Cepheid (CPHD) John L. Bishop on Q2 2016 Results - Earnings Call Transcript

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Cepheid (NASDAQ:CPHD)

Q2 2016 Earnings Call

July 28, 2016 5:00 pm ET

Executives

Jacquie Ross - Vice President, Investor Relations

John L. Bishop - Chairman & Chief Executive Officer

Daniel Madden - Chief Financial Officer & Executive Vice President

Analysts

William Bishop Bonello - Craig-Hallum Capital Group LLC

Brian D. Weinstein - William Blair & Co. LLC

Derik De Bruin - Bank of America Merrill Lynch

Sung Ji Nam - Avondale Partners LLC

Isaac Ro - Goldman Sachs & Co.

Doug Schenkel - Cowen & Co. LLC

William R. Quirk - Piper Jaffray & Co.

Jack Meehan - Barclays Capital, Inc.

Daniel Arias - Citigroup Global Markets, Inc.

Eric J. Criscuolo - Mizuho Securities USA, Inc.

Mark Massaro - Canaccord Genuity, Inc.

Tycho W. Peterson - JPMorgan Securities LLC

Vijay Kumar - Evercore Group LLC

Operator

Good day, ladies and gentlemen, and welcome to the Second Quarter 2016 Cepheid Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. As a reminder, this conference is being recorded.

I would like to introduce your host for today's conference, Ms. Jacquie Ross, Investor Relations. Ma'am, you may begin.

Jacquie Ross - Vice President, Investor Relations

Thank you, Michelle. Good afternoon, and welcome to Cepheid's 2016 second quarter conference call. On the call today are John Bishop, Chairman and Chief Executive Officer; and Dan Madden, Chief Financial Officer. Today's conference call is being broadcast live through an audio webcast and a replay of the call will be available later today at www.cepheid.com. Once again, we have published a summary of our prepared remarks ahead of today's call. This summary is available on the IR home page of our website and on request from Investor Relations.

During today's call, Cepheid will make forward-looking statements, including guidance as to future operating results and future products. Because such statements deal with future events, actual results may differ materially from those projected in the forward-looking statement. Additional information concerning factors that could cause actual results to differ materially from those in the forward-looking statements can be found in Cepheid's Annual Report on Form 10-K, Form 10-Q and other filings with the U.S. Securities and Exchange Commission, as well as in today's press release. The forward-looking statements, including guidance, provided during this call are valid only as of today's date, July 28, 2016, and Cepheid assumes no obligation to publicly update these forward-looking statements.

During the call, Cepheid will discuss non-GAAP financial measures. These non-GAAP measures are not prepared in accordance with Generally Accepted Accounting Principles. A reconciliation of the most directly comparable GAAP measures to these non-GAAP financial measures can be found in today's press release made available on our website.

With that, I'd like to turn the call over to Cepheid's Chairman and Chief Executive Officer, John Bishop.

John L. Bishop - Chairman & Chief Executive Officer

Good afternoon and thank you for joining us for a review of Cepheid's second quarter results. This was the solid quarter of execution across the company, including research and development, operations and sales and marketing, delivering an important return to growth in North America and a number of exciting account wins and announcements that we believe will set us up well for a strong revenue ramp in the back half of the year.

Total revenue of $146 million, was up 10% from last year or 12% in constant currency. This included 7% growth in North America, while international revenue grew 15% or 21% in constant currency. System and other revenue of $24.8 million was solid, while reagents and disposable revenue of $121.2 million grew 12% year-over-year or 14% in constant currency. As noted, this was quite a strong system quarter. In terms of the commercial business, we set a new second quarter record for system placements and, in fact, delivered the second strongest commercial system placement quarter ever. Cumulative system placements in North America are now more than 2,000 and total global placements now comfortably exceed 11,000.

Global placements included 12 Infinity systems, including three Infinities, through our new distribution partner Henry Schein. This of course highlights a moderate complexity opportunities for our POL/POC distributors. We have previously been discussing this point. McKesson and Medline have now also completed training with Cepheid and we are pleased with the building pipeline of business that all three of our non-acute distribution partners are developing.

Clearly it remains early days, but we are encouraged with what we're seeing to-date. HBDC placements were also strong. You will recall that we were expecting an additional 200 systems to be placed in India in the second quarter, and we did successfully recognize approximately 170 systems of that number during the quarter. The remaining units are expected to be recognized in the third quarter.

Moving to reagents, revenue grew 12% year-over-year or 14% in constant currency with record revenue in each of our franchise families HAIs, Critical Infectious Disease, excluding Flu, Sexual Health, Virology and Oncology and Genetics. Reagents were up 1% from last quarter, with sequential growth across all of our franchise family, again excluding Flu, more than offsetting the greater than $10 million decline in our seasonal flu sales. Cepheid continues to be recognized as the leader in molecular HAI testing.

This is a responsibility we take seriously and we continue to deliver important test to support infection control efforts at the hospital level and to aid and to fight against antimicrobial resistance at a global level. And just the last month, we have further extended our HAI portfolio in the U.S. to include surveillance claims for Xpert Carba-R for detection of carbapenem-resistant organisms, which represent a significant and emerging problem here in the U.S. As noted by the CDC, high-risk patients, for example, those admitted from long-term care facilities, patients who receive medical care in endemic regions and/or patients admitted to high-risk settings such as intensive care units, should be tested at admission, and potentially periodically during their facility stay for CRE. Xpert Carba-R has the potential to be an important tool in helping hospitals of all sizes manage the rising threat of antimicrobial resistance. Unfortunately, it is likely a question of when, not if, these super bugs become more prevalent and a surveillance test that delivers results in minutes, not days, could dramatically improve patient outcomes and the hospital's ability to manage outbreaks.

We're also adding a new test to our family of C. difficile products outside of the U.S., Xpert C. diff BT. As you may be aware, that Xpert C. difficile includes a target for binary toxin, in addition to toxin B, used to make a presumptive call for the hyper-virulent 027 strain. Importantly, recent studies have shown that the presence of the binary toxin strains, other than 027, have also been associated with poor outcomes and a high relapse rate. Other studies have also shown that some strains that test negative for toxin by EIA, but are nonetheless binary toxin positive may be associated with clinical disease.

With that in mind, some Cepheid customers have shown interest in a separate call out for the binary toxin, so we will be releasing Xpert C. diff BT, which allows for an independent reporting of binary toxin results in addition to toxin B. Further, we are excited about the data emerging from several studies, showing that independent of binary toxin status, bacterial load estimates generated by the Xpert C. diff test may correlate with disease severity, likelihood of recurrence, and toxin production. Taken together, we believe that the potential of the existing test design, which remains best-in-class, is now beginning to be more fully realized.

In critical infectious disease, excluding flu, recorded record revenue for the quarter, driven primarily by strong TB sales in both commercial and HBDC markets. While flu was down sequentially, as expected, it demonstrated solid growth year-over-year, reflecting our increasing share gain in molecular flu accounts and continued progress in accounts adopting our combined flu and RSV test.

Moving to sexual health, we had a number of very significant milestones right around the end of the second quarter. First, following the overwhelming success of the Dean Street point of care sexual health clinic in London, a number of similar services have been launched. Hammersmith Broadway, from the same team behind Dean Street, opened its doors in West London in late June, and Checkpoint Paris also opened during the second quarter, making STD testing ever more accessible.

We are currently discussing a number of other similar projects that we would see this to be a transformational model of sexual health testing, extending further throughout Europe and perhaps even to other parts of the world. Our success in CT/NG, however, extends beyond the point of care. As you know, we have had considerable success in transitioning some portion of the send-out market into in-house testing. We continue to be a key enabler of what we believe will be a continued trend towards test decentralization.

Interestingly, however, we are also starting to see some success in higher volume testing accounts. Right at the end of the quarter, we added a new U.S. hospital account with a projected volume of about 40,000 CT/NG tests per year. This Infinity placement displaced an incumbent competitor, beat out another competitor's bid and is an important further validation of Cepheid's ability to support high throughput customers. In part, we secured this placement using a competitive head-to-head study conducted by Max Chernesky, Professor of Pediatrics, Pathology and Molecular Medicine at McMaster University.

While the full Chernesky analysis is yet to be published, the first published study compared the workflow on the Infinity 80 directly with the Panther. Whether one or 192 tests, the Infinity was found to deliver results more quickly and efficiently than the Panther. Additionally, the Infinity required substantially fewer disposables to run this system, with no waste or incomplete batches and required only 36 minutes of monthly maintenance compared to two hours and 28 minutes for the Panther. We are confident that these Chernesky studies will go a long way to help everyone better appreciate the full capabilities of our Infinity systems.

Outside the U.S., many countries are preparing to implement a new requirement by the U.S. Immigration Service for U.S. immigrants, age 15 and older to be tested and if necessary treated for Gonorrhea prior to admission to the United States. The CDC points to NAT or culture testing and also encourages physicians to use less invasive specimens, such as urine or self-collected vaginal swabs. The requirements also point to treatment, which should be provided on-site or directly observed. With those requirements in mind, we believe that Xpert CT/NG offers the only practical solution for same day test and treat. And therefore, could be a valuable tool for doctors and testing services, appointed by the U.S. Immigration Service to conduct immigrant physicals.

Ahead of the October implementation, we have already had our first system deployment in Guatemala directly linked to this requirement and expect to see some additional activity building as these testing programs are initiated. Just after the end of the quarter, we announced the publication of a study in the Journal of Clinical Microbiology, that per the mayor protocol validates the use of Xpert HPV as a front line cervical screening test for use outside of U.S. Europe is moving substantially, more quickly than the U.S. and adopting HPV primary testing. So, this is an important milestone that means we are now – we can participate more fully in the European market.

Even at advance of the study Xpert HPV showed some growing momentum in the quarter. So we're looking for more solid growth in the back half of the year and into 2017. We are also further encouraged by recent studies showing that Xpert HPV test performs just as well for detection of high-risk HPV types or self-collected vaginal swabs as do physician collected cervical swabs, which for the first time enable same day test and treat protocols to be implemented and it avoids dependence on expensive and inconvenient liquid cytology-based collection systems.

Collectively, these data position the Xpert HPV test as a unique opportunity in cervical cancer provision programs outside of U.S. Finally, our virology products showed good momentum in the second quarter, consistent with our experience with CT/NG our early wins have primarily been test transitioning from send outs. No surprise, its taking a little longer to prove our capability, as a higher throughput solution, that can support even the highest test volumes in a more traditional centralized testing model. The Chernesky study will help with this and we have a pipeline of higher throughput virology opportunities that we expect to be talking more about, as we progress through the year.

Of note, we believe our virology test can deliver a particularly differentiated product solution in the point-of-care market. One drop-in sexual health service in Spain, for example, has introduced our HIV qualitative test for certain patients. While these kinds of clinics tend to use the less expensive EIAs for front-line testing, this clinic reflects that some of their negative EIAs to our PCR test. As a result, they have identified a number of HIV-positive patients that would otherwise have been missed. There is value here because a molecular test can pickup HPV earlier than an immunoassay that looks for antibodies that take time to develop.

This particular clinic evaluates a patient's history and, for example, if the individual, has had a partner recently diagnosed with HIV or has particularly risky sexual practices, they reflect the negative EIA to our test. With this approach, and during a six-month review period, they have identified at least six individuals as HIV positive that were not detected by the antibody test enabling those patients to get on antiretroviral therapy more quickly and perhaps lowering transmission risk.

We're encouraged by these developments and other ongoing discussions with potential customers for our virology tests. Within the portfolio, Xpert HIV Viral Load is currently the largest contributor to revenue, followed by Xpert HCV Viral Load. Of note, Xpert HIV Viral Load is starting to build some momentum in HBDC. I'll now move on to an update on the test and systems in our pipeline. Xpert Trichomonas for male urine testing was submitted as expected to the FDA during the second quarter. Xpert MRSA Next Gen remains on track for submission to FDA later this year. Xpert MTB/RIF Ultra remains on track for release outside of the U.S. later this year. And Xpert Bladder Cancer is on track for commercial release outside the U.S. in the fourth quarter.

Xpert Breast Stratifier is on track for commercial release outside the U.S. around the end of this year 2016 or early 2017. And Xpert Xpress Flu and Flu/RSV remain on track for release in both the U.S. and internationally this year with an expected time-to-result for positives in as little as 19 minutes. Xpert Xpress Group A Strep remains on track for commercial release in 2017.

HIV viral load continues in clinical trials in the U.S. with submissions targeted around the end of the year. And finally, our HCV Viral Load also continues in clinical trials and is targeted for submission to FDA in the first half of 2017. Moving to Omni, I'm pleased to share that we are making good progress. To give you a little more insight into what happens here, the original Omni design called for an I-CORE with a single sided heating system in contrast to the proven double sided heating I-CORE that we use in the GeneXpert. As we shared in April, this initially look to be working well but it became clear, as we ran the system on an ever broader menu of test that the thermal dynamics were not performing as robustly as we expected. Therefore we made the decision to leverage the double sided heating approach that we use in the GeneXpert.

I'm happy to announce that it looks to be working very well at this point. Our current expectation is to finalize the new Omni I-CORE prototype during the third quarter. We will look to update you on our Q3 call but for now, I can say that we continue to be confident in meeting the Q3 2017 timeline for availability in the emerging markets. Finally, we continue to make good progress with the Honeycomb System and we are moving toward – forward with the use of the system in the development of our Breast Signature product.

With that, I'll hand the call over to Dan.

Daniel Madden - Chief Financial Officer & Executive Vice President

Thank you John, and good afternoon everyone. Please note that I will be discussing non-GAAP results unless otherwise specified. Total revenue of $146 million grew 10% from the second quarter of 2015 or 12% on a constant currency basis. System and other revenue up $25 million, grew 2% from the second quarter of 2015 or 4% on a constant currency basis, and reagents and disposable revenue of $121 million grew 12% or 14% on a constant currency basis. North American revenue of $81 million grew 7% from Q2 of 2015 and includes the impact of a year-over-year decline in non-clinical revenue, and international revenue of $65 million grew 15% from the same quarter a year ago driven by both our HBDC and commercial businesses.

On a constant currency basis, international revenue grew 21%. Non-GAAP gross margin of 51.5% was flat from last quarter, slightly better than expected due to product mix. Non-GAAP operating expenses, excluding collaborative profit sharing were $70 million. GAAP net loss was $10.2 million or $0.14 per share and non-GAAP net income for the second quarter was $3.5 million or $0.05 per share. A reconciliation of our GAAP results to our non-GAAP results is available in today's press release.

Moving to the balance sheet, cash, cash equivalents and investments increased to $379 million. DSOs decreased to 39 days and inventory increased about $6 million to $157 million. Moving to guidance and given that our first half revenue is largely in line with our plan, there is no change to the 2016 full year revenue guidance established in December. We therefore continue to expect full year revenue in the range of $618 million to $635 million. It is clear that this revenue guidance points to a step-up in the second half of the year. As John discussed, we have a number of building catalysts that will impact revenue in Q3 and Q4, notably we expect momentum to continue to build in North America following the return to growth in Q2.

Included in North America, of course, we expect to see a growing contribution from our distribution partners, which as John noted, got off to a good start in Q2 with some particularly large system placements. Also in North America, we should start to see the impact of our recent wins in higher volume CT/NG accounts in addition to the sexual health clinic business ramping outside the U.S. We expect to see building momentum in HIV Qual, which received WHO pre-qualification in the second quarter, and HPV following the completion of the Meijer protocol. And finally, we expect to deliver the remaining 500,000 TB tests to India in the second half of 2016.

In terms of revenue linearity, we have historically seen a sequential decline in revenue moving from Q2 to Q3. This year, as a result of the items noted, we expect Q3 revenue to grow sequentially. Then, we expect the step-up from Q3 to Q4 to be similar to years past on a percentage growth basis.

We continue to target non-GAAP gross margin of approximately 52% for the full year. For the third quarter, we expect gross margin to be marginally lower than Q2 due to a higher mix of HBDC sales. We then expect Q4 gross margins to be higher, reflecting a lower mix of HBDC and the early benefit of our gross margin improvement program. We continue to expect full year R&D to be flat to slightly down on a percent of revenue basis, although up on a dollar basis, as we continue to invest in our test menu expansion, and system expansion programs. Further, there is no change to our full-year expectations for sales and marketing and G&A, which on a percent of revenue basis, we expect to remain flat to down modestly compared to 2015. And for 2016, we continue to expect non-GAAP operating margin of approximately 5%.

We are however revising our full-year GAAP and non-GAAP earnings per share estimates to reflect better-than-expected other income and expense and income tax expense amounting to about $0.09 per share on a GAAP basis and about $0.08 per share on a non-GAAP basis. With that in mind, we now expect GAAP net loss per share to range between $0.47 and $0.44 and non-GAAP earnings per share to range between $0.31 and $0.34.

Before I hand the call back to John, a quick update on our gross margin improvement objectives. We continue to make steady progress on our initiatives and we started phasing in a new lower cost enzyme in two of our Xpert products in June as expected. Our other manufacturing initiatives are progressing well and are also on track for phase-in starting later this year. We will update you on these again next quarter, but we are pleased with how things look right now. We continue to target a non-GAAP gross margin in the 56% to 58% range and a non-GAAP operating margin in the mid to upper teens for the full year 2017. And we are actively managing our 2016 activities and planning our 2017 activities with that commitment in mind.

And with that, I'll turn the call back to John.

John L. Bishop - Chairman & Chief Executive Officer

Thanks, Dan. In summary, this was a solid quarter that we believe set Cepheid up nicely for the back half revenue ramp. We're seeing momentum in our new products, particularly Carba-R and virology. We are seeing an increasingly robust pipeline of opportunity for our three U.S. POL/POC distribution partners. And we're seeing North America return to growth.

From an R&D perspective, we continue to make good progress on the U.S virology trials. And on our oncology products, which, don't forget, include two bladder cancer and one breast cancer test that are close to commercial release outside of the U.S. We're making good progress on Omni and Honeycomb, with both platforms on schedule. Our manufacturing cost reduction initiatives are progressing well, as Dan has detailed. And we continue to manage the business with the 2017 targets firmly in mind. Overall, this was a clean and solid quarter for Cepheid.

With that, I'll invite the operator to open the call to questions.

Question-and-Answer Session

Operator

Thank you. Our first question comes from the line of Bill Bonello with Craig-Hallum. Your line is open. Please go ahead.

William Bishop Bonello - Craig-Hallum Capital Group LLC

Hey, thanks a lot. A follow-up question on the Xpress Flu. Do you think that you're going to – you talk about 2016 release. Do you think you will have that in time for this next flu season? And when do you kind of need to have approval in order to be able to effectively market and get orders for the flu season? And then just as a tag on to that, the turnaround time seems a little bit faster than we had been expecting. Just curious if you think that's going to hold on Omni as well?

John L. Bishop - Chairman & Chief Executive Officer

Okay. Certainly, Bill. So, couple of questions. One, in order to really get maximum benefit out of any flu test release, you really want to be releasing that product earlier in the year, more around summer time, August, September, latest timeframe frankly to really give accounts the opportunity to verify the new product. So, where we will be releasing earlier will be internationally with CE Mark products. So certainly, I think that one is going to get probably the full benefit of the flu season. In the U.S., we're going to be a little bit late, I think, to get the full advantage of the Xpress test going in. So we may have some accounts, but accounts don't generally like to be validating in the midst of the flu season.

That said, we continue to see very good traction with our – even though we have a longer time to results, with our existing flu and the Flu/RSV products. Now, relative to the question on turnaround time, yeah, we're using there, similar to what we've done with a number of our products, we call it EAT and it means Early Assay Termination. So in other words, where you have a clearly positive result, then there is no need to run fully to completion, and that's where the timing will be the shortest.

So you will see some, if they have, it's a negative, then you're going to run all the way to completion and those are going to be a little bit longer. Relative to the Omni, the Omni – I fully expect that to be just as good as what we're seeing right now, on the GeneXpert, if not a little bit better. Remember that going in on the Omni, that we will be including active cooling there, so the big majority of this is how the chemistries make the test run, so I don't expect to see a big, big difference there, basically going to be reacting about the same, but if anything the Omni will be a little better.

Operator

Thank you. And our next question comes from the line of Brian Weinstein with William Blair. Your line is open. Please go ahead.

Brian D. Weinstein - William Blair & Co. LLC

Hey, guys. Thanks for taking the question. I was on another call, so I apologize if you hit this earlier. But can you talk about early feedback from your distribution partners? How you're feeling about those relationships? And then on the U.S. sales force, are we kind of at full speed after the ramp up of the sales force last year? Are we seeing full contribution for them, or is that still going to accelerate in the back half of the year? Thanks.

John L. Bishop - Chairman & Chief Executive Officer

Okay. So on the distributor questions, yeah, we're seeing very solid activity with all of our – all three of our distributors, recognizing that Henry Schein group got quite a bit of a head start. So we've relatively recently finished training for McKesson and Medline. We're seeing lot of activity there, so a building pipeline for them. The primary item, Brian, that was really encouraged about, as we've been saying all along that there is significant activity and moderate or complexity accounts there and then opportunity in those accounts and we've clearly seen that already with the Henry Schein placements there. And then particularly, as we said, these were three Infinities going into these accounts.

We're also seeing with the accounts from a menu standpoint, a lot of interest and a lot of the driver's actually been CT/NG, along with C. diff and then some of the accounts were flip-flopping back and forth. We've seen GBS and some trichomonas. So, one of the big things we've been saying is, we have a menu of 18 tests, which are potentially applicable in that market and we see that in play already, so I'm feeling very good about that. Relative to the U.S. sales force, yes, they're up to full speed, but as you would expect and that's what we've planned for in the plan for this year, that momentum will continue to build as we go forward in the year and certainly you're seeing that as you look at Q1, now Q2 and expect to see more, even greater growth in the U.S. the remainder of the year.

Operator

Thank you. And our next question comes from the line of Derik De Bruin with Bank of America. Your line is open. Please go ahead.

Derik De Bruin - Bank of America Merrill Lynch

Hi. Good afternoon.

John L. Bishop - Chairman & Chief Executive Officer

Good afternoon, Derik.

Derik De Bruin - Bank of America Merrill Lynch

Great. So, acknowledging that you have a – the significant ramp you have in the second half of the year, can you – is there any sort of backlog metrics or committed revenues that you could share – some sort of metrics that gives a little bit more comfort other than just sort of the new product ramp and – and what's out there? Just a little bit more color around your level of confidence in the back half plan? Thank you.

John L. Bishop - Chairman & Chief Executive Officer

Well, we'll give you – we'll give you some, and I will give you a little bit of metric, which we'll talk about on the HBDC. Relative to North America, it's a combination of items there. One, we continue to outgrow the market relative to HAIs. We see that continuing. With regard to – what we called out in our prepared remarks, starting to get some high volume accounts in the CT/NG. As those accounts come online, of course, those volumes are going to be more realized in the second half of the year. So, all of that then becomes additive. We see the activity with the Carba product particularly getting the rectal swabs, so that it can be used for surveillance. I think it's going to be helpful on that product. As we look at timing, we get there looking for getting the male urinary claim for Trichomonas. That is going to help, I believe also in the U.S. market.

Now, other drivers giving you some quantitative aspects, which we called out in the call. We talked about in HBDC, the 500 units going into India. Those 500 units we expect to have those fully finished. Well, most of them are finished, as we said, Q2 a little bit rolls into Q3. But more importantly is the test volume, there's 800,000 tests to go with those, we only shipped 300,000 of the 800,000 during the first half of the year. The other 500,000 tests will come in the second half of the year along with continuing momentum that we see in HBDC.

Now, the other areas are a combination of internationally, so one in EMENA. We're calling out – we're seeing increased activity with opening of additional sexual health clinics like Dean Street. Those clinics are going to be coming online and of course that's going to be new test volume, which given when they're coming online right now is going to impact more second half of the year. Going forward, we're also seeing a ramping with the Virology products, we called out some examples there in Europe. And then, the other item is, we're seeing some building momentum in the emerging markets.

Operator

Thank you. And our next question comes from the line of Sung Ji Nam with Avondale. Your line is open. Please go ahead.

Sung Ji Nam - Avondale Partners LLC

Hi. Thanks for taking the question. John, could you comment on your outlook for the European market in light of what's going on with Brexit and maybe some other macro factors? And do you foresee any kind of potential disruption on the regulatory side, in terms of getting products cleared and things like that? Thank you.

John L. Bishop - Chairman & Chief Executive Officer

So, couple of comments. So you – one, maybe talk about in Europe on the Brexit situation. On Brexit, we've seen no negative activity at that point. In fact as we're seeing – talking about the momentum continues to build. Now, on the regulatory side, if you're talking about the new guidelines coming and impacting CE products. Now, I don't see any disruption in that. It's going to be quite a few years yet for that is actually implemented. And then, we'll have the opportunity to go in and address the new guidelines at that point in time. So, I don't see any disruption to product flow, I don't see a slowdown in that regards. The things in Europe continue to do quite well.

Operator

Thank you. And our next question comes from the line of Isaac Ro with Goldman Sachs. Your line is open. Please go ahead.

Isaac Ro - Goldman Sachs & Co.

Good afternoon. Thanks for taking the question. I wanted to talk a little bit about gross margin, it's obviously been a key focus for the company and quarter-to-quarter appreciate there is always a moving – a lot of moving parts in it. But was interesting in the comments you made about the enzyme program, the things you're doing there on the cost of goods side. And I'm curious, if you can maybe quantify the union economics or give us some kind of a benchmark quantitatively in terms of how significant that would be, either for the individual product line and maybe ideally kind of across the overall portfolio? Is that something that could be significant as you roll it out and scale it up? Thank you.

John L. Bishop - Chairman & Chief Executive Officer

So Isaac, I'll answer part of that, and then Dan can certainly jump in here. So yeah, we'd given some analytics on that before by giving an example. We're looking at enzyme units on a cost per enzyme unit basis. So if we looked at – theoretically if our costs, for example, were around $0.05 per enzyme unit and then we were dropping that cost to around a $0.01, so fivefold reduction. That's very, very significant relative to what we're doing. So, as we make that applicable to new product introductions, we've also indicated we're going to be applying that against some existing products, and those volumes out there once we deplete old inventory, the overall impact on the margins is, of course, quite significant and all that coming straight through the bottom line. Dan, you have additional?

Daniel Madden - Chief Financial Officer & Executive Vice President

Yeah, I think you asked more specifically about how does it affect broadly? And as we've disclosed before, we expect a 300 basis point improvement taking that fivefold reduction across the variety of products that we expect to transition enzymes in and the benefit of some of our newer products that come out with those lower – and lower cost enzymes. So we expect a 300 basis point impact on gross margins overall in 2017.

Operator

Thank you. And our next question comes from the line of Doug Schenkel with Cowen & Company. Your line is open. Please go ahead.

Doug Schenkel - Cowen & Co. LLC

Hey, good afternoon and thank you for taking the questions. Just on Carba-R. You've talked about the expectation for this product to be used more in surveillance settings. Can you give us an idea of how meaningful this product is for the company today? How quickly this change in thinking may alter your internal revenue model? But I guess bigger picture, do you believe this will accelerate HAI revenue growth beyond the roughly mid-single digit levels you've targeted over the next few years or should we still think of HAIs as a mid single-digit grower? Thank you.

John L. Bishop - Chairman & Chief Executive Officer

So, right now let's say the jury is still out fully on Carba-R. Right now it's a, I would say, it's less than C. diff relative to clearly an overall opportunity. We've just started with the rectal swab claims, we have had the product out a while in Europe. There is a running debate, in fact even in Europe, there was a lot of discussion earlier, about using it more broadly as a surveillance product. That hasn't yet occurred, still being used as a diagnostic product.

Now, the factors that I would see impacting in the U.S. markets, it's going to depend upon the incidents of occurrence that we start seeing here. Initially we may see diagnostic utility based upon outbreak. But as we've indicated, there are really – this is a very significant problem with increasing concerns. I know there is a lot of discussion within the clinically community on the pros and cons and what's the best way to go here. If this moves into a surveillance product, then you're going to have something that we'd look more in the range of more like a C. diff type of a product relative to total revenues that are there for the product.

As you look at HAIs in general over time, unfortunately the answer to your question is yes, I think what's going to happen is, we may go along here for next year or so with HAIs more in the single-digit growth, but the adoption of Carba-R and frankly, there is a lot of discussion on C. diff right now on looking at potential C. diff for identification of carrier status. If that comes online later then yes, that's going to push the growth of HAI's up versus where we're growing at right now. I mean the big thing to say is that this is unfortunate, but it's a developing problem that's going to exist on a worldwide basis.

Operator

Thank you. And our next question comes from the line of Bill Quirk with Piper Jaffray. Your line is open. Please go ahead.

William R. Quirk - Piper Jaffray & Co.

Great. Thanks, good afternoon. I guess John, on Omni, does the double heating approach at the I-CORE, does that change any of the assay turnaround time metric? Does it affect the cost of goods at all associated with the system? And I guess just lastly, are there any other issues that you're working on with the product? Or is this considered to be the prevailing problem and it now looks like it's solved?

John L. Bishop - Chairman & Chief Executive Officer

Correct, Bill. Yeah, this was the big problem with the Omni of course, the big reason for the delay was getting the I-CORE in a really robust manner. To your question, specifically from a timing standpoint, what we're seeing right now with the Omni, I mean, I guess within every cloud sometimes there is a silver lining. We're actually seeing with the design that we're running on right now, the system is likely going to be more robust than the original design, even had we gone forward and it worked broadly with all of the menu, the new design is even more robust than where we were. So I'm expecting this to work very well. Out in the field, from a time to result standpoint, it's going to be, I think maybe a little bit better, we've maintained the benefit of active cooling on the Omni, the existing GeneXpert system doesn't have active cooling.

Of course, one of the major attributes or benefits of that is that as you're working, particularly in the High Burden world, and you've got a lot of high ambient temperature, having active cooling on board is going to make the system ever more effective in that kind of environment. So, I think right now things are looking very good with the system. We're tracking as we said for Q3 2017, and I think things should go well. Now relative to your question on cost, going to the double-siding, yeah, it added a little bit to the cost, but nothing significant. So, our margins here are going to be very good even with the announced pricing that we've already put out there.

Operator

Thank you. And our next question comes from the line of Jack Meehan with Barclays. Your line is open, please go ahead.

Jack Meehan - Barclays Capital, Inc.

Hi, thanks. Good afternoon, guys. I have a two-parter on HBDC. Just as we're building our second half revenue build, what are some of the moving parts between instrument and consumables related to the India order just to keep in mind? And then as you look out further, there is some new competition looking to enter the market. What's your strategy to build on the strength that you've been able to build today? Thanks.

John L. Bishop - Chairman & Chief Executive Officer

So, a couple of things. So, as you've seen already, we've actually given the numbers. So, for India, the first half is going to be more weighted on the instrument side, second half is more weighted on the test side. So, the 500 units being primarily delivered in the first half, a few more left to be delivered in Q3, but then the big impact comes with the incremental 500,000 tests to be delivered during the second half of the year.

Now, it's interesting, and I really get a kick out of that, that you're asking me that question about new competition coming into the market because I've said for a long time that these are very interesting markets and markets of the future. And because of the action that we've put out in the market, and success frankly, yeah, you do see competition really trying to move and come into the marketplace. A general comment is that we are very well positioned. I mean we're doing well with the install base that we have now. The Omni going out into that market is going to extend our reach even more. So you go right into the microscopy centers.

Now some of the competition that you're talking about coming into the market, there was a report there, where our competitor's product worked pretty well on the HIV. But the big difference is their cost per test is significantly higher than where we are. Their cost on the system is significantly higher than where we are, and the system is quite a bit larger than the Omni, as we come with the product there, and even the battery backup that goes with that is quite a bit larger than where we are. So, we're well positioned. The Omni is very much the product of tomorrow that's there coming into the market.

The last item that I would comment there, one of the big benefits we've said with the GeneXpert all along is that with the investment that's been made by all of the NGOs in getting the product into the market, they're getting immediate incremental benefit because they can run other tests on the system other than TB, and now we're seeing that. I mean, there are already evaluations underway, and in some places, they're already utilizing HIV Viral Load, and they'll be using HIV Qual and ultimately HCV going into the marketplace. So we're looking to really leverage, one, the very large install base that we already have. And then two, extending our reach with the Omni system.

Operator

Thank you. Our next question comes from the line of Dan Arias with Citigroup. Your line is open. Please go ahead.

Daniel Arias - Citigroup Global Markets, Inc.

Yeah. Hi. Good afternoon. Thanks. Just going back to the distributors, John, on the Infinity placements that came through Henry Schein, just curious whether there is more of a concerted focus on higher throughput machines for those guys? And if so, would you expect to see an uptick in the quarterly Infinity installs as they get going? And then if I could sneak in a quick follow-up, just wanted to confirm that when you say virology is ramping that that means revenues were up sequentially in 2Q? Thanks.

John L. Bishop - Chairman & Chief Executive Officer

Okay. So, on the Infinity systems, you know, it's interesting, one of the things that I've said about the moderate complexity POL aspect of the market is that they have the advantage of all of our systems right now. And that's exactly what played out here. So, these placements actually started off with initial discussions on a smaller GeneXpert system. And then looking at the breadth of menu looking to be employed there, they went to the larger Infinity based systems.

Going forward, I expect to see more of the same. I expect to see combination of GeneXpert systems, but then as an account individually wants to go for broader breadth of menu utilization, the Infinity is going to really make sense, particularly as you look at the smaller Infinity 48 system where we sell at a minimum of 16 modules. So, they get really the extra benefit, and then they can build, and that's the other item that I feel really good about, is that they'll be able to – as they start using more menu, they build volume, then they can add incremental modules on to the system. So, all of that's working well, and that's showing some very good promise.

On the virology scenario, we had strong sequential growth out there on that, to your question. So yeah, we do see that ramping.

Operator

Thank you. And our next question comes from the line of Eric Criscuolo with Mizuho. Your line is open. Please go ahead.

Eric J. Criscuolo - Mizuho Securities USA, Inc.

Good afternoon. John, I didn't hear much on the – much discussion regarding China. So I was wondering, if you can give us an update on the status there and any developments in particular, the large fleet of instruments that were delivered couple of years ago, and what's the utilization like right now? Thanks.

John L. Bishop - Chairman & Chief Executive Officer

Sure. Thanks for asking that question. Actually China is doing very well. In fact, to your question on the 900 systems that were delivered over there and to a large extent were sitting dormant. The group over there is doing a really good job and the fellow that's heading up China has done an outstanding job and is making progress that those systems are now starting to be utilized. So a number of them, not fully all of them yet, but a number of them now have gone live and being used on a routine basis.

The other product that we have over there the C. diff is actually doing very well, and we're seeing growing momentum in China. So it's interesting, he sent us a video of the release and looking at everything that we're doing with all of the other countries around the world and the breadth of our menu, and here they have this release at a trade show in China, and the booth was mobbed. I mean, there were quite a large number of people there, and it was for one product and just the C. diff. So it's been making a big impact. And as we get more menu in China, I'll be expecting for a lot larger return. So all-in=all, it's growing, it's doing very well.

Operator

Thank you. And our next question comes from the line of Mark Massaro with Canaccord Genuity. Your line is open. Please go ahead.

Mark Massaro - Canaccord Genuity, Inc.

Hey, guys. Thanks for taking the question. I also missed the beginning prepared remarks. But I wanted to ask, if there is any update to the progress with reference laboratories? We were aware that you have at least two large labs. Are you seeing any increased adoption by assay? And can you provide an outlook for adoption of additional labs both in the U.S. and Europe? Thank you.

John L. Bishop - Chairman & Chief Executive Officer

Yeah. Well, so as we've looked at that, I mean, our primary customers are using the menu that we've talked about. We haven't really broadened the menu there. We have added a number of other additional reference laboratories there. And then specific to your question, yeah, we have a number of labs in Europe, reference labs that are utilizing our product and it varies because they'll have branches around the world, so we have mixed utilization of the menu in those labs around the world.

Mark Massaro - Canaccord Genuity, Inc.

Thank you.

Operator

Thank you. And our next question comes from the line of Tycho Peterson with JPMorgan. Your line is open. Please go ahead.

Tycho W. Peterson - JPMorgan Securities LLC

Hey. Thanks. John you talked about winning a high throughput account in the head-to-head with cancer. Can you maybe talk on just pricing dynamics for CT/NG? I mean, as you compete on more of these high throughput deals, how should we think about pricing trends? And then, similarly with Viral Load, you expect a similar level of take-off activity, if that market heats up a bit?

John L. Bishop - Chairman & Chief Executive Officer

So, yeah, as we've indicated, and frankly that was one of the key items that we included, when we reset our guidance on the gross margins to 56% to 58%. That was part of the – big part of the mix that we were looking at. There wasn't just a question of mix with HBDC, but as we've really been growing in success in sexual health and recognizing that the ASPs are going to be less there, those are already factored into the – the mix.

We did put in the same thing and to answer your question specifically, yeah, we see prices coming down on virology. Certainly that's come down and we've seen some significant drops in the emerging markets. In that regard, the one big difference we're not necessarily going to go and don't need to go fully head-to-head on pricing with the ultralow prices in the emerging markets, because those are centralized testing and the big thing we're going to take there, is take advantage of our – both our existing and the Omni and go after the disseminated market, which if – if they were to continue only with centralized testing be impossible for them to meet the goals that have been stated for those markets on patient management and treatment.

So, I expect those are going to grow very nicely. And we will be taking those at a higher price point. So, yes, in summary, the price points on these items are in fact stepping down. We have considered all of that – all of that's factored into our guidance. The good news there is our enzyme program is absolutely on track and we're successfully going to be rolling that product out. So, we're well prepared to be able to compete in those markets and frankly the other good news that I'm particularly enthusiastic about is that we're getting recognition on our systems that our systems can in fact do a good job and as the Chernesky paper showed I've long said that the Infinity is the most efficient, highest volume system on the market and that study really reflected that realization.

Operator

Thank you. Our last and final question comes from the line of Vijay Kumar with Evercore ISI. Your line is open. Please go ahead.

Vijay Kumar - Evercore Group LLC

Hey, guys. Thanks for taking my question. So maybe just a clarification question. John, I think you mentioned – you called out the sequential sort of 3Q revenue ramping higher than the past two years. And then just wondering if you could comment on the drivers 2Q versus 3Q and what's changing? Because if I look at your gross margin commentary in a mix driving 3Q margins below 2Q, it feels like most of the HBDC shipment to India that's probably going to fall in 3Q, is that – is that the right way to think about the sequential ramp? Thank you.

Daniel Madden - Chief Financial Officer & Executive Vice President

Yeah. Vijay, this is Dan, just to clarify. So, what we said was if you look at the last couple of years for example, you'll see that historically we've had a step-down from Q2 to Q3 and this quarter, this coming quarter Q3, we are expecting a sequential step-up. HBDC is certainly a part of that, I mean we are expecting a meaningful contribution from HBDC in the second half. It's not just the India reagents, we do expect the India reagents to be a driver in the second half overall, some of that maybe Q3. But as we've talked about before, timing with India is always a little bit uncertain, but overall, we do expect a higher contribution from HBDC in the third quarter, which is of course driving our guide there, if you will that gross margins will be sequentially down a little bit.

Operator

Thank you. That does conclude today's Q&A session. And I would like to turn the conference back over to Ms. Jacquie Ross for any closing remarks.

Jacquie Ross - Vice President, Investor Relations

Thank you. Today's webcast will be available for replay on our company's website shortly and will remain available for at least 90 days. If you have questions following today's call, please contact Cepheid Investor Relations at 408-400-8329. Thank you for your interest in Cepheid and have a great afternoon.

Operator

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program. And you may all disconnect. Everyone have a great day.

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