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Strategic Diagnostics: Roth Capital Conference Presentation Transcript

by: Roth Capital Conference February 21, 2007 | about: SDIX

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Strategic Diagnostics, Inc. (SDIX)
Roth Capital Conference
February 21, 2007 12:30 pm ET

Executives

Matt Knight - CEO
Stan Fronczkowski - CFO

Presentation

Moderator

Okay. We will go ahead, and get started here. The next company to present is Strategic Diagnostics. Strategic Diagnostics develops, manufactures, and markets antibody products and analytical test kits for a range of food, water, agricultural, industrial, environmental and scientific applications in the U.S. and internationally.

With us today presenting on behalf of the company is Matt Knight, CEO. Matt?

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Matt Knight

Thank you, and good morning. I am going to expand our range of products and services by saying that we are an antibody technology company. We produce, manufacture, and market immunoassays, production antibodies, and other high-value biological reagents. This is a transition that we've been leading in the company over the last couple of years and I am going to spend today talking to you about our progress, and how this will drive growth going forward.

I will, like all good salesmen, start with a disclaimer. So, here’s the forward-looking statement.

There are three major market segments that we are facing today that are result of a fair amount of research and development in the company over the last two years. First one is the antibody market; in yellow are the seven segments of this market.

We have sized this market with the help of Campbell Alliance, a life sciences consulting firm out of Raleigh/Durham. They have sized the market at about $5 billion. We are sizing the sell-to market for our products and services at $1.5 billion. This is a major change for SDI that had traditionally seen a sell-to market for our antibody products of about $150 million, and I'll talk to you about that more in a few slides.

As the moderator said, we have made for our entire 16-year history, test kits for industrial application to the food safety market, the agriculture market, water quality market, and environmental remediation market. That business continues today to be about 55% of our revenues. It's good, solid, cash flow profitable business.

Of the $385 million designated here, $200 million of that market is really the food pathogen testing market, which we have seen in the news so much in the last couple of weeks. And so, that is getting the majority of our focus in this segment. I'll talk a bit more about that.

And then we are going to spend some time talking about a new market for us in the area of industrial bio-fermentation. We are entering this market in conjunction today with a partner called Broin Companies.

Broin is the second largest manufacturer of ethanol in the United States. This is a technology built on a proprietary platform and patent that is pending for the use of a new type of bacterial virus that we will discuss a bit.

Let me talk first about the antibody business. This is an important business for the company. It’s 45% of our revenues. It grew faster than the combined average growth rate of the market that we have identified. In the third quarter, we said that this business will continue to accelerate in successive quarters. We will be announcing our fourth quarter performance on March 1st. There was no way to get that out before we got here.

We have become a fully integrated antibody company, everything from the design of the antibody to its production, to its processing, to its inclusion in an assay or test. We have built this on a new proprietary technology that I will talk about in a minute.

Our customers in this market are Merck, Johnson & Johnson, Roche, Dade Behring, and Abbott. So, we have entrée to some of the major users of antibody technology; here in California, down the road, Scripps is a customer of ours. So, we will talk a little bit about how we are building on these four capabilities, new business facing the life sciences marketplace.

We see our four major capabilities going forward in this market as: one, our current position as a leader in the custom antibody manufacturing business. Today most of our business still is based on the production of antibodies to the design specifications of a customer. We are moving to building new antibodies that are proprietary to SDI.

We have larger production facilities. We are able to make large volumes of antibodies. We have new technology of high throughput production of these antibodies. We have an outstanding scientific community, 15 PhDs in all of the disciplines necessary to do world-class antibody development. We have strong and growing customer base. And we have innovation in the form of a new platform called Genomic Antibodies.

Now, why are Genomic Antibodies important? Well, if you were a pharmaceutical company or a researcher or an investigator, the way you were able to make antibodies historically, starts with the proteins and you basically immunize an animal with the protein. You can immunize an animal with a native or recombinant protein. So, some protein you just took out of a piece of diseased tissue or some protein that you expressed in system like E. coli. One protein can take six months to produce and the antibody protein combination can cost upwards of $30,000 for one.

You can also use a process called peptide antibodies which are synthetic constructs of amino acids used to immunize antibodies. They are relatively inexpensive, relatively fast, they don’t work very well. They are not all that effective in terms of their performance in developing new biomarkers, new therapeutics and new test kits. They have some application in research and are widely used. So, there was a big gap here.

What if somebody could come along and create a process for delivering the efficacy of a native recombinant protein at a price that was at or below our peptide antibody and that’s what SDI has done.

This is the business that we are building. We launched our first product on this platform called mouse polyclonal Genomic Antibodies in the first quarter of last year. We just passed the $1 million mark on projects on that platform in that whole market; it was only a $10 million in market.

So we are very excited and you'll see in a minute, we have a whole pipeline of new products coming out based on this platform. What are they good for? Why do people want a Genomic Antibody? Well, first of all, they are faster, cheaper, better. I mean, everybody wants that product. How do you do something that is faster, less expensive, and gives you better performance? We think that’s true with Genomic Antibody.

In fact we have been able to raise antibodies for a number of clients to target that they could never have produced; the protein too, because these proteins are very highly conserved. These are proteins that maybe cell-surface proteins, transmembrane proteins, other highly conserved proteins that you would never be able to produce. So, you would never get any antibody to them any other way.

They are playing a major role with some of our customers in pathway elucidation and candidate validation. The drug industry does not have a problem with too few candidates. The drug industry has a problem with too many candidates. And so they need tools to help them sort through these candidates and prioritize them. So we have customers like Berlex with which we have made an announcement last year; now a part of Bayer that has been using this technology for that application.

They get better data to help them decide which projects to move on into an NDA or into the clinic. We can create libraries of the antibodies. In fact we are just finishing our first library of few 100 antibodies to gene characterize the breast cancer.

And we are working collaboratively to make these antibodies available to researchers and other collaborators who are looking at new forms of biomarkers. Nobody has ever had 200 breast cancer antibodies to look at one time in a library. So this is a new-to-the-world kind of event. We are very excited about it. And also Genomic Antibody supports typical drug discovery activities like mass spect microarray knockout models. They are very complimentary to that.

Now, one of the unique things about SDI is, we have developed this very-staged incremental business model. Unlike a lot of biotech that you may hear at present, we are not burning investor's cash. We are a positive company and we are not raising money. We are cash flow positive. We have plenty of facility to continue to invest, this is all our investment.

So, we have a very-staged model to lead us into new market segment that will produce revenue and continue to fund our investment and research and development allowing us to reach various market segments and products that are of higher value and higher potential value to the company.

As I said, we have a vary significant pipeline from having almost no R&D in antibody technology three years ago to having a pipeline full of new product offerings over the next two years. This is very exciting for the company. Each of these is being developed with various types of revenue models and we continue to anticipate that this segment of our business will grow beyond the combined average growth rate of the industry, which as I said has been estimated at 16%.

To talk a minute about our test kit business, obviously immunoassays are a great adjutancy to a company that's in the antibody business because an antibody, a good antibody by definition is something that has specificity and sensitivity to a target. And so if somebody said we are making good antibodies; that means that it’s functional. It has a use.

And in our case, we have applied some of our expertise to developing technologies for things like the detection of food pathogens. Salmonella is doing an E. coli. This is a very significant part of our business. It’s the fastest growing part of our test kit business. It has been growing above 25% for SDI. We just launched the third of a family of products called Salmonella SELECT for Listeria. It’s a very, very unique technology. I’ll talk about that in a minute.

We also have a fairly well established business in the detection of genetically modified organisms. This has been something that the company has been involved in for a lot of years. It’s not a high growth business, but it’s a very profitable business.

The same is true for our Water Quality business. I have heard, this is described by some of our investors as a free option in our company. The Water Quality business, again, is a very good, solid, $5 million, $6 million a year, very profitable business for SDI. Our customers are mainly drinking water utilities, the municipalities.

What's going to be the compelling event here? Well, if there was ever a 9/11 type event involving water or water supply, I think, you would see this business explode. This is the only Department of Homeland Security approved methodology for a broad spectrum detection of toxins in drinking water. So, we run it, we like it. It's running very profitably, and we keep it.

And then we have a long-term legacy business for the use of immunoassays to detect environmental pollutants, these are things like PCBs, polyaromatic hydrocarbons, pesticides, and other types of products.

This is just a slide where we are running a promotion right now, introducing our Salmonella SELECT technology to the market. And we like this technology, because like all of our technologies, it's built on two fundamental and very important concepts of doing business for us. One is we need to have a proprietary position that we feel is differentiated. So, we want things that are proprietary to SDI.

In this case, the two components of the Salmonella SELECT product -- it has two proprietary components. One is the antibody panel, which is proprietary to SDI; and the second is the enrichment media that uses this bacteriophage technology, which I'll talk about in a minute.

The second thing that we want all of our technologies to do is to deliver a very documentable competitive advantage to our customers. We want our customers compelled to use our products because they save money. They save money and time. They save money and labor. They save money and training. They save money and product, or product disposition. They know that they have accurate and reliable results, and this is what the food industry is getting with SELECT.

This product has the lowest level of false positives for Salmonella of any method that we’ve run side-by-side including PCR. So, we are very excited about that. It also has lowest level of false negative results of any method that we’ve run side-by-side, including PCR. And that’s because SDI is really focused on the combination of sample preparation, and enrichment, and detection. So when we walk into a customer in the food pathogen marketplace, we are talking to them about a 10% to 20% reduction in total cost in use, and this is what's driving that business.

And I’m going to call your attention to this little critter right here. It looks like a lunar lander. In fact, that’s the kind of the high tech presentation we made, and this thing is called the bacteriophage. And bacteriophages are probably the most ubiquitous carriers of DNA in the world, everywhere.

Wherever there is bacteria there is bacteriophage, that's why the world hasn’t been overrun by bacteria. They are viruses, and they have a very elegant specificity to a particular bacteria. You will find that there may be a bacteriophage for a specific species of bacteria.

And I’ll tell a quick anecdotal story. I think I have time. When we were working on the Salmonella SELECT product, which took us 2.5 years to come to market with, we had a problem. And our problem was that as we increased the sensitivity of our assays, so that it picked up all 2,500 different species of Salmonella. We started to lose specificity.

It was very hard to find antibody that would react only with Salmonella, and wouldn't start reacting with other organisms that looks a lot like Salmonella. This was a big problem, because our design goal for the product was to have a false positive rate of less than 2%, a market leading rate.

This was when our scientists came across this idea that they could use bacterial viruses, and absolutely knock out all of the competing and cross-reacting organisms that we saw in these food samples that we were testing. And when we started to do a global search, we discovered no one had ever thought of this idea. So in 2004, we filed for a patent. That patent was published last year.

And about the time the patent was published, I went to the corn ethanol industry, and made a call on the Broin Companies. The Broin Companies are our partner in the development of this technology. They are the second largest domestic producer of ethanol, and the world's largest producer of dry corn milled ethanol, accounting for almost a billion gallons of corn ethanol production today.

So, we were interested in going to them with this technology, because we knew that they had issues. And by the way, anybody processing a high-value product from a non-sterile renewable source is going to have the same problems, whether its ethanol production or Lysine production or bio-plastics production or Nutrasweet production.

These raw materials that come into a plant, like an ethanol plant, are just loaded with bacteria that usually are competing with the production organisms. So, let's talk about ethanol.

In the case of ethanol, a corn comes into the plant it’s full of lactic acid producing bacteria. In fact, we've identified over 41 different species of lactic acid producing bacteria that are coming into corn ethanol plants in this country. And if the plant cannot control lactic acid producing bacteria, it competes with the yeast fermentation for the sugars that are in the fermentation.

And what happens is, it wins. It starts converting sugar that would normally go to ethanol production to lactic acid and some ethanol, but it consumes a lot of the sugar going to it. So, yields go down. So, now the ethanol production industry has to deal with it.

And what they have been historically doing is they’ve been using temperature, lots of heat. They’ve been using antibiotics, $3 million to $4 million per billion gallons production, and they’ve been using pH to limit the growth of these lactic acid bacteria.

Well, when they do that they sub-optimize the performance of yeast, and its ability to covert sugar to ethanol. It slows the yeast down. So if you could come up with a technology as we have that would eliminate the lack of gassed in bacteria. Allow the fermentation to be optimized for maximum yeast production, you would increase yield because more sugar would be available and increase yield because the fermentation would not take as long

So those are the two primary benefits of this technology that we are developing with Broin. The third benefit is it eliminates the need for antibiotics and we are pretty comfortable at this point, that USC and FDA is going to preclude the use of antibiotics in plane ethanol because the bi-product of this process is something called the dry distiller grain and it goes to the feed, it goes to animal feed. And so the USC and FDA do not want antibiotics in animal feeds.

So we are uniquely positioned here. This is a key project for both of us. You may have seen yesterday that we announced that we had met our first milestone, which we had identified all of the bacteria, all of the viruses that we will go into this reagent package to control out the gassed bacteria. And so it’s a pretty compelling business for us. Its real, its there, it's not cellulose ethanol that may or may not happen five, or six years from now. It’s a very real market and it's established. We are with the right players and we are still not finished developing it or establishing all the commercial terms.

But we think that domestically in dry corn ethanol its worth anywhere from 10 million to 30 million per billion gallons of ethanol produced to SDI, very, very high margin of business. And that will also be applicable in sugarcane ethanol. That will be applicable in lysine production and it will be applicable in Nutrasweet production and enzyme production. We have a non-sterile feed source being converted to a high-value product.

So these are the three drivers of growth in our business. We reported improved results in the third quarter, 16% growth in our antibody business, and only 4% growth in our test kit business, largely impacted by [RIGMO] business. We expect that to be an area of low or little negative growth. And then the phage reagents, which should come to market and will be commercialized in the next 12 to 18 months. It's very near-term for us and we are very excited about it.

Financially, as I said, we report fourth quarter on March 1st. We have said starting in the second quarter that we expect sequentially quarter-over-quarter improvement. There is no reason for me to change that expectation.

Today, as I chat with you, we, as I said, are profitable. We have no real long-term debt. We have a lot of cash on hand. We have a lot debt for provision in our company.

Obviously with Stan joining the company we are looking forward to using our financial abilities to help to drive our growth going forward. And Stan anything else you want to add or comment regarding the financials.

Stan Fronczkowski

As Matt said, we do have a lot of cash. We do have debt capacity. We have got a lot of room to leverage future growth opportunities.

Question-and-Answer Session

Moderator

Okay. Thanks, Matt. We have time for a question or two. If you could wait till the microphone reaches viewers, so the webcast can pick it up, I would appreciate it.