Nanosphere's (NSPH) CEO Michael McGarrity on Q2 2014 Results - Earnings Call Transcript

Aug. 6.14 | About: Nanosphere, Inc. (NSPH)

Nanosphere, Inc. (NASDAQ:NSPH)

Q2 2014 Earnings Conference Call

August 06, 2014 05:00 PM ET

Executives

Michael McGarrity - President and CEO

Roger Moody - CFO

Analyst

Bill Bonello - Craig-Hallum

Chris Lewis - ROTH Capital Partners

Operator

Good afternoon and thank you for attending the Nanosphere Incorporated Second Quarter 2014 Corporate 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, August 6, 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 on this call will be 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.

Michael McGarrity

Thanks, [Tracika] and thank you all for joining us for our Q2, 2014 results call. With me today is Roger Moody, Chief Financial Officer of the Company. Today, we released our results for Q2 of 37 new customer placements and $2.7 million in revenue. These results fell short of all expectations; however, we continue to see consistent growth in our consumable revenue which was up 108% paced by our blood culture assays. Our shortfall was largely due to our instrument sales which were below expectations and down sequentially and year-over-year.

Roger will provide more detail on the mix and shortfall, but first I would like to provide some perspective on these results and the associated impact on our guidance and revenue build. We continue see a lengthy time for initial gram-positive customers to convert from placement to live implementation. While we have made progress in standardizing this process, it is clear we have not yet seen a reduction in the time it takes.

We expected and have seen some recent customer placements move more quickly through the process. But these do not make up for those that take significantly longer. Even with that challenge, we have built the U.S. customer placement base over 260 microbiology labs over half of which are producing consumable revenue, but we are confident that are consumer business is continuing to build.

The instruments sales timing and purchase rental mix of our customers is proven difficult to predict or project. As we saw on the second half of the Q2, these delays had a material impact on the quarterly revenue and associated build towards our guidance of $19 million to $21 million of revenue for 2014. For that reason, we’re resetting our guidance to $14 million of revenue for 2014. This includes a substantial discount to our instruments sales projection. It is clear that this also has an impact on our consumable revenue as some customers are set to go live and cannot come for to test purchase till the contract is executed.

So while we remain confident on our pipeline and continue growth in consumable revenue, we need to account for the impact of these developments. I will comment on how we plan to overcome these challenges, but first let me turn the call over to Roger to discuss our operating results.

Roger Moody

Thanks, Mike. This afternoon, I will summarize Nanosphere’s second quarter 2014 financial results. For additional information on these topics, please refer to our press release and 10-Q both of which are available on our website, www.nanosphere.us.

Our customer base and test utilization continued to grow although at a slower pace than we anticipated. While the culture test sales are consistently growing while the timing of our instruments sales has extended beyond our expectations. Utilization for customers that have adopted our gram-negative or gram-positive test remained in line with our plan.

Now, I will review second quarter 2014 results. Second quarter revenue was $2.7 million as compared with $1.9 million in the second quarter of 2013 and $3.3 million in the first quarter of 2014. Year-over-year revenue growth was driven by consumable sales that increased to $2.2 million or 108% compared to 1.1 million in the second quarter of 2013. The growth in consumable revenue was driven by our blood culture gram-positive test and initial sales of our gram-negative tests.

Instrument revenue fell sequentially and year-over-year, resulting from customers differing their instrument purchases. Cost of product sales increased in the second quarter to $1.7 million, due to increased volume. Gross profit margin increased year-over-year from 32% to 38%, driven by reduced production cost per unit for our tests. Selling, general and administrative expenses in the second quarter of 2014 were $6.7 million compared to $4.2 million in the second quarter of last year.

The increase in SG&A was due to field sales and customer support team expansion. Research and development expenses were flat at $4 million in the second quarter of 2014 and 2013. Total operating expenses in the second quarter were $10.7 million as compared to $8.2 million in the second quarter of 2013. Net loss for the second quarter of 2014 was $10.1 million compared with $7.8 million in the second quarter of 2013. Net cash decreased in the second quarter by $11.2 million, resulting in the cash balance of $21.8 million at the end of the second quarter.

The increased use in cash in the second quarter included $1.6 million of inventory buildup due primarily to deferred instrument sales.

Summing up, our consumable business continues to grow at a steady pace and instrument sales have proven to be challenging. We expect the recent addition of our gram-negative test and the roll out of our enteric test to positively impact both of these trends. Now let me turn the call back over to Mike.

Michael McGarrity

Thanks, Roger. Let me conclude with an emphasis on our focus as an organization, to continue to build the leadership position in the molecular microbiology market as well as address the basis for the shortfall.

First is on our commercial execution where we will be accelerating our expansion of both field sales and clinical and technical support team. As we better understand the sales process, we have concluded we need to accelerate this expansion. There are three key initiatives that we will advance to drive our customer and revenue build.

First, we have to find a model for success that we are seeing in a group of our sales reps that are highly productive. We are replicating this in both our selection and sales process which has obviously led to some proactive turnover but we are confident we'll address this issue and expand productivity across a wider distribution.

Second, we need more feet on the street. We know the time to productivity is a factor particularly in the complex blood culture sale and we need to accelerate expansion of sales and implementation ramps to drive this productivity and process in a more consistent and predictable way.

Third, we will drive new process based sales and pricing programs to accelerate the time to sell our rental contract. These will include financial incentive to customers in order to achieve this objective and hold our customers more accountable to the process we lay out in the implementation blueprint.

We expect these initiatives to accomplish the following; allow for more focused territory penetration for new placements, implementation and contract timing, improve our time to work customers through the validation and implementation process and allow for immediate focus on driving our additional menu through our current customer base as well as new pipeline customers. We believe that this expansion and focus will achieve these goals.

I also would like to comment on the second key initiative of the company which is the development efforts of our next generation instrument. We anticipate providing a first look at our alpha prototype instrument at the upcoming Association of Molecular Pathology meeting in November. While it is still early to project the full launch timing, we are accelerating development efforts both internally and with outside partners.

In conclusion, we are resetting our expectations for 2014. However we remain positive that we are building a loyal customer base around which to drive additional menu as evidenced by the early uptake of our gram-negative test and that our menu continues to perform at the required sensitivity and specificity providing a significant competitive advantage.

These are points of evidence that we are building a foundation for growth in both our customer base and associated revenue. We will look forward to reporting the results of these execution initiatives in the coming quarters.

Thank you for your interest in and support of Nanosphere and I will turn the call back over to Jessica for questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions). And we will go first to Bill Bonello with Craig-Hallum.

Bill Bonello - Craig-Hallum

Handful of questions here, I guess the first thing is just regarding the placements. Is the sort of shortfall relative to your previous expectations? Is that at all related to the timing around the full Enteric panel? Are using customers with purchasing decisions on hold until you have a more complete panel on the market?

Michael McGarrity

Yes what we’ve seen Bill is that we actually have a number of customers who are currently ordering the Enteric panel with the bacteria only and there are probably more higher majority of them who are waiting for the viral and that could allow for a push and the placement approval on timing and placements which we're allowing for a net adjustment.

Bill Bonello - Craig-Hallum

And the latest thinking and when that will be available?

Michael McGarrity

We’ve submitted in July and so we would be projecting sometime by the end of Q3.

Bill Bonello - Craig-Hallum

Okay and then it seems like to some extent at least the placement issue seems to be one of competition versus market adoption at least just looking at the competitive numbers out there. I mean [BAMRU] reported 150 placements in Q2 that’s nearly five times what you guys placed in the quarter. I guess can you give us some sense of why you’re not seeing the type of traction that they’re seeing how often you’re sort of in a head-to-head competition and losing out to them et cetera?

Michael McGarrity

Yes, two comments, Bill. I would just check on their results because I believe the 150 was for the first half and I also would point to the fact that we report I believe [BAMRU] has communicated that those are instrument placements and we report new customer placements. So our average customer placement is three to four processors. I would you would take the 49 plus 37 times 3 to 4 to get our total number, so I think again 150 was the first six months of the year and it’s a little bit apples to oranges from our processors standpoint. Does that make sense?

Bill Bonello - Craig-Hallum

Yes.

Michael McGarrity

Let me comment though on your second part of your question which is competitive dynamics. We do see BioFire in more of our competitive situations. We do continue to see our assay outperformed theirs from a sensitivity and specificity standpoint particularly in the area of specificity and the risk of generating false positives presumably due to amplification and they have communicated that in the field with certain blood culture battles. So again what we are not seeing across our customer base is performance impeding or delaying uptake adoption or utilization and ultimately we would expect again to see additional competition continue to build in the market.

Bill Bonello - Craig-Hallum

Okay and then just one last question, if I could, I mean it looks like at least that the burden that you’ve sort of been having you’ve got less than two quarters of cash on the books. You are talking about expanding your commercial effort and moving forward with NextGen development I would assume that sort of with the revised guidance you’re not going to be able to access the line of credit just how you’re thinking about financing this growth?

Roger Moody

Sure, I'll take that one, Bill. This is Roger. We will be looking at a wide array of financing alternatives that includes our debt facility and working with our debt providers. We will also -- we’ll get the ATM facility that we put in place with Aspire Capital. We'll also will get traditional stock offerings as well as potential investment from strategic partners. So we will look at a full array of financing possibilities to ensure that the Company is well capitalized down the road to fund these investments.

Operator

And we’ll go next to Chris Lewis with ROTH Capital Partners.

Chris Lewis - ROTH Capital Partners

I guess first just high level on the visibility of the business at this stage it’s seem kind of the first half of ’14 visibility has kind of improved with the larger customer base and building pipeline, but I guess given the quarterly results here and lowered outlook for the year, how are we supposed to think about the visibility you have into your business at this stage?

Michael McGarrity

Chris, I think a couple of things, the instrument sales shortfall that we point to -- is we had expected over $1 million coming out of the Q1 into backend of Q2 over $1 million in capital.

So it’s a meaningful impact on the quarterly revenue. So what we’re doing is taking a more conservative look as we go forward to say that two things that the conversion of the capital purchase or the instrument sales I should say may take longer than we anticipated for a number factors related to the capital budgets and the timing of when they complete their validation and go live.

And that we’re not going to build than expectations with that materially improve although we are going to investment in, in accelerating that. There is an associated test revenue impact to that as we see more customers that are ready to go live and a number of them will need to wait until they get the contract so they can purchase and report our results. So, all these efforts from a standpoint of sales productivity and field are meant to accelerate not just the go live timeline but the mix of capital, of instrument purchases and rentals. And we anticipate with some of these instrument purchase delays that we could see a higher conversion to rental or usage agreements which we are seeing.

Chris Lewis - ROTH Capital Partners

Okay, so going after that mix of the 37 instruments this quarter, what percent were cash sales versus rentals? And then for the 90 to 115 implied placements in the second half of ‘14, what does the guidance assume in terms of mix percentage for cash sale versus rental?

Michael McGarrity

Yes, two points, let me comment first on the -- additional comment on your visibility, I do want to comment on our gram-negative. We doubled close to 70 of our current customers are in the process of going live with our gram-negative assay which would say that we are seeing that reduced time to live in our current customer base. So, we ultimately believe we have visibility to a composite decrease in the time to test purchase and utilization in our customer base and we believe we will see the same with the enteric assay.

As far as your question on purchase and rentals, remember our process here which I referred to in my action items is that we place systems into instruments into a customer side under a validation agreement. We then work with the customer on an implementation program for them to go live and then there is a period of time where they cover under a long-term contract to either purchase, lease or reagent rental. What we are seeing is as we move more and more customers through that that last component is where we are having a little bit more challenge with predicting and projecting.

The process of them or getting test on the additional menu items is going as we are planning from the standpoint of seeing that gram-negative. So, I don’t think that when we reported these quarterly placements, they are not either purchase or rentals. These are placements that we have made previously that are then converting to a PR or rental. That makes sense?

Chris Lewis - ROTH Capital Partners

And then I guess on the consumable side of things, maybe just talk about how we should think about that trending I guess over the next two quarters and then into ‘15 with the menu expanding and customers becoming live?

Michael McGarrity

So, we anticipate as we have commented that the majority of our gram-positive customers will adapt our gram-negative assay. And our early experience is that that is a correct assumption.

We also anticipate that the majority of our current installed placements and customers will adopt our enteric panel when cleared fully with the viral. Our early information and visibility is that that is a correct assumption.

So, we believe we have continuably we have leverage in our existing customer base that our focused sales initiatives will continue to drive and you will see that associated growth as we go forward in the coming quarters. And obviously the key is that we continue to drive customers into purchasing utilization which we have visibility to that continue.

Chris Lewis - ROTH Capital Partners

And one more if I could sneak one in, on the sales force, what’s the size of the sales force today and then can you quantify the number of reps and implementation specialists you plan to hire?

Michael McGarrity

Yes, we have 22 total right now, mix of sales and implementation specialists and we will probably push that close to 30 with an additional mix here. That was obviously and our plan was to accelerate to expand the sales organization as we developed additional menu and move through the market. We are essentially pulling that in, in accelerating the expansion. The second comment related to that is the one I made about the productivity which is important because we are seeing a meaningful number of sales reps and percent of our sales force running at the productivity that would take us through our numbers.

We are seeing obviously that the time to productivity particularly with the blood culture takes time and that the profile of the reps based on our improved approach we have changed out a few of those. So, we are getting ahead of that acceleration and time to productivity so that we can more quickly get all of them or at least, I mean you are always going to have a certain productivity curve in your sales organization. But we think we can move that to the right from the standpoint of getting that capacity and productivity.

Operator

We will go next to Bill Quirk with Piper Jaffray.

Unidentified Analyst

This is Alex on for Bill. Just quick questions from me, so what’s the viral portion of the panels, what kind of validation time should we expect for the entire enteric panel?

Michael McGarrity

So, we have some customers, Alex, we have brought the enteric panel bacteria only in for some initial validation work and we would anticipate that some of those customers would go live with the bacterial and then add the viral as its cleared. We obviously see probably more that will wait on the viral and go through that validation process. We do not anticipate the lengthy validation and implantation process we see with the blood culture with the enteric assay and our early customer discussions as far as how that validation timeline will go is validate that. We want to get some experience there but that’s why we believe that that timeline comes down.

Unidentified Analyst

And specifically, if you could go ahead and provide some color on exactly where the guidance shortfall is coming from? Is it mainly the instrument declines or deferrals? Or is it longer validation time than expected?

Michael McGarrity

Well there is two aspects to it. The instrument purchase shortfall is largely what we experienced in the first half of the year and particularly in the end of the first quarter where we had a significant instrument projection of over $1 million that did not come in. In our average deal size that’s a meaningful number of customers and a number of those customers are -- therefore in some respect stalled and going live and purchasing test. But we would anticipate a continued increase in our live revenue producing customers in the back half. We are just not anticipating that we catch up and hit that mix of instruments sales and timing in the back half of the year. So there is an associated impact on the consumables but the majority of the shortfall has been the instrument sales.

Operator

We will go next to Mark Massaro with Canaccord Genuity.

Unidentified Analyst

Hi, this is David filling in for Mark. Can you give us a sense I know you just gave us the breakdown of -- the pick on the gram-positive; can you give us what percent of placement orders are picking up the gram-negative?

Michael McGarrity

We have close to 50 to 70 of our current gram-positive customers that are in the process of going live with our gram-negative assay and we anticipate that trend to continue. So I would say that I wouldn’t project the 100% of them, but our signal from our current customer base as we would anticipate a significant majority of those to go live with the gram-negative. And encouragingly when they take it in and go validate with their time to live based on all the work we’ve done with the gram-positive is obviously because we’re only a quarter and half into our launch that, that's a lot more straightforward.

Operator

We’ll go next to Shaun Rodriguez with Cowen & Company.

Unidentified Analyst

Hi, this is (Ryan Blicker) [ph] filling in for Shaun. Thanks for taking the question. So you noted guidance lowering to the lower than expected instrument sales and the associated impact on consumables, however, our expectation was that getting the ramp from preexisting customers would be enough to get your log posted to original guidance than you seem to be targeting now, so was the original guidance a lot more geared towards new customer growth than the expected or something changed in your expectations about preexisting customer ramping?

Michael McGarrity

If I understand your question -- we had a significant expectation of instrument purchases in our forecasting plan and when we look at last year, we did approximately $1.4 million in instrument purchases in Q4 and we also have a backlog of customers that are indicating their intent to purchase the instrument and it’s managing that timing. So I would anticipate that we may have had a higher mix of instrument sales in our number than some of the models out there, but we will see by lowering that expectation we’re also adjusting to the fact that we have not seen not do we expect an improvement in our time and that sometime to live in revenue producing and that some of those may actually extend based on the delay contract either instrument purchase or rental execution of a long-term contract.

Unidentified Analyst

You mentioned gram-positive customers and how they’re taking up the gram-negative test. What’s the estimated pull through for those customers?

Michael McGarrity

So our projection on the gram-positive is $50,000 per customer per year and our anticipation on the gram-negative is most of $30,000. And we still like the $50,000 is probably little on the $30,000 but that looks great.

Unidentified Analyst

Okay thanks and one just quick one at the end. So the bump of SG&A you mentioned further accelerating the sales expansion, how should we think about that spending number moving forward, is it going to continue to accelerate sequentially?

Michael McGarrity

The SG&A will but we’re looking for opportunities to cut cost offset that SG&A increase and we do expect the revenues to continue grow that will and you’ve seen the margins are expanding. So that increased profit contribution combined with other areas of spending of cost savings we would expect to keep the spending roughly flat over the next two to three quarters.

Unidentified Analyst

Okay so we should continue to see R&D coming in lower than previously estimated.

Michael McGarrity

About flat. The cost of revenue will be across R&D and SG&A.

Operator

And this does conclude our question-and-answer session. I will turn the conference back to Michael McGarrity for closing remarks.

Michael McGarrity

Thanks, Jessica. I just want to thank everybody for their time and continued support and we look forward to the results of our initiatives here going forward to continue to build our base. Everybody have a good evening. Thank you.

Operator

This does conclude today’s conference. Thank you for your participation.

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