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Nanosphere, Inc. (NASDAQ:NSPH)

Q1 2014 Earnings Conference Call

May 7, 2014 10:00 AM ET

Executives

Michael K. McGarrity – President, Chief Executive Officer and Director

J. Roger Moody – Chief Financial Officer, Secretary, Treasurer and Vice President-Administration

Analysts

S. Brandon Couillard – Jefferies LLC

Shaun K. Rodriguez – Cowen & Co. LLC

Bill B. Bonello – Craig-Hallum Capital Group LLC

Chris W. Lewis – ROTH Capital Partners LLC

Jeffrey Frelick – Canaccord Genuity, Inc.

Bill R. Quirk – Piper Jaffray & Co

Operator

Good day everyone and welcome to Nanosphere, Incorporated First Quarter Financial Results Conference Call. We appreciate your continued interest in the company. Today from Nanosphere are Michael McGarrity, President and CEO; and Roger Moody, Chief Financial Officer.

Before we begin, I’d like to remind everyone that various remarks about future expectations, plans, and prospects constitute forward-looking statements for purposes of Safe Harbor Provisions under the Private Securities Litigation Reform Act of 1995. Nanosphere cautions that these forward-looking statements are subject to risks and uncertainties that may cause our actual results to differ materially from those indicated.

Among the factors that could cause our actual results to differ materially, include but are not limited to Nanosphere's ability to develop commercially viable products. Nanosphere's ability to achieve profitability, Nanosphere's ability to produce and market its products, Nanosphere's ability to obtain regulatory approval of its products, Nanosphere's ability to protect its intellectual property, competition and alternative technologies, and Nanosphere's ability to obtain additional financing to support its operations and other risk factors identified from time to time in our reports filed with the Securities and Exchange Commission.

Any forward looking statements made on this conference call speak only as of today's date, Wednesday, May 7, 2014, and Nanosphere does not intend to update any of these forward-looking statements to reflect events or circumstances that occur after today's date. This conference call is being recorded for audio rebroadcast on Nanosphere's website at www.nanosphere.us.

All participants are in a listen-only mode. The call will be followed by a brief Q&A session. I’ll now like to turn the conference over to Michael McGarrity, President and CEO of Nanosphere, Incorporated. Please go ahead.

Michael K. McGarrity

Thanks, Aprelle and good morning and thank you all for joining us for our Q1 2014 results call. With me today is Roger Moody, Chief Financial Officer of the company. We continue making progress in building our leadership position in the molecular microbiology market enabled by our Verigene System.

Q1 provided evidence of that progress as we added 48 new customers to our base of microbiology laboratories that have adopted the Verigene System for our expanding menu of tests. That menu also fueled revenue of $3.3 million for the quarter. It is clear that menu is the catalyst for broad platform adoption, and we are confident that our offering of respiratory Gram-Positive and Gram-Negative, as well as our C. difficile and Enteric panel pending regulatory clearance will continue to drive adoption and associated revenue growth. We also remain confident in our projection of approximately 200 new customer placements and $19 million to $21 million in revenue for 2014.

I want to take a moment to emphasize that while our singular focus remains on execution to these goals, it is also important to emphasize that there is clear evidence of our progress toward our mission of improving patient care, lowering cost for the healthcare system, and delivering exceptional customer value. I would like to share this evidence and plans to accelerate this mission, but first let me turn the call over to Roger to review our operational results for Q1. Roger?

J. Roger Moody

Thanks, Mike. This morning, I’ll summarize Nanosphere’s first quarter 2014 financial results. For additional information, please refer to the related news release and 10-Q filing both available on our website, www.nanosphere.us.

As Mike noted, we are continuing to see some positive results in our infectious disease business. First, our customer base is growing with 48 new customer placements. Second, we are seeing steady progression in the rate of customers purchasing blood culture gram- positive tests. And third, initial orders from customers that have converted into live utilization remain consistent with our early experience of $50,000 per customer per year.

We are encouraged by the initial signs of adoption and believe that added tests in our infectious disease menu will help accelerate our customer and revenue growth.

Now, let me turn to the first quarter results. Revenues were $3.3 million compared to $2.4 million in the first quarter of 2013. This growth was driven entirely by blood culture gram-positive tests. Revenue contribution from consumables increase significantly in the first quarter of 2014 as we have more customers utilizing our tests and there were fewer systems sold.

Through the first quarter, we continued to see our blood culture gram-positive customers purchase tests at a rate of $50,000 per customer on an annualized basis. Costs of product sales increased to $2 million in the first quarter of 2014 from $1.5 million in the first quarter of 2013 due to increased volume. Gross margins increased from 35% in the first quarter of 2013 to 38% in the first quarter of 2014 driven by reduced test costs.

Turning to expenses, research and development expenses were $5.2 million in the first quarter of 2014 as compared to $5 million in the same period last year. This increase was driven by investment in new product expansion and manufacturing scale-up.

Selling, general, and administrative expenses in the first quarter of 2014 increased to $5.6 million from $4.4 million in the first quarter of 2013 due to field sales and customer support team expansion. Total operating expenses in the first quarter were $10.9 million as compared to $10 million in the first quarter of 2013.

Net cash decreased in the first quarter by $8.5 million, nearly all of which was driven by operating activities. In the first quarter, we entered into a $30 million common stock purchase agreement with Aspire Capital. We also amended our term loan agreement with Oxford Finance and Silicon Valley Bank to extend the period in which we have – we can draw upon the second $10 million tranche of debt until September 2014.

We finished the first quarter with $33 million in cash. We reaffirm our 2014 guidance of $19 million to $21 million in revenue and 200 new customer placements. Summing up, we’re pleased to see further signs of customer adoption and revenue growth. This momentum is driven by our customers’ recognition of the value of our expanding infectious disease menu.

Now, let me turn the call back over to Mike.

Michael K. McGarrity

Thanks, Roger. Well, our mission to improve patient care and lower healthcare costs may seem ambitious. There is clear evidence that we’re advancing this mission. This evidence resides in our customer base, and the data that they have generated that clearly points to reduce length of stay, reduced overuse of last-line antibiotics, and demonstrated economic outcomes to hospitals of all sizes and demographics.

In fact, at the recent Clinical Virology Symposium there were four posters with compelling data related to our Enteric panel pending FDA clearance and our 16-target, expanded respiratory panel currently in development. In addition, five studies will be presented at the European Clinical Congress on Infectious Disease next week, and a 11 posters will be presented at the American Society for Microbiology Meeting later this month, all highlighting the accuracy and clinical benefit for both our Gram-Positive and Gram-Negative blood culture tests.

Our opportunity to accelerate these initiatives and revenue growth will only improve with the following developments. Regulatory approval of our Enteric panel will nearly double our revenue opportunity from our current menu.

Development of the only expanded respiratory panel that will allow for flexible results reporting tailored to each clinician and patient algorithm. Development of our next generation Verigene system that will allow for a number of customer-driven improvements and keep us in the leadership position we are building amid future competitive dynamics.

In conclusion, we have clear indicators of our progress toward our goals of; one, building a sustainable and loyal customer base; two, building an expanded menu that will continue to drive revenue growth through that customer base; three, building a validated standard for performance that will serve as a hurdle for future competitive entrance; four, executing on straight forward path to cost reduction that will allow us to be the low cost supplier of these complex solutions and drive margin improvement. We are focused on and excited about our progress for continued growth in 2014 and look forward to delivering value to our customers, patients, and shareholders. Again I would like to thank you all for your interest in support of Nanosphere, and I’ll turn the call back over to Aprelle for questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Brandon Couillard of Jefferies.

S. Brandon Couillard – Jefferies LLC

Thanks, good morning. Roger, could you give us the number of U.S. microbiology customers at the end of the first quarter and the number of whom are live?

J. Roger Moody

Brandon, we have over 250 U.S. microbiology, of which 130 of those or more live between Q1 and now. And, I’d also comment that we have 25 gram-negative customers – more than 25 gram-negative customers as of today that have gone live, which we see as a real positive from the standpoint of a trend that we predicted from a standpoint of gram-negative not taking as along as gram-positive.

S. Brandon Couillard – Jefferies LLC

Got you. And then Roger, was the mix – could you give us a view of the mix between cash instrument sales and consumables revenue in the first quarter? Were system sales down sequentially and/or year-over-year? Was there a step down in RVP? I am just trying to get a sense of the factors behind the modest sequential decline in revenue?

J. Roger Moody

Sure, as you know Brandon, we don’t break it out, but the system sales number was down year-over-year and sequentially in the first quarter. We don’t think that that’s an ongoing trend; we think we just happen to have had fewer outright sales in the quarter and more reagent rentals, but all of the growth -- in fact there was a decline is system outright sales made up for by the growth in increased -- in revenue from Gram-Positive tests.

Michael K. McGarrity

I would just add Brandon that our test revenue, which carried though as Roger said, the significant majority of the quarter is becoming more predictable. The capital is still subject to timing, and I think that’s what you’re seeing, and we’ll continue to see in our quarter-to-quarter over and under. But it’s important to note that those capital orders did not go away, they just push timing wise as they work through the capital system, and we still feel confident in a mix of approximately 50% from a purchase order versus reagent rental, but those are timing adjusted for quarter-to-quarter. So, our - what is more predictable and that we saw the positive growth trends was in our core microbiology blood culture business, and actually there was a steep decline in the respiratory sales in the quarter that probably could have covered that capital push.

S. Brandon Couillard – Jefferies LLC

All right, super. Thank you.

Operator

Next, we’ll hear from Shaun Rodriguez of Cowen & Company.

Shaun K. Rodriguez – Cowen & Co. LLC

Hi good morning guys, so first actually just to follow-up on Brandon’s just to be clear. And I don’t think that the system revenue number is that big so, to me it’s not that much of a swing factor. So I guess to be clear, was consumable revenue down sequentially, and if so, that’s what you’re attributing to RVP decline sequentially?

Michael K. McGarrity

No, the consumable revenue increased both sequentially and year-over-year.

Shaun K. Rodriguez – Cowen & Co. LLC

Okay.

J. Roger Moody

Shaun, so the timing on capital is -- can be meaningful from the standpoint of Q4 to Q1.

Shaun K. Rodriguez – Cowen & Co. LLC

Okay.

J. Roger Moody

But we saw in sequential, sequential increase in test --.

Shaun K. Rodriguez – Cowen & Co. LLC

Okay, that’s helpful. And then on Enteric, any feedback from FDA I know your competitor there seemed to have at least announced their submission later, then it sounded like you did yours, and then I think they’ve received theirs already. So, any feedback on the submission there for Enteric?

Michael K. McGarrity

Yes, we remain confident in our clearance and we’re in discussions with the FDA on our submission. We don’t view the timing is meaningful from the standpoint of our position in the marketplace, and I think the evidence of that would be the timing last year of the BCID panel for BioFire and our follow-on with Gram-Negative almost two quarters or six months later. I think it’s still -- our pipeline remains strong for Enteric panel.

Shaun K. Rodriguez – Cowen & Co. LLC

Okay thanks. And then last one from me, I thought the placements were a good start for the year. Are these all U.S. micro labs, and then what – is the expectation that a good majority of these will be running both of the sepsis panels in pretty short order here?

J. Roger Moody

Yes and yes, there was significant majority, U.S. microbiology, we anticipate that continuing, we are not building a lot of expectations from our international and U.S. blood culture gram-positive, gram-negative, and the majority of enteric as well and we’re seeing a positive start to our gram-negative customers from the standpoint of time – from timing, clearance timing at the beginning of January to install software update, train, and validate, we’re encouraged by the number going live.

Shaun K. Rodriguez – Cowen & Co. LLC

Got it. Thank you guys.

Operator

Next we’ll hear from Bill Bonello of Craig-Hallum.

Bill B. Bonello – Craig-Hallum Capital Group LLC

Hey, good morning guys. Thanks, I just wanted to make sure I heard something correct you did say that respiratory was down significantly year-over-year, is that right?

Michael K. McGarrity

No, what we said was we saw a rapid decline in the quarter, so we traditionally would see a respiratory run through the first quarter, both last year and this year we saw rapid decline and kind of that decline came quickly and either the capital push or the respiratory decline is probably the difference and where our plan – was but our plan we continue to run at or on track for our plan with our core test business which is what’s the basis for driving the growth.

Bill B. Bonello – Craig-Hallum Capital Group LLC

Great, okay and then just a question as you think about the pipeline going forward of customers, to what extent do you think that the strong Q1 placement number is a reflection of the anticipation of the enteric panel versus are there a bolus of customers that actually want to see clearance on enteric and then are more ready to pull the trigger after that.

Michael K. McGarrity

Yes, I think we feel good about the pipeline across our menu and really continue to see the majority of our pipeline customers anticipating brining out the blood culture and the enteric. So I don’t believe there is any timing related. That said obviously as I committed menu always drives your placement activity and your adoption. What I would add is that what we are excited about that we’re seeing is customers speaking to customers, so this data that I highlight is not just posters – to have posters of publications for publication sake. There is a real trend that we’re starting to see were other customers are using this data as their baseline for adoption validation and implementation and we have a publication that will be coming out. But I’ll just say is a community based hospital that saw really good numbers related to what we see in some of our higher level publications related to time to optimal antibiotic therapy, reduction in length of stay and pharmacy costs that cover more than the cost of full implementation of the test as well as inpatient discharge cost.

So we candidly not use to get a whole lot of leads, it was us knocking on doors to introduce and sell the concept of this and what we are starting to see is this which we believe bodes well for market conversion across each demographic of hospital from community base to academic medical center. So we think that carries the pipeline that was reflected in the 48 new customer placements in Q1.

Bill B. Bonello – Craig-Hallum Capital Group LLC

Okay, great. And then just one last question, you mentioned that a lot of the customers adopting systems in the quarter intend to use Enteric. What’s kind of your latest thinking on that sort of 250 plus micro customers? What percentage eventually you think intend to use Enteric?

Michael K. McGarrity

We are not giving an exact number, but we would say a significant majority of our continued customers as far going forward.

Bill B. Bonello – Craig-Hallum Capital Group LLC

Okay, thanks a lot.

Operator

Next we’ll hear from Chris Lewis of Roth Capital Partners.

Chris W. Lewis – ROTH Capital Partners LLC

Hi, guys good morning.

J. Roger Moody

Good morning.

Chris W. Lewis – ROTH Capital Partners LLC

First, I guess just on the revenues, how should we think about the cadence of revenues going forward throughout this year. If I look at the past two years, I think the second quarter has remained either flat or sequentially down from the first quarter. So trying to get a sense of that will continue this year or we can expect an increase sequentially in the second quarter. When I look at the guidance I understand it’s back end loaded with the menu expansion and kind of further materialization of Gram-Positive. So in order to get to that revenue guidance, should we expect that acceleration to begin in the second quarter or does that ramp happen more in the second half of this year?

J. Roger Moody

Yes, Chris, two comments there. Just to reiterate your point. So we – 35% of our revenue over 35% of our revenue last year came in Q4 that’s due to obviously menu timing as well as capital, and while we have not built a whole lot of expectation in the Enteric panel into our model we would anticipate that customers going live on Gram-Negative as well as the capital cycle that is somewhat unpredictable will drive largely revenue growth into the second half of the year Q3 and Q4. That’s the way, that’s probably the difference between maybe the way our plan and model builds versus where yours or where another model may be and that’s why we don’t provide quarterly guidance, but we see our plan building to our guidance number of $19 million to $21 million and the capital is what’s difficult to predict timing wise and as we get customers validated on gram-negative in the back half of the year that’s where it starts to kick in where you’ve got the gram-positive customers, more gram-positive customers going live, and gram-negative coming live and then the adoption associated with this we had in the Q4 and out not only the capital cycle, but the enteric starting to come on.

Chris W. Lewis – ROTH Capital Partners LLC

Okay, great and then with enteric, so just to confirm do you remain confident in clearance in the first half of 2014 those expectations been pushed out a bit based on FDA discussions?

Michael K. McGarrity

We projected midyear clearance of enteric and there is not a material change in that based on our discussions with the FDA.

Chris W. Lewis – ROTH Capital Partners LLC

Okay, and then I was hoping you could go through the size of the sales force both field sales and customer support teams and how are the plans to grow that this year.

Michael K. McGarrity

Yes, we’ve about 20 field sales from our quarter standpoint territories and we have – we’re adding a couple more of these clinical implementation specialists that we refer to and we’re really working through a couple of things rep by rep, territory by territory which is how is the go live process going and how can it be best impacted from the standpoint of sales reps versus clinical implementation consultants and we did a survey recently of a representative sampling of our current customer base both those that are live and those that have not yet gone live. And we received really (a) positive and (b) productive feedback on how we can best impact that process over a number of different hospital types. We’re using that data to try to really predict and project the best mix in the field to continue to accelerate the go lives and we’re confident that we’ll able to do that.

Chris W. Lewis – ROTH Capital Partners LLC

And then on the menu expansion opportunities and pipeline, when should we expect some more details on those developments in terms of the expanding respiratory panel in the NexGen platform, any potential timing expectations that we should consider or is that something that you’ll provide more detail as you get closer to that? Thanks.

Michael K. McGarrity

Yes, I think we’ll provide more details I would say that it won’t affect our 2014 although we’re encouraged by our development progress on the expanded respiratory panel, we really believe from a customer feedback standpoint and these are customers that are both running a respiratory molecular method now and/or have not adopted one from the standpoint that I’ve articulated in the past, and was the impetus for our development strategy around providing the flexibility for patients selected panels [within a broad] [ph] panel and we think that will be the catalyst for broader conversion and we’ll update quarter-by-quarter here on our progress there.

Chris W. Lewis – ROTH Capital Partners LLC

Okay, that’s all from me. Thanks guys.

Operator

And next we’ll hear from Jeff Frelick of Canaccord.

Jeffrey Frelick – Canaccord Genuity, Inc.

Yes, Mike strong placements in the quarter, the 48 was a good number probably looking for; how would you compare the sales funnel as you enter Q2, how is that trending versus how you entered in Q1?

Michael K. McGarrity

I don’t, I guess I’d say that we were – we feel positive that our pipeline will support our guidance of new customer placements and you are always most – you have the best visibility to your near term pipeline. I think that if you looked at our broad pipeline it definitely supports more than that, but we just know how the timing goes with adoption of these type of tests. And Enteric will follow the same path where the interest in our pipeline is significant and we are just anticipating timing on getting things approved and moved in whether the customers are going to – go to budget approval before they bring the system in or bring it in to validate go live like they have with the gram-positive blood culture because it was an unplanned budget item. So to answer your question, we feel confident that our pipeline supports continued growth in our customer placements and then driving the menu through those.

Jeffrey Frelick – Canaccord Genuity, Inc.

Okay, and then with respect to the kind of timing of the selling cycle, you feel that’s kind of peak - not necessarily asking you if it’s coming yet. I know you’ve kind of indicated that gram-negative is not taking as long and maybe Enteric will be a little bit does it feel like it’s kind of peaked the timing there on the selling cycle?

Michael K. McGarrity

Yes, it’s still moving around Jeff; I would say that I’ll stand by what I said that we’re confident that we’ll contract based on what we’re seeing and doing, but we have not seen that yet.

Jeffrey Frelick – Canaccord Genuity, Inc.

Okay, and then just last question with respect to the 48 placements - how competitive were these, also are these just conversion from culture, did you see BioFire [end of phase] [ph] in lot of these?

Michael K. McGarrity

Mixed, I would say a mix, Jeff.

Jeffrey Frelick – Canaccord Genuity, Inc.

Okay, that’s it from me. Thanks.

Operator

And next we hear from Bill Quirk of Piper Jaffray.

Bill R. Quirk – Piper Jaffray & Co

Great. Thanks, good afternoon, excuse me good morning everybody. Mike, I want to go back to the fully automated development system for a minute. If we think about the competitive landscape here over the next couple of years. I assume GenMark will be thrown in the mix here, obviously we’ve got BioFire to recent approval and Luminex is working on automated system too. So, help us think a little bit I guess about the engineering focus of the company, and then maybe Roger kind of secondary question, how should be think about maybe associated R&D spend trending here in conjunction with this and obviously other pipeline products.

Michael K. McGarrity

Yes, Bill, I think that the - from a standpoint of the engineering design behind the NexGen platform, it’s really incorporating what we know from our customer base our improvements that will put us in a better competitive situation and continue to drive our share towards us and I would say that, our focus historically was on conversion from our original genetic approach to testing and developing sample through result feasibility in the development process not necessarily focused on the best customer interface. And I think that while our customers find this is going to be easy to use we recognize the competitive dynamics in the market will dictate improvement to that. And we are confident that we can execute on the key improvements that will put us in competitive situation against those platforms with our menu.

J. Roger Moody

Bill, just to answer your question about financials, the development effort that we have underway is baked into the current spending rate that we reported for the first quarter which was $5.2 million in research and development. I would expect to see something like that in the coming quarters, as we start moving into clinical trials on assays and may have a slight change to that R&D spend from quarter-to-quarter, but that’s at least a couple of quarters out from now.

Bill R. Quirk – Piper Jaffray & Co

Okay, got it. And then just thinking a little bit about I guess kind of going back to Jeff’s question regarding looking at deals and how competitive deals are et cetera. Mike, you alluded to the sales team really was kind of initially in education efforts. And no doubt that’s a little, it’s a little less education now and perhaps little more crowded in terms of deals. So can you talk, just help us think a little bit about of your placements and how many of these are kind of strolling in and pitching the benefits. And there is not a competitive situation where as compared to where you got customers that are taking a look at all the available and potentially future platforms.

Michael K. McGarrity

Yes, I think, I mean I will just answer with our current competition. So BioFire, we’ve seen the most activity where they have their respiratory business which you would expect. I would say that we have – that doesn’t preclude us from competing in those situations. I would also say that we’ve commented not to try to paint competition as a positive but the reality is that there is a growing awareness of the value. And I would say, while it’s still a complicated sale for all the reasons that we’ve discussed, two things, one we’re getting better at it and on understanding how to drive the process, and the data that is associated – candidly we have - more of our customers have done their own studies to justify and validate the implementation and adoption that we anticipated. That’s probably one of largest factor as we’ve discussed, have a significant discussions related to I would say that continues but it’s more of a validation and not a – let’s see if this is really real. That’s probably the best way I could characterize it.

And we also see as much activity across both the low middle and high end from a standpoint of the way you characterize hospitals from the standpoint of bed size and demographic. And I think that our salesforce and support organization is getting better at understanding how those characteristics drive the way they are best supported from an adoption and from a validation and implementation standpoint. So it’s a lot of an answer, but I think it kind of addresses what we’re seeing both from a standpoint of, no hospitals are the same, but they’re starting to look more, like they can go into (indiscernible) try to bring them up.

Bill R. Quirk – Piper Jaffray & Co

Got it. Okay, very helpful thank you.

Operator

And this does conclude today’s conference. Thank you all for your participation.

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