have realized that $2.5 million in synergy savings year to date and expect those synergies to total $5.4 million for 2010.

Our effective tax rate has been significantly and adversely affected by the non-deductibility of one time transaction costs for DHI, a reevaluation for certain deferred tax assets due to a lower state tax rate and the exclusion of the federal R&D credit. Unfortunately due to these one-time differences the rate is very sensitive to any change in estimated full-year earnings.

However, assuming the federal R&D credit gets passed later this year, we believe our effective tax rate for 2010 should approximate 40%.

I will now turn the call over to Doug.

Douglas C. Bryant

Thank you John. For today’s call I will first provide an update on our progress with our near-term initiatives to accelerate revenue growth and then update you on the status of our new product development programs.

Let me first start with DHI. As John mentioned, DHI reported revenues of $10.1 million in the second quarter, the first full quarter under our ownership, which represents an absolute decline of $2 million versus what DHI reported in the second quarter of 2009.

Accounting for 2009 pandemic sales of $2.5 million and the lack of a 2010 respiratory season which we would estimate had a $1 million impact, we would have seen overall revenue growth of 15% for DHI in this quarter consistent with our earlier expectations.

One product line that was not affected by the severity of the respiratory season is Thyretain. One of the key near-term initiatives is to grow physician orders of Thyretain. Thyretain is our brand name for TSI, Thyroid Stimulating Immunoglobulin the presence of which is indicative of Grave’s Disease. Revenues for the product increased by 18%in the second quarter. To accelerate the growth of this product we began our focused sales efforts on primary care physicians in early May. In addition to directing our POL to spend a significant amount of it's time on Thyretain activities, we engaged to contract sales organization to augment those sales activities beginning in the third quarter. It's early but we believe we’re on the right track and that the investment in the CSO is warranted and the data support this.

On comparing the first four weeks of the dedicated Thyretain efforts against the second four weeks of that same dedicated selling we noted total calls numbers increased 11.5% from about 1300 calls to 1500. The ability to actually see the physician was up over three-fold from about 160 calls to about 500. The perception that a physician would begin ordering Thyretain as raised by the sales rep increased 55% from a 6.6% success rate per call to just over 10%.

While the statistics indicate that our focus training and message are working, the true proof will be acceleration in our Thyretain revenue growth in future quarters.

Another product line that we expect to contribute to DHI’s near-term growth is the FastPoint virus identification kit which detects eight individual viruses in about 25 minutes. DHI launched this product in 2009 after obtaining patent pertaining clearance form the FDA in September. In addition we met a significant milestone in this quarter as DHI cultured DFA virus screening kit was approved by the Chinese state food and drug administration.

A third party has estimated that the aggregate market potential for D3 ultra in China is about $40 million to $50 million.

And finally in terms of near-term commercial efforts we had hoped to launch our next generation FIT, the fecal immunochemical test for colorectal cancer screening in the third quarter but unfortunately that new product as it is currently configured does not perform as we had hoped and we will not be launching this product this year.

There are several unique and complex technical and biological issues that are common to all iFOB tests including ours. Until these are adequately resolved we anticipate physicians will continue to be reluctant to switch to fecal immunochemical tests from the inferior yet market-leading guaiac test for fecal or for blood.

Importantly in the last few months, our R&D scientists have identified and are now actively working out solutions for these issues. We anticipate incorporating these important design changes into our new products in the back half of this year. In the meantime we will continue to commercialize our existing products the sales of which have actually grown nicely apart from a very small base.

Let me focus now on the status of our product development programs. We have free lateral flow opportunities in the very near term. They are QuickVue modern nucleosis, RapidVue hCG and RFC10. On August 2nd we will re-launch and beginning shipping our QuickVue lateral flow device for mono-nucleousis, a customer favorite. This product is a five minute IGM specific test that is suitable for serum, plasma and whole blood specimens and yields good clinical accuracy.

While mono testing is not a huge market we see this need as an opportunity to provide to the enthusiasm exceptional product alongside other products such as Strep that carry the trusted for few brand name.

Our next opportunity is RapiVue hCG, a new lateral flow pregnancy test designed to compete with lower-priced brands that will be available as soon as we receive FDA clearance. Manufacturing and marketing of RapiVue will take place surely after regulatory approval.

Our QuickVue RSV10 lateral flow device is another test that is ready to launch pending a favorable FDA response. RSV10 us intended for use with children under six years old over 85% of whom will experience an RSV infection and is to analysts the first ten-minute RSV test on the market.

Sample preparation is identical to that used for influenza products offering other work flow on patients care advantages for our users. Clinical trials were completed as plans and our form 10K was submitted to the FDA earlier this month.

And all these lateral flow diagnostics will make use of our highly automated production facility, increase our market share and will create cash positive contributions to the bottom line.

Now I’d like to talk about our instruments systems for the next generation lateral flow as well as for PFA asseys. For lateral flow we’ve made great progress on our next generation lateral flow reader and assays system.

A host of improvements have been made and we anticipate with the completion of the graphical user interface in October we will be ready to begin clinical trials concurrent with the onset of the next influenza season.

Project Bobcat, the internal name for our automated PFA reader is an objective cell imaging platform that provides the opportunity to decentralize testing. Currently PFA tests are performed in about 1000 larger hospitals because the laboratories of these institutions have the required fluorescence microscope and highly virologists to operate and interpret the stain specimens.

In contrast the Bobcat reader will be used in place of a fluorescent microscope to automate the reading of direct fluorescence assays in a liquid medium. As a result, PFA tests performed on Bobcat can be run by less skilled personnel allowing us to address a much broader market.

We hope to end our clinical trials this December and we are planning for FDA’s submission in the first half of 2011.

We are making significant advances in developing automated platforms related to both lateral flow and PFA testing formats. When fully developed we expect that these instruments systems and their respective consumable materials will drive substantial domestic and international interest.

I would now like to add more color to our molecular diagnostics program. We have a three-pronged molecular diagnostics strategy that will enable us to develop products in the inner market to address unmet clinical needs.

The first part of our strategy is the introduction of a non-instrumented platform. The second part is the introduction of an open box molecular diagnostics that can be run on leading molecular diagnostics systems. The third part of our strategy accommodates an integrated molecular diagnostics systems that initially try against a moderately complex environment.

We are focusing on the needs of the small and mid sized hospital laboratories which we feel are underserved and will operate initially within our core strength of infectious disease.

Our non-instrumented platform will result from our collaboration with Bio-Helix that makes use of Bio-Helix, their proprietary isothermal application technology in combination with our lateral flow development and manufacturing capabilities.

In working with Bio-Helix our R&D team has discovered a process that significantly reduces the time required per sample processing. We expect to have the first two products launched by the end of 2011 and the beginning of 2012.

Our open box molecular diagnostic assays are designed to work on molecular diagnostic platform. We are making significant progress in commercializing DHI’s molecular assays.

There still is a lot of work to be done but we are expecting an influenza molecular diagnostic to be launched in 2011 followed quickly by other analyzed for which work has already begun.

Finally we continue to make nice progress on our low-cost integrated molecular diagnostic system. We hope to have an announcement in the near-term regarding access to certain technologies that will enable us to deliver the system within the three to four-year timeframe that we have previously communicated.

We expect the levels to work already performed at DHI by migrating over our open box assays onto the integrated system when it is ready.

With this set of technologies, we will be positioned to offer the full range of molecular diagnostics in one package with reduced upfront development risk to us and relatively small upfront development costs as well.

Our three-pronged strategy allows us to effectively participate in a market that has a lot of promise without having to invest a large amount of money upfront.

In closing I would like to point out that our integration with DHI has been very rewarding. We have great near-term opportunities and a pipeline of new product that will drive future growth.

A year ago we had one near-term product in the development pipeline. In a little over a year we have open new markets, filled the pipeline with new products and are now a market leader in DFA tests.

In the absence of a meaningful flu season in the first half of 2010 we have all tried to create for ourselves many opportunities outside of flu and the recent activity has paid off. We are evolving from a business predominantly dependent upon flu severity into a diversified industry leader that can deliver high value products across the diagnostics continuance.

That concludes our formal comments for today. Operator, we are now ready to open the call for questions.

Question-and-Answer Session

Operator

Absolutely. (Operator Instructions)

Looks like our first question comes from the line of Zarak Khurshid with Wedbush Securities please proceed.

Zarak Khurshid – Wedbush Securities Inc.

Hey guys, thanks for taking the questions. First with the FIT product experiencing some challenges and your other various R&D programs, how should we be thinking about the R&D expense going forward?

Doug Bryant

Go ahead John if you like.

John Radak

Sure, so last quarter as we mentioned we expected to spend about $6 million a quarter in that range going forward to 2010 and we’re still on track with that kind of an estimate.

Zarak Khurshid – Wedbush Securities

Great and then with respect to the business and integration costs in the quarter, how might those play out over the next couple of quarters?

John Radak

So we’ll be winding those down somewhat for the remainder of the year. But as we still have an on-going business development effort active here at the company and we’re looking at opportunities on on-going basis.

Zarak Khurshid – Wedbush Securities

Okay great and then I’m just curious about the Thyretain sort of launch here. What has been the push back by positions if any and what are the major challenges you see in that market?

Doug Bryant

This is Doug, Zarak. I haven’t been made aware of significant push back but I would say that the key issue is mainly around awareness. Primarily the test had been ordered previously by endocrinologists and the question is whether when predominantly women affected by hyperthyroidism present with physicians, whether the primary care physician should be ordering a T side to determine if in fact the cause of that hyperthyroidism is Graves.

I would say that so far, at least as reported by our sales people, that the primary care physician audience has been fairly receptive to the concept and in many cases has indicated that they will order tests when they see low TSH’s.

Of course we have to see what the end result of that is at the large reference labs that run these tests over the next couple of quarters.

Zarak Khurshid – Wedbush Securities

Okay, sounds good and then lastly, can you tell us what the targets are you’re thinking about for you molecular program? I heard flu in there but what are the other things on the menu and speaking of flu, coming out of AACC it seems like there’s a lot of talk about molecular H1N1 in general, flu tests and – is that really an attractive market? It seems like there are many players in that area that seems like even a small opportunity to begin with likely just the surveillance labs.

Doug Bryant

Sure, let me divide that down in a couple of different parts starting with what we’re working on. We’ve previously disclosed that the first two BioHelix assays will be an MRSA product for confirmation of blood culture and secondly, a C. diff product. In addition we have obviously those assays already developed at DHI which correspond to the same test that we have for DFA. So you would expect that those would be what we come out with as we roll these molecular diagnostic assays up and clearly one of those as you mentioned is [inaudible]. But I do think you are right that there are both a number of players in that molecular diagnostic space and what we haven’t seen so far is a significant migration from any other type of testing over two molecular.

One of the things that’s probably worth considering now is that where tests are done for molecular is a significantly different place than where rapid diagnostic tests are performed. Most of our testing as we’ve previously stated occurs in the physicians’ offices where a 5, 10 or 15 minute assay is very much needed.

So we view the two different segments to be completely different and so far what we’ve seen on the molecular side is a concentration of testing at the very large institutions that not only do diagnostic testing but also would be using those molecular diagnostic tests or surveillance.

Zarak Khurshid – Wedbush Securities

Okay thank you.

Doug Bryant

Sure.

Operator

Our next question comes from the line of Steven Crowley with Craig-Hallum Capital Group. Please proceed.

Steven Crowley – Craig-Hallum Capital Group

Good afternoon gentlemen. A couple of questions, maybe picking up on the discussion around Thyretain. Now that you had it under your belt or under your roof for a while, I’m wondering what your assessment is of how big a product opportunity this is for the company.

Doug Bryant

Well so far as I stated we see growth of about 18% but that was before we started with our campaign to educate physicians. So we’re thinking Steve that we could easily do 20 to 25% in terms of year over year growth. If we were able to do that over 3 years that would at least double the market within that three year period of time and so I would say just generally that we see that we could probably double or triple the market within 3 or 4 years.

Steven Crowley – Craig-Hallum Capital Group

And in terms of an inflection point that could change that growth rate and make it more gaudy than 20 to 25%, is one of the keys acceptance by the large clinical laboratories and where are you in that process?

Doug Bryant

Well right now as we’ve said before our largest customer is LabCorp but there are several others that do this testing as well including Quest and some of the major regional reference labs. So I would say first that the acceptance at the lab level is already there. There are already several different places where physicians can send these requests to. So the issue really isn’t there, the issue in terms of an inflection point is when it becomes routine and standard of care for a physician to either confirm or eliminate Graves disease as a possibility when a patient presents with symptoms of hyperthyroidism and it’s pretty clear that as that ramps up that it’s either the major reference labs decided that they were going to use their sales forces to help us out, that clearly would be something that might accelerate that.

Steven Crowley – Craig-Hallum Capital Group

Okay that’s very helpful. On the topic of DHI, you gave us a feel for the revenue performance which was pretty darn close to what we were expecting. You discussed cost synergies as if they maybe exceeded your expectations at the get-go. Is that an accurate inference?

Doug Bryant

The cost energies are exceeding our expectations. Remember when we had announced the acquisition initially we said that we would be mutual to slightly accretive and here we found, once we got actively engaged in the integration process that they were actually more savings than we had hoped. So yes that’s true.

Steven Crowley – Craig-Hallum Capital Group

And then in terms of the other piece of the puzzle there with DHI, what can you tell us about the gross profit performance of the business relative to initial expectations and maybe versus a year ago?

Doug Bryant

So far at least in this quarter the gross margin is better than it was last year and 2009. In addition I would say that when you’re comparing with our existing business of strep and pregnancy, those gross margins are actually better. So on quarters like the second quarter where we had very low respiratory disease and sales of flu and strep, those products then clearly DHI is a help to the overall gross margin profile.

Steven Crowley – Craig-Hallum Capital Group

Right, now John, you gave us a couple of the revenue categories in the new breakdown during your prepared comments, I’m struggling to find them here with I think you gave us upper respiratory and reproductive in women’s health. Are you going to post the breakdown of revenues by category on your website like you did last time?

John Radak

We will Steve but just for everyone’s benefit on the call, the gastrointestinal disorder category had revenues of approximately $1.6 million in the quarter and the other category had revenues of approximately $1.2 million.

Steven Crowley – Craig-Hallum Capital Group

Great and then just in terms of operating expenses, there were some things that came into play in the second quarter that were pretty beefy as it related to the DHI deal business development. It sounds like some will linger but it seems like also there are more synergies building. Should we think about the prospects for overall operating expenses in Q3 to be down noticeably from the 99 in Q2, just a little bit flattish? What kind of help can you give us there?

John Radak

I would expect it to be around flattish so some of the savings will offset some of the other investments that we’re doing like the CSO organization.

Steven Crowley – Craig-Hallum Capital Group

Okay, great and just one final question from me. As it relates to the mono test and your comments around the re-launch that the customer response has been very good, can you help us understand a little bit some of the functional advantages or performance advantages of that test and how you’ve been able to step back in and get a I guess a surprisingly good or a very good customer response to it?

John Radak

I think the keys really are that it’s an IGM specific mean, it’s indicative of an active infection. Most customers would say that they prefer an addition that’s a five minute test. So it’s pretty quick and again it’s part of an overall skew. It comes with a strong brand name of QuickVue. So we think we’ll do fairly well in the category. Of the 10 million infections that are in the United States approximately that results or has resulted in a little over 3 million tests per year.

So again as I stated it’s not a huge product but it’s certainly a nice addition to the overall product portfolio that we offer our customers.

Steven Crowley – Craig-Hallum Capital Group

Excellent, thanks for taking my questions guys.

John Radak

Thank you Steve.

Operator

Our next question comes from the line of Scott Gleason with Stephens Incorporated. Please proceed.

Scott Gleason - Stephens Incorporated

Doug and John, thanks for taking my questions. Doug to start off, can you just give us an update on kind of where the current inventory situation just as far as flu tests are out in the channel and whether some of that resolved in the second quarter?

Doug Bryant

Sure Scott. At the end of the quarter we ended up with just about 800,000 tests, a little bit less than that at distribution spread across numerous distribution centers. We would suggest that that’s probably not a whole lot more than we would like to have in the channel as we approach Q3, Q4. That end user level we also see per our channel checks that our end users have about a kit to two kits on their shelves which is not significant.

So we would expect that as our distribution partners actually move forward and remind physicians to begin ordering product in advance of the upcoming flu season that not only will physicians be ordering our products as well as our competitors honestly. But that will result in our distribution partners needing to order product at some point in time between now and the end of 2010.

Scott Gleason - Stephens Incorporated

Okay, great and then Doug, when we think about the commercial integration of DHI into the business, you guys will talk a lot about the cost synergies, can you maybe give us some additional color on maybe any winds you guys have seen in terms of [cross on] opportunities with hospitals?

Doug Bryant

Sure. I would say it’s a bit anecdotal at this stage but we’ve launched a couple of programs with our key distribution partners and those are underway now. Cleary there was a lot of training to do that’ been accomplished. There were organizational changes that needed to be made; those have been accomplished as well.

So a great deal of work has been accomplished but I would say in terms of seeing results it’s still just a little bit early. Other than the weekly activity sales analysis that we see that would suggest that our guys are doing pretty nicely.

Scott Gleason - Stephens Incorporated

Great, thanks for taking my questions guys.

John Radak

Thanks Scott.

Operator

Our next question is a follow up question. It comes from the line of Zarak Khurshid with Wedbush Securities. Please proceed.

Zarak Khurshid – Wedbush Securities

Thanks again for taking the follow up. Just had a question about sales force sort of incentivization and bandwidth. So are the reps at all sort of disincentivized to drive flu versus Thyretain and some of these other products?

Doug Bryant

It’s a tough one to answer Zarak. Certainly in the second quarter and as we go into early three quarters there’s no distraction there primarily on Thyretain because frankly speaking there is no flu right now. As we get into the middle of the 3rd quarter and then in the 4th quarter, obviously our guys will be spending time in support of our distribution partners’ reps and making sure that whatever the demands the physicians have are being met.

But I don’t really see a conflict in terms of incentive plans, no and remember we’re augmenting those Thyretain efforts with the contract sales organization. So that gives a little bit of bat at horsepower and those folks will not be focused on the flu segment.

Zarak Khurshid – Wedbush Securities

Got you and then do you have any sort of thoughts on flu awareness within the physician community I guess coming out of last season and with early activity or light activity this year. Any sense for a potentially higher base line levels of flu testing once the next flu cycle comes through.

Doug Bryant

Well based on our own internal analysis that we would have based on our telesales calls and the activity that we saw through Web MD. We know there are now more physicians that are likely to test for flu than before and there are a number of data points that would indicate that. In addition I would say though offsetting that, if we’re completely candid there were some physicians who expressed that they would be discontinuing testing because of what was perceived to be the lack of sensitivity to H1N1, particularly if the physician didn’t get an adequate sample.

So I would say overall we had seen in the last 5 year period that penetration go from 15 to 30%. We don’t know precisely what it ended up being at the end of 2009 but I would suggest that it was something approaching 40% of physicians and that will end up with some sort of net gain, I couldn’t tell you how much of a gain that would be. But there will be more physicians now testing Rapid, using Rapids for flu we suspect.

Zarak Khurshid – Wedbush Securities

Understood, thanks.

Doug Bryant

Sure.

Operator

(Operator instructions). And it looks like this is all the time we have today, please proceed with your presentation or any closing remarks.

Doug Bryant

Okay, well this concludes the call for today. John and I thank you again for your time this afternoon and for your continued support. Take care everybody.

Operator

Ladies and gentlemen we thank you for your participation and you may now disconnect.

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