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Executives

Doug Bryant – President and Chief Executive Officer

John Radak – Chief Financial Officer

Analysts

Zarak Khurshid – Wedbush Securities

Scott Gleason – Stephens

Pete Vitali -- William Blair Company

Steven Crowley – Craig-Hallum Capital Group

Quidel Corp. (QDEL) Q3 2010 Earnings Call October 27, 2010 5:00 PM ET

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the Quidel Corporation third 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)

I would like to turn the call over to Mr. John Radak. Please go ahead.

John Radak

This is John Radak, Chief Financial Officer at 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 its three months ended September 30, 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 Ruben Argeta (ph) at Quidel Corporation at 858-646-8023.

Please note that this conference call will include forward-looking statements within the meaning of federal securities laws. It is possible that actual results and performance could differ materially from these stated expectations. For a discussion of risk factors, please review Quidel's Annual Report on Form 10-K, registration statements, and subsequent quarterly reports on Form 10-Q, as filed with the SEC.

Furthermore, this conference call contains time sensitive information that is accurate only as of the date of the live broadcast, October 27, 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 on the financial results for the quarter and year to date, provide details on the DHI acquisition synergies, and speak to our financing activities. Doug will provide color on our near term and longer term business growth prospects, and give an update on our new product pipeline. We will then open the call to your questions.

Total global revenues for the quarter were lower, when compared to Q3 of 2009, primarily due to the benefit associated with last year’s flu pandemic. Excluding the impact of influenza on the combined businesses, our revenues in total grew approximately 4% in Q3 of 2010, over the same period of the prior year.

DHI contributed $9.4 million of revenue in the quarter, international revenues accounted for 11% of total revenues in Q3 2010. In the following comments on revenues, I will compare our business on a pro forma basis, as if DHI had been acquired at the start of 2009. For Q3 2010, global infectious disease revenues were $16.2 million versus $56.9 million in the prior year Q3, which benefitted from last year’s flu pandemic.

Global flu sales in Q3 2010 were modest, as is more typical for this time of year, and were reflective of distributor outsales. DHI Respiratory and General Neurology revenues declined 42% and 39% respectively from Q3 2009, again, primarily as a result of the benefit in 2009 of the flu pandemic. In 2010, revenues were favorably impacted by 9% growth in the herpes product line, compared to Q3 2009, this product has been growing consistently in the 5 to 10% range over the last several quarters.

Global sales of strep A increased 5% over the prior year quarter. The global revenues of our reproductive and women’s health category increased 13% in Q3 2010, to $8.7 million. This increase was driven primarily by pregnancy issues, and a 21% growth in the thyroxine product line.

The gastrointestinal disorders category, made up primarily of H.pylori, enterovirus, and iFOB was up 18% from Q3 2009, to $1.7 million. Other product revenues were $1.7 million in Q3 2010, a $500,000 decline from the prior year, reflecting some softness in our veterinary product line.

Gross margin in Q3 2010 decreased 55% as compared to 69% in the prior year, primarily as a result of an unfavorable product mix shift, associated with significantly fewer flu sales this year, versus last year. Operating expenses were $18.8 million, compared to $14.2 million in the prior year, this includes $4 million of DHI’s operating expenses in the current period, as well as $1.6 million of intangible asset amortization associated with the DHI acquisition.

Research and development costs were $6.1 million, in line with our expectations. Stock based compensation expense was $1.3 million for the quarter, versus $0.8 million for the same period in 2009. With regard to the DHI integration, we have successfully implemented the majority of the cost synergies, and we anticipate $6 million in total synergy related savings for 2010.

In addition, we are working toward cross selling revenue opportunities identified earlier in the year. As you saw from our earnings press release today, in Q3 2010, we recognized tax expense on a pre-tax loss. This was because included in a tax provision is $3.2 million of tax expense to reduce the tax benefits recorded in Q1 and Q2, to our current estimated effective tax rate.

The effective tax rate has declined in Q2, primarily as a result of a reduction in our forecast of full year pre-tax income. On our last quarter conference call, we indicated that we expected our full year effective tax rate to approximate 40%, assuming Congress extends the Federal research credit. Today, with the same assumption regarding the Federal research credit, we expect the full year effective tax rate to approximate 38%.

During Q3 2010, we took steps to maintain financial flexibility. First, we amended our credit facility to provide a no test period in Q4 for certain of our financial covenants. Second, we filed with the SEC a $150 million universal shelf registration. I will now turn the call over to Doug.

Doug Bryant

Thank you, John. For today’s call, I’ll 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. Before I begin, however, I want to remind the audience that our strategic intent is to create shareholder value by creating a broader based diagnostic company, with products and market segments in which we have significant expertise and know how.

For the past 18 months, Quidel has been focused on three strategic imperatives. First, utilizing our core infrastructure to launch two to three new products per year; second, strengthen our distributors emphasis on Quidel products, and finally; third, develop a molecular franchise. As we execute these strategic imperatives, we’ll be building a broader, more diversified diagnostic company, with an ability to capitalize on respiratory disease epidemics as they occur.

In terms of near term growth drivers, there are three products that we expect will have an impact in 2011. QuickVue Influenza A+B, Thyretain, and our recently launched Lateral flow immunoassay. Starting with flu, we continue to see influenza as a growth driver for our business in Q1 2011, and over the next several years. While rapid flu test usage by physicians has grown substantially in recent years, we believe that the rapid influenza test market is still underpenetrated, and that there is opportunity for growth.

From 2003 to 2008 the number of patients presented to physicians with IOI that were tested with a rapid flu test has increased dramatically, and the market has more than doubled over that period. In 2009, physician adoption of rapid diagnostics increased further still, albeit during the pandemic.

We are encouraged that during Q3 2010 most of our major distributors had significant increases in their out sales, when compared to the same time in 2008, our last non-pandemic flu season.

Since current IOI activity is only slightly above what we saw in 2008, we believe it is likely that the reason for the increase is that more physicians are purchasing product and that we will see a larger customer base going forward, into the 2010/2011 season, as a result. In addition to flu another growth driver and near term opportunity for us is Thyretain, a test that is specific for TSH receptor antibodies that are stimulating, and therefore confirmatory for Graves disease.

Although we continue to see a growth rate in the high teens, we’ve not reached the inflection point in the market, the point at which every potential Graves patient is routinely tested. This, of course, is where our current marketing activities are aimed. We’ve refined our view of the domestic TSI testing market and estimate that it’s an annual 2.7 million test opportunity. We do see increased interest and positive feedback from endocrinologists and (inaudible 0:16:12) so targeting them is key.

We’re also in the middle of finalizing an economic benefit model for Thyretain to determine the cost of undiagnosed and mis-diagnosed Graves disease to the health care system. So far, the preliminary results are very positive. We remain committed to driving growth in this product, and have an internal goal to grow Thyretain appreciably in 2011.

Moving on, this quarter was an exceptionally good period for our product development teams, as we launched four products. We relaunched QuickVue Mononucleosis, which will serve an estimated 3.3 million test market in the US. We launched RapidVue pregnancy, as our fighter brand, to gain access to the price sensitive segment of the pregnancy testing market. QuickVue RSV 10 just recently launched, as unique, as it is to our knowledge, the only FDA cleared 10 minute respiratory syncytial virus test on the market. The test also employs the identical test method and sample preparation as the QuickVue Influenza A + B test, allowing for the use of the same nasopharyngeal patient specimen when testing for influenza or an RSV infection.

QuickVue mononucleosis, RapidVue HCG, and QuickVue RSV10 are derived from our core lateral flow technologies, will leverage our existing automated production facility, and will provide cash positive contributions in the near term. Equally important, these launches demonstrate that we have the talent onboard and the processes in place to develop and commercialize products, and to execute our longer term strategic plan.

In addition to the three lateral flow products just mentioned, MicroVue BA was launched by Quidel Specialty Products Groups this September. MicroVue BA, the most recent addition to Quidel’s autoimmune complement product line allows for the rapid quantitative detection of the BA complement fragment in experimental samples, including urine, serum, and plasma. Although our revenue expectations for MicroVue BA are not large, the autoimmune complement category as a whole has grown 17% on a trailing 12 month basis, and is another solid cash positive contributor.

Our initial promise to the investment community was that we would introduce two to three new products per year. As of Q3, we’ve exceeded that challenge for 2010, and look forward to exceeding that challenge in a meaningful way in the next couple of years as well.

Let’s talk next about the two new instruments that we have in development in our product pipeline as we see it today. First is a fluorescent immunoassay instrument that employs an improved assay chemistry format and an objective read on a small benchtop analyzer. In addition to eliminating the variability among different practitioners in reading a visually read assay, which gives physicians more confidence, assays in development for influenza and strep have demonstrated a significant improvement in analytical sensitivity to date.

The graphical user interface for the instrument is nearing completion, and we’re on track to begin clinical trials in Q1 2011. Our initial product menu will include flu A+B, followed by strep A later in 2011, with additional menu thereafter. Also under development is the bobcat, and automated instrument that eliminates manual processing of direct fluorescent antibody slides, and significantly reduces the time involved in interpreting liquid DFA samples.

Traditional DFA testing takes between 90 to 120 minutes. With fast point liquid DFA the slide preparation is reduced to about 12 minutes, and the bobcat instrument interprets the slide for the presence of eight different viruses in three minutes, for a total assay time of 15 minutes. The bobcat eliminates the need for a fluorescent microscope, and therefore does not require a highly skilled virologist to operate it, or certainly not much of their valuable time.

We think that ease of use, a 15 minute result, and an assay cost under $30 will be a very compelling reason for many customers to take a look at bobcat. We’re on track to begin clinical trials in Q1 2011, and are targeting a Q4 launch. Next, I’d like to talk about our progress with molecular diagnostics. As we mentioned in the past, we have a three part molecular strategy consisting of a non-instrumented set of assays, open box assays, and an integrated system.

With regard to non-instrumented assays, we’re working with BioHelix to develop Cdif and MRSA molecular tests, with additional menu plans. We’ve received positive feedback about the technology and platform, particularly due to recent improvements in total use workflow. This platform allows clinical labs to more easily run molecular diagnostics without having to invest in a molecular instrument that can be cost prohibitive. We will begin clinical trials for MRSA and Cdif in the middle of 2011.

The second part of our molecular strategy is to develop open box assays, which are molecular diagnostic kits that will be performed on commercially available molecular platforms. We’re making good progress, and in fact, are slightly ahead of our internal schedule. Our current development menu consists of seven infectious disease analytics. Clinical trials are scheduled to begin in Q1 and Q2 of 2011.

Third is our integrated platform strategy. We’ve entered in to an exclusive licensing and joint development agreement with Northwestern University and the Northwestern Global Health Foundation to develop an automated molecular diagnostic testing platform that will incorporate clinical sample preparation, nucleaic acid extraction, amplification and detection. We expect product launch to take place in 2014, and are excited about the commercialization of a lower cost integrated system, and the benefits that will bring to clinical labs.

As will all product development activities, there’s inherent uncertainty with development and/or clinical trial outcomes. Activities remain subject to change, but we nonetheless felt it important to share with you our progress and planned activities as we see them today.

In conclusion, we’re moving forward with our plans to diversify our business. We have good near term prospects to drive growth, and have made significant product development advances over the last three quarters, largely due to our investment in R & D. We’re beginning to show the results of a reinvigorated product pipeline and the internal competencies we’ve acquired as a result of that effort. We’re executing on our strategy to position ourselves as a broader based diagnostic company, and are moving in the right direction, away from a heavy dependence on seasonal products, like flu and strep, and toward a more diversified portfolio with higher growth product lines. That concludes our formal comments for today. Operator, we’re now ready to open the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions.) Your first question is from the line of Zarak Khurshid with Wedbush. Please proceed.

Zarak Khurshid – Wedbush Securities

Hey guys, good afternoon. Thanks for taking the question. I was just curious, what are the challenges you’re seeing with penetrating the Thyretain opportunity? and what are you learning about the kind of challenges within the sales force as well?

Doug Bryant

The biggest challenge is that when we polled physicians, on average, many are not aware that there is an assay that would be confirmatory for Graves, so our mission at this point is mainly educational. So we’ve got the sales force who are doing a great job, I think, of making the calls they can, but 30 people on the ground can only go as fast as the number of calls they can make each day, right? We are doing a great deal of work around educating physicians through other means, including symposia, workshops, webcasts, and we have a number of papers that are due to come out in the fall, which will be helpful.

Zarak Khurshid – Wedbush Securities

Great. I have a followup question regarding the R&D around the fluorescents reader and the bobcat. How should we be thinking about the R&D expenses associated with the development of those platforms? Should it – will it be ramping up as you get closer to FDA approval, and manufacturing scale up?

Doug Bryant

That’s a great question, Zarak. Let me start by saying that as we exit 2010, a lot of the instrument development cost will fall off, and then they will be replaced in the first half of 2011 by clinical trial cost. So if, indeed, all of those things that we described actually hit the timing that we have in mind, it’s entirely possible that in Q1 and Q2 that our R&D expense will increase slightly, but then be offset in Q3 and Q4 by an equal amount, such that by the end of 2011, we will still have an R&D expense that is about the same as we’re seeing in 2010.

Zarak Khurshid – Wedbush Securities

Great, that’s helpful. Thank you.

Operator

Your next question is from the line of Scott Gleason with Stephens. Please proceed.

Scott Gleason – Stephens

Hey Doug, hey John. Thanks for taking my question. I guess would you be willing at this time to share a little bit more information about the second generation lateral flow product? I guess when we start thinking about the actual system cost, to the end user, we start thinking about workflow, and then also maybe from a cost of goods sold standpoint on the disposal basis. Can you give us some granularity on what that would look like?

Doug Bryant

The short answer is I don’t think it would be appropriate to announce what our costs are for either the instruments or the reagent. I can tell you that when we look long term at the strategic plan, we certainly see gross margins and operating margins that improve throughout that period.

Scott Gleason – Stephens

Okay. And then Doug, can you give us an update in terms of what’s going on with the second generation fecal occult blood test?

Doug Bryant

We’ve -- especially now, are at the point where we need to make a decision as to changes to the product that would make it inherently easier to read than the current methodology. Right now, as we see it, our product as well as the other competitive fecal occult blood tests that are in the market all suffer from the same problem and that is that they are positive at levels that may not be particularly useful for physicians. And so we’re looking at ways that we can improve the product such that when a physician sees a positive, it’s at a level that’s indicative of the need to refer that patient for colonoscopy. So until we can see greater traction in the market, we’re not sure when we should make that investment through that product.

Scott Gleason – Stephens

Okay, great. And then just last question, when we start looking at the bobcat platform, I guess when we think about a virologist performing these tests, how are they reimbursed? Is there a technical component and also a professional component? And I guess would that professional component change at all, in terms of thinking about a direct read in the laboratory?

Doug Bryant

So Scott, let me make sure I understand the question. Are you asking about reimbursement for DFA testing generally?

Scott Gleason – Stephens

Yeah, I’m talking about the virologist. Would there be any change in terms of how they would get paid when you start introducing the bobcat? In terms of their incentive structure with the test?

Doug Bryant

There should not be any change, if you’re talking about an inpatient, of course, that’s not a reimbursement question. On an outpatient basis, DFA tests, the reimbursement is the same for the existing as well as the future.

Scott Gleason – Stephens

Okay, so there’s no professional/technical component associated with this?

Doug Bryant

Not that I’m aware of, no.

Scott Gleason – Stephens

Okay, thank you for taking my questions.

Operator

Your next question is from the line of Pete Vitali with William Blair Company. Please proceed.

Pete Vitali -- William Blair Company

Hey guys, question for you on where you are at right now on the percent of revenue that you are generating from seasonal versus non-seasonal products. Kind of what the current run rate is?

Doug Bryant

That’s a tough question to get at right now, because of the – we’re at the seasonal low period. Generally, we believe that by the end of the season, we’ll probably be roughly around a third of our revenue will be seasonal.

Pete Vitali -- William Blair Company

Are there any long term goals that you guys have as far as where you’d like to see that in the next two to three years?

Doug Bryant

No, that would be impossible to do, because what would be unbelievable is to grow the non-seasonal by some huge percentage, but also grow the seasonal by that same huge percentage. So I’d have to say that no, we don’t have a specific goal to say that the seasonal would be low as a percentage of the total. Because frankly speaking, if we had seasonal products that grew hugely, that would be fine.

Pete Vitali -- William Blair Company

Okay, thanks guys.

Operator

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

Steven Crowley – Craig-Hallum Capital Group

Good afternoon, gentlemen. I want to ask you a little bit of a follow up on Thyretain and the whole thyroid area. In terms of some of the push marketing and other sales activities that you’ve tried to crank up, what are some of the leading indicators that you’re looking for, in terms of response? Besides more test ordering, are you seeing some reaction to your actions that leads you to some encouragement at this point? That what you’re working can have a positive impact?

Doug Bryant

Well, like any commercial organization, we have a system in place where we track, weekly, the activities of our sales organization, so we know the number of calls that they attempt to make, and then the number of calls they are successful making. We know the responses from the physicians, either positive or negative, and so we track all those things. I would say though, Steve, we should be careful of that, because even though those are a positive, just because a physician says “Yes, I will start ordering TSI when I see a certain level of TSH result” doesn’t mean that actually translates, necessarily, into test ordering. We do see positive signs, but I won’t be satisfied until I see a dramatic shift in actual sales of our product into the big reference labs. And thus far, we’re seeing very good growth, you know, year over year, very high teens for sure, but it needs to ramp up dramatically past that to be the product that we ultimately think it could be.

Steven Crowley – Craig-Hallum Capital Group

And some of the other potential opportunities for you in that thyroid or thyroid disease complexer, is your pursuit of those opportunities contingent on whether you can get this ball rolling a whole lot faster, or just have the steady progress there? Are you waiting on those decisions, or is so logical that you that you’re likely to proceed with some of those other product initiatives?

Doug Bryant

Not only Steve, is it logical, but we’re highly confident and we think this will happen, therefore we’ve already funded internally another program that’s closely related to Graves disease. So if you look at the autoimmune disorders, Graves of course is the largest and most common, followed by rheumatoid arthritis. The third most common in the US is Hoshimoto’s, which is also Hoshimoto thyroiditis, which is also related, and we’d incorporated a similar cell based format, so to say it again, not only are we confident, but we’re already making the investment on the R&D side.

Steven Crowley – Craig-Hallum Capital Group

Great. and then as a precursor to what you’re going to be doing with bobcat, the introduction of fast point DFA tests, and – have you had some success getting a fair number of evaluations of that technology out there in the field, and beginning to convert those? Where do you stand on that process?

Doug Bryant

Let me start by saying while we are very happy with the progress we’ve made with the integration of DHI generally, certainly one of the disappointments was that we didn’t have a respiratory season in Q1, the season during which we’d expected to start up a large number of evaluations, so we’d expected to be further along in the process. So starting the process in the summer we knew it was going to be slow anyway. Having said that, I think the most encouraging thing, Steve, is there are a number of evaluations ongoing already, equally encouraging, most of those evaluations were started by the former Quidel sales force, which says something about the segment that we’re going into, and then third, we’re encouraged by actual sales we’re starting to see now, in October. So I would say we’re at the very beginning of that stage during which we achieve traction, and it’ll be our objective now to follow up with customers as we go into the respiratory season, and not only get product ordered, but get it reordered.

Steven Crowley – Craig-Hallum Capital Group

Great. One more from me, and I’ll hop back in the queue. On the development project and the relationship with Northwestern and the intention to bring the system as you described in your prepared comments, it seemed like the angle of those comments was about bringing in a much more cost effective solution to the marketplace. You also envision a certain set of differentiated capabilities or a disease group or disease groups where the features and functionality of the system will be best suited. Can you give us a little more of the picture of the opportunity you’re looking to shoot at, there?

Doug Bryant

Well, as a result of the agreement initially, we’re obligated to co-develop with them a HIV viral load product, which would be distributed to emerging growth countries, and we would use that expertise to load in other assays along the way. Certainly all the things that we have currently as open box assays, the seven analogs that I mentioned a few minutes ago, those would be immediate candidates. So along the lines of infectious disease, and certainly respiratory disease products, those would be obvious for us. But there are some other candidates as well that we certainly are interested in.

Steven Crowley – Craig-Hallum Capital Group

Great. Thanks for taking my questions.

Doug Bryant

Thank you, Steve.

Operator

That’s all the time we have today. Please proceed into your presentation with any closing remarks.

Doug Bryant

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 everyone.

Operator

Ladies and gentlemen, we thank you for your participation and ask that you please disconnect your lines. Good bye.

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