Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Cepheid (NASDAQ:CPHD)

Q2 2008 Earnings Call

July 24, 2008 4:30 pm ET

Executives

John Bishop - Chief Executive Officer

Jacquie Ross - Senior Director of Investor Relation

Andrew Miller - Chief Financial Officer

Dr. David Persing - Chief Medical and Technology Officer

Rob Koska - Senior Vice President of Worldwide Commercial Operations.

Analysts

Dan Leonard - First Analysis

Bill Quirk - Piper Jaffray

Quintin Lai - Robert W. Baird

Peter Lawson - Thomas Weisel Partners

Zarak Khurshid - Caris and Company

Brian Weinstein - William Blair

Bruce Jacklin - RBC Capital Market

Amrou Almanaseer - 36 Capital

Dan - UBS

Operator

Good day ladies and gentlemen and welcome to the Cepheid's Fiscal 2008 Second Quarter Earnings Conference Call. My name is Michelle and I will be your coordinator for today. At this time all participants are in listen-only mode. We will be facilitating a question-and-answer session towards the end of today’s conference. (Operator Instructions). As a reminder this conference is being recorded for reply purposes.

And now I would like to turn the presentation over to your host for today’s conference Ms. Jacquie Ross, Senior Director of Investor Relation. Please proceed.

Jacquie Ross - Senior Director of Investor Relation

Thank you Michelle and welcome to Cepheid's Fiscal 2008 Second Quarter Conference Call.

On the call today are John Bishop, Chief Executive Officer, and Andrew Miller, Chief Financial Officer. In addition, joining for the Q&A portion of the call are Dr. David Persing, Chief Medical and Technology Officer and Rob Koska, Senior Vice President of Worldwide Commercial Operations.

Today's conference call is being broadcast live from audio web cast and a replay of the call will be available later today at www.cepheid.com.

During this call Cepheid will make forward-looking statements including guidance of the future operating results. Because such statements deal with future events, actual results may differ materially from those projected in the forward-looking statements.

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 in addition to today's press release. The forward-looking statements including guidance provided during this call are about only as of today’s date July 24, 2008. And Cepheid assumes no obligation to publically 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 Principals.

A reconciliation of the non-GAAP financial measures to the most directly comparable GAAP measures can be found in today’s press release made available on our website again at www.cepheid.com.

Finally, and as a reminder this conference call is being recorded.

With that I would like to turn the call over to John Bishop.

John Bishop – Chief Executive Officer

Good afternoon and thank you for joining us this afternoon. As you may have already seen on our earnings release results for the second quarter are mixed. Most importantly we continue to demonstrate strong performance in the Healthcare Associated Infection or the HAI market driven by increased adoption and utilization of our GeneXpert system and strong Xpert MRSA test sales. However, this was somewhat offset by less than expected clinical products sales to other companies. Primarily Becton Dickinson or BD as we will refer to them throughout the call and Roche. Additionally bottom line results were significantly impacted by one time cost associated with a cartridge part manufacturing problem during the quarter that has been fixed. I will address both of these issues in more detail momentarily.

Our second quarter revenue of $42.1 million was up 55 same quarters a year ago. However despite continued strong year over year growth of 239% in our core clinical business. Total revenue was down 6% from last quarter due to the less than expected sales to non-core clinical partners and the expected decline in biothreat sales. In order to provide a clearer picture of the ongoing strength of our core clinical business which addresses the rapidly growing molecular HAI opportunity for this call we will break out our core clinical sales and our non-core clinical partner sales within the clinical category.

Sales to non-core clinical partners include sales of our SmartCycler instrument to BD as well as OEM sales of selected test through Roche. During the second quarter sales of disproof of products declined 33% sequentially. Primarily due to an unexpected drop in purchases of the SmartCycler instruments by BD. As has been discussed during prior call SmartCycler sales to BD were expected to decline due to the expiration of our contract in November of this year.

However, there was unexpected and significant reduction in BD purchases late in the quarter together with the reduction in the forecast for the remainder of the purchasing period. We will continue to meet out obligations with regard to BDs purchases through early November of this year but have modified forecast in anticipation of significantly lower SmartCycler purchases by BD. On a similar note Roche unexpectedly delayed and cancelled. Contracted purchases of a specific first generation OEM test product. This action impacted Q2 sales and were more significantly, negatively impact sales in 3 and Q4, both items will of course be illuminated from our expected product sales guidance for 2008. While we would have preferred more predictable decline in sales to non-core clinical partners, the negative impact was more than offset within the clinical category by sales growth of our clinical products to laboratories where we delivered another strong quarter, a very strong performance.

With the continued expansion of the HAI market and the success of our expert MRSA test and GeneXpert system are core clinical product sales grew 14% sequentially over Q1 and 239% year-over-year. Specifically, expert MRSA test sales grew to approximately $11 million up from approximately $8 million in Q1. We placed an additional 108 GeneXpert systems and 426 modules during the quarter bringing our cumulative installed based to 717 systems and 3560 modules.

Our corporate accounts group extended our portfolio of agreements with GPO's during the second quarter. In addition to previously announced agreements with Novation and Premier five additional GPO agreements were added highlighted by a single source agreement to net assets supply chain systems, a business partner to more than 2400 hospitals and 30,000 non-acute care providers. Our corporate accounts group also added 10 new integrated delivery networks or IDN agreements during the quarter led by a soul source agreement with Health Management Associates a leading operator of 64 hospitals in 16 states. Collectively, these additional GPO and IDN groups serve over 8000 hospitals throughout North America.

In view of our continued progress we remain confident that we are on track to achieve our expert MRSA sales guidance of $52 million to $55 million for the 2008 fiscal year. Developments of additional HAI products continues to be on track. The MRSA SA skin and soft tissue infection product or SSTI continues under FDA review and our MRSA SA blood culture test is expected to be submitted to the FDA this quarter. Clinical trails for C-diff and VRE are expected to be completed before the end of 2008 which is ahead of schedule. As such, our R&D expenses associated with the trails are expected to be higher than previously anticipated for 2008. Both tests are expected to be released in Europe before the end of the year.

In subsequent to the end of the quarter, Cepheid announced the formation of its HAI consortium. The objective of the consortium is to established global connection between hospital laboratories and leading academic laboratories in order to track involving drug resistance patterns, very determinants and the emergence of the new strains associated with specific HAI's. The resulting information will be used in the design of new or improved HAI we were fortunate to be able to attract world renown molecular epidemiologist Dr. Fred Tenover to head the program. Dr. Tenover is currently Director Officer of Antimicrobial Resistance at the CDC in Atlanta Georgia. The market for MRSA and other HAI test is continuing to develop in a rapid test, impart driven by legislatures across the US which enacting legislation mandating healthcare facilities to report HAI’s as well as implement infection prevention and control programs which may include MRSA screening. Presently two thirds of states mandate HAI reporting including one state Arkansas which has voluntary reporting. Of the non-mandating state seven states have created a task force to make recommendation on how they implement and infection and control program including HAI reporting. The majority of the state legislatures have adjourned for 2008.

Nine states enacted legislation are revised regulations related to HAI and MRSA surveillance. In an interesting development to Louisiana enacted the healthcare consumers right to know legislation earlier this month. This comprehensive build will require healthcare plans, healthcare providers and medical facility to report all information related to healthcare cost, quality and performance data to the Louisiana to partner develop of health on a periodic basis. The reported data will be made available on our website to allow the public to compare cost quality and performance of healthcare providers, healthcare plans and medical facilities in Louisiana. Now at the end of May the Tennessee governor signed a law requiring all healthcare facilities to perform a local risk assessment or MRSA. If there is not a reduction of MRSA infections the healthcare facility is required to implement a comprehensive program to reduce infections which may include but its not limited to consideration of use of active surveillance testing for high risk groups to identify a person is colonized or infected with MRSA. And as previously reported four states specifically Illinois, Minnesota, New Jersey and Pennsylvania currently require their hospital to conduct MRSA screening at some point of patient hospitalization.

During the 2008 legislative session six additional states brought similar bills to be considered as well as 11 states with bills requiring HAI reporting and two states with bills requiring healthcare facilities to implement an infection and control program. With more states having adjourned for 2008 only California and the District of Columbia and Massachusetts still have active legislation. California has two builds which together will require hospitals institute and HAI prevention and control program including screening all ICU and surgical patients who may be colonized MRSA colonized are infected. The state legislature has until August 31 to deliver a bill for the Governors signature.

On the district that Columbia legislation mandating hospitals to have an MRSA surveillance bill still underway in Massachusetts legislature is in the process of passing a comprehensive healthcare spending reform bills that includes the provision mandating hospitals to report HAI data is a condition of license here. The bill language mirrors the regulation that was implemented in March 2008 by the Massachusetts the partner of public health requiring hospitals to report HAI data effective July 1st 2008.

At the federal level six bills related to the infection prevention and control including mandatory HAI reporting are still pending in congress. As reminder the federal of government does not currently have mandatory HAI reporting or convention and control program standards. Instead, HAHS revise solely on voluntary reporting and is only issued recommended practice guidelines through the CDC. On last month the US centered health and education laboratory, labor committee, all they are hearing to examine the emergence of MRSA and antimicrobial resistance in the United States. Testimony was presented by representatives of the CDC and the FDA about their efforts to track and invest resources in combating antimicrobial resistance infections. The purpose of the hearing was to reengage interest in the strategies to address antimicrobial resistance legislation, which would promote research and establish a regulatory agency at the US Department of Health to coordinate activities at the federal level.

Now turning to our systems development program, we will be unveiling our new Infinity 48 system at the American Association of Clinical Chemistry, or AACC, meeting next week. The system will provide fully automated test cartridge handling with a daily throughput of over 1,300 tests. As the system will have true random access capability, the Infinity will be able to run up to 48 different tests with any mix of infectious disease oncology or other genetic diseases simultaneously. We continue to expect to initiate shipments of the system in December of this year and I might add that it was noted on Fed Biz Ops today of one of our first potential purchase orders for Infinity 48, which came from a VA institution, I believe, in the Tampa area.

Biothreat sales were 3.2 million lower in the second quarter versus Q1. The reduction in Biothreat sales was due to an expected reduction in test used by the US Postal Service or the USPS, resulting from seasonality and dual line use of one test system associated with a deployment and expansion program. Now test demand for USPS for their fiscal 2009 is now expected to be 1 million test cartridges. The USPS fiscal year runs October 1st through September the 30th, and as such their first quarter at this new lower volume represents our fourth quarter of 2008. The new lower volume is also reflected in our adjusted revenue guidance for 2008 along with the previously noted reduction in non core clinical partner purchases expected from BD and Roche. Andy will give you some more detail on that later in the call.

Now on our gross margin on product sales which was also below our expectations for the quarter primarily as a result of a production issue related to a GeneXpert cartridge part. Given that this was occurring, with high volume production at an incident rate of less than 1%, this could have taken an extended period to find and resolve. However, our operations team did an outstanding job in quickly finding the cause and correcting the production issue with no impact on product availability. We fully expect our product gross margin to return to first quarter levels in the current third quarter.

Now, I would like to turn the call over to Andy for a detailed discussion of the financial results.

Andrew Miller - Chief Financial Officer

Thank you, John. Note that growth comparisons are year-over-year unless stated otherwise.

Total revenue grew 55% to 42.1 million within which product sales grew 65% to 39 million. We experienced continued year-over-year growth in both system and reagent and disposable sales. Although these were down quarter-over-quarter due to the reduced activity in our non core clinical business as John described, other revenue consisting of contracts, grants and research was 3.1 million. Our clinical business overall however saw continued strong growth and now represents a record 66% of total product sales. Growth here continues to be driven by ongoing adoption of our GeneXpert platform and utilization of our Xpert MRSA tests, resulting in year-over-year growth of 144%. For the first time this quarter, Xpert MRSA test sales of approximately 11 million exceeded our legacy Biothreat business, which at 9.4 million or 24% of product sales continues to represent a diminishing element of our total revenues.

Industrial sales at 3.7 million continued at a relatively constant level. In terms of geography, North American product sales excluding the bio threat product for the US Postal Service were approximately $20 million an increase of 121%. After strong first quarter Europe was down slightly from the previous quarter but continued to perform well on a year-over-year basis with product sales of 9 million up 74% from the same quarter a year ago.

Most to the rest of the statement of operations, gross margin on product sales declined to 41% on a GAAP basis and to 43% on a non-GAAP basis sequentially down four points, primarily due to the manufacturing challenges outlined by John, and exacerbated by the lower than anticipated clinical partner sales. Again, we fully expect third quarter product gross margin to be back inline with our first quarter performance. We believe that this challenge is behind us and to date in the third quarter we have not realized any related additional manufacturing expenses.

Reflecting our gross margin results GAAP net loss was 7.5 million or $0.13 per share. On a non-GAAP basis net loss was 3.5 million or $0.6 per share.

Turning to the balance sheet, cash, cash equivalent and investments were 46.8 million an increase of 4 million from March 31st due mainly to strong improvement in our DSO to 40 days. We also recorded an additional write down of 0.9 million to our auction rate securities or ARSs. As a reminder we have 25 million par value of ARSs, our ARSs have no exposure to subprime mortgages, collateralized debt obligation or other similar securities related to the credit crunch. However, due to the current lack of liquidity within the broader ARSs market the auctions has failed since February 2008. As a result we reclassified our ARSs to non-current assets in our balance sheet and we have recorded cumulative write downs of 3 million as a temporary impairment. The cumulative write down is reflected in other comprehensive income in the equity section of our balance sheet. We continue to believe that our cash, cash provided by operation are sufficient to meet our anticipated operating needs.

Moving to guidance, it has been necessary to revisit our full year guidance in the phase of lower than expected non-core clinical partner sales and lower than anticipated biothreat sales in the fourth quarter from the US Postal Service. Note, that we expect US Postal Service related sales to further decline by about one million in the third quarter, and by an additional 2 million in the fourth quarter. You will recall that the Postal Services transition to the dual collector system as reducing test volume. For fiscal 2008 we now expect total revenue in the range of 173 to 177 million. Product sales are now expected to be in the range of 164 to 167 million. The new lower guidance reflects only lower expectations for our non-core clinical partner business and lower expectations for our biothreat business. Expectations for our core clinical business remain unchanged reflected in guidance for our expert MRSA test sale, unchanged at 52 to 55 million for fiscal year 2008.

Finally, based on lower revenue, lower second quarter profitability and higher R&D investment in support of our accelerated C-diff and VRE clinical trials we now expect full year GAAP net loss to be in the range of 20 to 22 million or $0.35 to $0.38 per share, excluding approximately 15 million related to stock compensation and one million related to the amortization of acquired intangibles. Non-GAAP net loss for fiscal 2008 is expected in the range of 4 to 6 million or $0.7 to $0.10 per share.

Now let me turn the call back to John.

John Bishop – Chief Executive Officer

Thanks Handy, while our Q2 results were less than we expected in total, our results continue to demonstrate the significant growth we are achieving in the MRSA market and the development of the HAI market in general. We see the market continuing to involve into three distinct segments, surveillance testing, diagnostic testing of symptomatic patients and testing of presurgical patients. We are on track to have the most complete portfolio of products in the industry to meet the needs of these developing markets. In addition we are actively developing a broad line of test for other market applications which will be more fully discussed during our upcoming Analyst Day presentation on July the 28th. We are seeing the GeneXpert Systems technology changing the way of healthcare practitioners who provide patient care with molecular testing. Large laboratories and taking advantage of the efficiency of the operation the GeneXpert system provides and smaller laboratories are now capable of obtaining dependable molecular results that were not previously available to them. Clearly our opportunities are significant and we are committed to providing the platform of choice along with a broad and growing test menu.

With that, I will turn the call back over to the operator, so that we can take your questions.

Question-and-Answer Session

Operator

(Operator Instructions). And your first question comes from the line of Dan Leonard of First Analysis. Please proceed.

Dan Leonard

Hi, good afternoon.

John Bishop

Good afternoon Dan.

Dan Leonard

John, first question on the non-core clinical, you mentioned the biggest shortfall was from in fact SmartCycler, Dickinson, they had their call earlier today and they left their forecast for that business unchanged. So help me better understand why there will buying, you know, selling as many regions, but buying less instruments, is it – repurchase a lot better than……….

John Bishop

Well, yeah first of all I mean, we are aware of their call and if you look at their actual growth, their growth quarter over quarter was de-minimus, I believe that they are -- what was our first quarter there, their quarter there was about 10 million and they only advanced to 10.3 million. And so as we are looking at it and based upon everything that we are seeing in the field the information we are receiving is that we are taking far at a way the majority of the new accounts coming on. They do seemed to be doing better in Europe than they are in the US. I can tell you in the US market, our assessment is that we are taking you know, near 7 out of 8 new accounts that are signing up. So that’s were we really saw the followup and their purchases were US units. The forecast we have from them continues with the relative to European units.

Dan Leonard

Okay.

John Bishop

So yeah that’s where we were surprised, because you know, we received a forecast from them routinely and that’s why we based our numbers on. So that’s the only thing we have to go by, when they came back and see substantially reduced and zeroed out, some of the purchases for the remainder of the year. That’s where we get the data.

Dan Leonard

Okay. And then on gross margin, you mentioned a couple of head winds in the quarter, but I didn’t hear you mentioned anything around rising resin costs and then the impact that could have on your plastic cartridges, did you notice anything late?

John Bishop

Well the good news here is that operation has done a great job and they have locked in purchase commitments and pricing. So we are covered with no impact on rising resin cost for the next 18 months.

Dan Leonard

Okay.

John Bishop

And then even post that as you look at the proportion of that represents a portion of the cartridges a significant part of our cost. But as we look at that potential costs increase 18 months from now versus other initiatives that we have underway, we believe we are well on a position to absorb any increase associated with resin costs post the 18 month period.

Dan Leonard

Okay. And then my final question. Do the challenges and gross margins this quarter impact your view on what the -- Tom what the gross margin can look like long-term?

Thomas Gutshall

Absolutely not, I mean as we indicated this was clearly is a one time event. And I am -- well it was really problematic relative to the impact on the margin. I mean I really give kudos to the operations group. One of the issues that we have set right along here is that we are now an high volume production. And one of the interesting barriers frankly to entry into this market for other people wanting to do the same thing, as you got to be getting into high volume production which brings its own issues ended up itself. And so when this issues, you have high volume production with an incidence of occurrence of the problem part happening at a less than 1%. So the team did a great job to identify something on a low frequency basis and correct it and we did not interrupt product shipments during the quarter. So no, not at all, I think quite to the contrary, we are going to be talking a lot more about our margins and programs in that regard at the Analyst Day and we are feeling very good about what we see for margin outlook.

Dan Leonard

Okay. Thank you.

Andrew Miller

You are welcome.

Operator

And your next question comes from the line of Bill Quirk of Piper Jaffray. Please proceed.

Bill Quirk

Yeah, thanks. A quick question for you. Can you help us think a little bit about in terms of the non core the clinical partner revenue? What the split there is between BDX and Roche and you are not giving me exact numbers John, but just I mean 50/50, 60/40 that type of thing?

John Bishop

Well, as far as where we as we indicated, the bigger impact on that was -- well, in the Q2 the bigger impact was BD. Now as we go to Q3, looking at the reductions there, the larger impact will be Roche as well as Q4. So in total as you look at this, the big majority really is Roche relevant to that OEM product. Now we got into that product when we acquired Sentech last year. That was a business for which we diligent and did have a fixed contractual commitment with that. So obviously we are currently in discussions with Roche in that regard because as I said this was totally unexpected and bound with the contract.

Bill Quirk

Okay, I understood. And then any change to recent pricing trends within your MRSA cartridges?

John Bishop

Yeah, actually no. We are doing quite well relative to our ASP on the cartridges.

Bill Quirk

Okay, very good. And then also just, if we look at utilization and obviously you can break down utilization in a couple of different ways. We tend to look at it on a two quarter lag. And it's been in and around about 13% or so for a couple of quarters now. And I guess I am trying to figure out John is should we work under the expectations that this should increase in the future or are we looking at kind of a mid teens, kind of flattish type utilization once people get up and running, they stay flat or are you seeing or do you expect to see rather additional testing volume being pulled through on existing installed?

John Bishop

Okay, so let me see if I can add to the specifically as possible Bill because as you will anticipate it's highly variable depending upon the account. Now on a general trend basis, we are yes seeing accounts once they are up and running starting -- and generally they are starting with the high risk population. We are seeing a trend that they are starting to grow beyond the high risk population and expand that definition that they are going to sweep into that area and we are seeing a step up in testing of all admissions. And then specifically within the VA segment because they started ahead of everybody else that trend is occurring at a little bit more rapid rate than in the non VA segment at this point.

Bill Quirk

So would you argue that there is still room for growth in the VA, John?

John Bishop

Correct, versus what you are saying right now, that is correct.

Bill Quirk

Okay, very good. And then lastly just a housekeeping question. Can you give us the general in North American, rest of world and then one of the respective module association…?

Company Representative

Certainly. Let me…

John Bishop

Number of sites, I can get it, I have got it here. So systems in US in North America were 37 and in Europe was 71 for a total of 108 and the modules in the North America 273 and in Europe 153 for a total of 426.

Bill Quirk

Very good, thank you. I will jump back in the queue.

Operator

Your next question comes from the line of Quintin Lai of Robert W. Baird. Please proceed.

Quintin Lai

Hi, good afternoon.

Company Representative

Glad to hear you Quint.

Quintin Lai

As we look at the modules or systems, we tend to focus on the modules a little bit less than they were in Q1. Could you talk a little bit about what are the trends that you are seeing given that some of these states have already I guess the legislature has already home, are hospitals in the non mandates states still sitting on the sideline waiting to find out what the revs are going to be for them or where we have with some of these early adopters?

John Bishop

Okay, so you have got a number of elements there Quint and let me give you some broad answers to them and then I will ask Rob to comment on some issue. So first Bob, what we are seeing in trending, yes it's helpful relative to accounts coming online within mandated states. However, we are also seeing and we have a number of states that are amongst the leaders relative to GeneXpert replacements and test utilization which are in non-mandated states. So what we are seeing from my prospective is a broader acceptance I think we are, lot of people are about crossing the caseum so to speak from your early visionary pioneers to having the suppler more broadly adopted, my view is we are about two-thirds of a away across that at this point and time, and its much more on the side that institutions are recognizing that they need to implement a surveillance program that hygiene and barer protectional loan will not due to job. So I think we are seeing more, more movement in that regard. Now with regard to the legislative activity, yeah, we are seeing in a couple of states some up tick in interest ahead of legislation like in California, it is continuing with the legislative activity. The other item that you want to look at with regard to modules per cabinet place is that we have done a very nice job, Rob has done in the US and penetrating a larger institutions and that’s why you are seeing part of where the majority of the placement being the GeneXpert 16 variously popular. Now, given that there is only finite number of the larger institutions then as you would expect we will start penetrating and accelerating to rate the smaller institutions and with that the number of modules will decrease. Rob you want to comment additional?

Robert Koska

Yes only other color I would like to add Quinn is that as we look at this particular quarter we saw pretty much of bimodal distribution on our GeneXpert cabinets. In fact, GeneXper’s 16 fully loaded cabinets were up quarter-over-quarter, but what we saw is a decline in those institutions purchasing GX four and 18 cabinet and they opted to be able to go with GeneXpert four cabinets in those instances. And that is pretty much consistent with the profile of hospital size that we were dealing with in those situations.

Quintin Lai

As you look at the reaffirm guidance for the year for clinical sales what should we expecting to see in terms of modules for the third and fourth quarter?

John Bishop

As we’ve indicated with the modules you have two issues now that are going to I think impact the ability to predict the run rate. One, we will continue to expect to see good system in module placement as we indicate a little long that’s going to be lumpy depending upon the capital available to institutions within the quarter and still far to way the big bulk of all our systems are not placed, they are primarily sold. So very much you need capital available for that. But then relative to one of the other questions it was just discussed the while ago, we’re seeing now an increase utilization within the accounts. So as we look at run rate on the test that will be driven by replacements but also a broadening of a definition that an account is going to be using for testing their population.

Quintin Lai

My final question I will jump back into the queue, you kind of give color account wins when you are going head to head against BD on the new clinic assets side. But then what are you seeing with respect to accounts said are trying to make decision between NAT and culture?

John Bishop

Actually we have some debt on that, now I will ask Rob to address that. Specifically, we will have a slide for you on that at the analyst discussion on Monday.

Robert Koska

Yeah Quintin, clearly year-over-year those institutions implementing an active surveillance program requires testing of their patients in last year that was estimated at about 21%, we currently see that from the Apex surveys at about 28%. Now clearly our best potential customer is somebody that has already made the decision to be able to impact their infection rates by doing surveillance. But on the other hand we do see institutions, primarily smaller institutions that are jumping in right now that has nothing in place and in certain instances don’t even have the capabilities of doing microbiology and jumping into the molecular era with our particularly test. We currently estimate all of the hospital marketplace that 7% of institutions are now selecting molecular as their modality of choice for surveillance testing.

Quintin Lai

Alright, thank you Rob, thank you John.

Operator

And your next question comes from the line of Peter Lawson of Thomas Weisel Partners, please proceed.

Peter Lawson

John, I wonder if you could just talk better things the Roche issue when it is fixed then you said it had no affect on revenue just hit margins?

John Bishop

Yeah it, where we found is I indicated that is going a long and it was a little incidence, we identified the trend about two-thirds of the way through the quarter, and then immediately went about the fix, so this was something that was an event that occurred later in the quarter versus earlier in the quarter.

Peter Lawson

Okay, but do you think it is completely fixed now there is no chance of…

John Bishop

Yes it is, yeah, we identified, as I said that I have to talk to the operations group because we identified the route caused and put a fix in on that issues, so that one is behind us.

Robert Koska

And of course the recent hits margins is the scrap that we work at the end of overhead, that’s basically the onetime margin hit.

Peter Lawson

Okay.

John Bishop

And based on this we did not go on back order to a single customers, and I think that’s very important to point out.

Peter Lawson

Okay, thank you. And then on the marsh business what happened there?

John Bishop

Okay. So that product was by first generation PCR products are not a real time product. The product was also sold, was or still is being sold in a specific area of the world. What happened was that we were actually in process of manufacturing the product with some shipments to go out during the quarter, they came late in the quarter so we don’t want this shipment, push back some shipments and canceled a number of shipments there. So as I said we had a contract there and so we have discussions with them about that and how we’re going to handle that entire issue.

Peter Lawson

Okay. And then how much revenue is it risk in the guidance, what else is coming from BD and Roche that guidance number with this economy side?

John Bishop

Lets see any other – we do have some other products that we do produce for Roche which are realtime PCR products. I don’t see them as at risk, the volumes there are much lower. Frankly the volume was higher. On this first generation product its there, and the other we’ve stripped out other company sales that we had in the guidance. So basically I mean, my view of this is that it’s unfortunate that it happened precipitously all look onetime right now but this is something I didn’t want the company to be dependent upon at all, I really focused on where we have controllable business and sales to laboratories which is the core for growth in the future of the company. So I think that we’ve accounted for all of this with the guide adjustment that we’ve taken right now.

Peter Lawson

You have stripped out the BD revenue zone?

John Bishop

Yeah well the BD other band what they have indicated for their forecast for Europe.

Peter Lawson

Okay, thank you so much John.

John Bishop

You are welcome.

Operator

Your next question comes from the line of Zarak Khurshid of Caris and Company, please proceed.

Zarak Khurshid

Hi guys thanks for taking my question, sorry to harp on the Roche issues, but could you clarify what fraction of Sentech sales are related to that specific Roche product, I think Centex exited ’07 tracking at about 8 million a year annually you know, if you pull out that Roche product how should we be thinking about that business.

John Bishop

Well I think, you don’t have a full formula on that now, because you have got mixed in the EPOGene sales, I mean that’s now over a year and so we have our own EPOGene sales that are mixed in there at this point in time, but the Roche sales as we look at that on a -- when we look at this on a quarterly basis, I mean they were significant, relatively to the Centex sales going in. I mean we bought them you know, was there, sales were primarily driven by OEM products nominally driven by the EPOGene product sales.

Zarak Khurshid

Okay. So as we are seeing in Roche, remind me do -- those shipment to fully come back later this year?

John Bishop

I am sorry Zarak, I was just looking at one other item. What was your question again?

Zarak Khurshid

You know, the Roche related weakness, so are we going to see that business ever come back or as Roche phasing out this product?

John Bishop

No, I think that we are taking that business as phased out. And let me come back and I think just to make it easier for you is give you a specific number. Its worth about $2 million a quarter.

Robert Koska

Not in the quarter we just had?

John Bishop

Correct.

Robert Koska

It’s only a partial quarter, but going forward.

John Bishop

Looking at Q3 and Q4.

Company Representative

Yeah.

Robert Koska

2 million a quarter.

John Bishop

Correct.

Zarak Khurshid

Okay, all right. And then looking at the system sales I mean it looks like overall instrument revenue was quite strong considering the drop off in BDX you know, again just to get a little more granular, could you give us a sense for what your expecting in total SmartCycler sales and what actually came through with BDX and is the fall off, maybe a function of them stocking up of SmartCycler earlier this year and maybe late last year?

John Bishop

Yeah I think you are asking for some supposition there, but I would agree with the later portion of your comment. I mean they have purchased a lot of product in the later part of last year and earlier this year. Looking at the situation and looking at their growth which I have discussed earlier in the call that it would be reasonable to expect that they are carrying a fair amount of inventory and did not want to add to the inventory in the face of their growth that they are right now certainly in the US market.

Zarak Khurshid

Sure. And then maybe if you could comment on how the effective ASP per module helps benefit or pat those instrument sales. It looks like it was you know, the price are getting per modules going up and is that relating -- how is that relating to the different configuration you are selling?

John Bishop

Well that’s exactly right. That’s the inverse aspect as the sales going down and if you look at our pricing configurations, the retail price point per module goes up. So the lower module price points are only in the larger configurations. In fact when you see the infinity, as you look at infinity 48 and the price point there you see a substantially lower price point per module, but as you go down to a -- you go down to a four then the price point per module jumps up substantially.

Zarak Khurshid

Okay, great. Just wanted to make we weren’t missing anything there. And then if you could just over again the timing of the biothreat you know, the government calendar and what the year is exactly that you are expecting the 1 million modules and I mean this is a little bit of a surprise to us. So……..

John Bishop

Surprise to us as well.

Zarak Khurshid

Okay. So when did you figure out that they were going to that two the dual kind of configuration and again when did this -- how fully implemented is this reduction across the mail processing centers and you know, just a little more color on the timing would be helpful for us?

John Bishop

Sure, absolutely. So to give you all the details on the post office we have said over a number of calls in fact since last year that the post office was going to go into a broader use of the program for a different type of mail format in addition to what they are currently running with. In the context of doing that they previously had one BDS unit that’s the by as our detection system per processing line within the post office, and if they have figured out that they were going to port two lines into one BDS unit which would bring down the total volume of test, and then once they redeployed the units that were freed up from the lines that the volume of testing would go back but we did not anticipate that it would go back to the 2 million level that they were running at.

We had also indicated that previously we thought that their volumes would drop down, could be in the area of 1.3 and 1.5 million cartridges as they moved to for that period into redeploy. So we were surprised this year when we expect that it was a cartridge PO coming in, in that range nominally at least about a 3 million on the cartridges, so we were surprised to get indications that they where going to go with 1 million cartridges. Now in addition to that as we’ve indicated there is tends to be seasonality and it tend to take disproportionately more cartridges in the fourth quarter. We don’t see that happening this year or either because they have existing inventory so we think two things that we’ve just been made aware of is that they’re going to level load the one million that they’re going to be taking for this year, for their fiscal year and the fiscal year starts October 1st. So there fiscal year is October 1 through September 30th which then makes our, that then their first quarter is our fourth quarter. So what hit the fourth quarter this year was we expected the seasonality Q4, the volumes to be higher to take those #1. #2 we expect that the total volume for the process in fiscal 2009 to be in the range that I have discussed.

So what's happens now is they come back with 1 million with their volumes and so, that would be level spread as we look at Q4 through Q3 of next year, then they will go into the next volume, now we will say this. There is a benefit that we’re enjoying with the five year agreement, because part of the five year agreement as a minimum volume purchase for them that they’re committed to annually of 1 million. So they can't go below one million and once they increase their deployment going to this other format whatever that occurs then we could expect some recovery in volume.

Zarak Khurshid

Okay so when did the five year period end?

John Bishop

We are going into what third year?

Robert Koska

Third year starts on October 1st yeah.

Zarak Khurshid

So I mean I guess the key question are they facing out or significantly ticking to reduce below that 1 million cartridge level at some point?

John Bishop

Yeah, so the answer for that as far as we see now is no, they are not facing out. But the overall utilization as they pulled units off line in ramp two lines into one gave the drop that we’re looking at right now. The question is going to be a better question is where they stand on redeploying the units that they’ve taken off line?

Zarak Khurshid

Right.

John Bishop

Right now I don’t really see those being deployed and impacting the earliest would be their fiscal 2010 year.

Zarak Khurshid

Okay and that again is the flat canceller.

John Bishop

That is correct.

Zarak Khurshid

Initiative?

John Bishop

That’s right.

Zarak Khurshid

In appropriate word if that was fully deployed, where do you sense for cartridge utilization on the flats canceller?

John Bishop

Now I think you can potentially see volume up in the - I will give you a range I think running around about a million 4 to the million 7.

Zarak Khurshid

Okay. Okay, great sorry the harp of biothreat stuff but…

John Bishop

Its quite right, it was unexpected for us as well.

Operator

Your next question is comes from the line of Brian Weinstein of William Blair. Please proceed.

Brian Weinstein

Hi, good afternoon. I am trying to get my head around here. Can you just confirm, I think you have something like 30 reps in the US, plus national account reps, yet you are only 38 systems in the quarter, can you explain why this is sold on per rep basis, why this is your hard sale at this point? Are you hitting a wall – what’s going on in the US?

Robert Koska

This is Rob Koska, and today first of all it generally takes anywhere between 3 and 6 months to be able to get a representative fully integrated and productive. I think that we have cross that threshold towards the end of the second quarter and then towards the third quarter here, well I think that we have a highly productive sales force. But alluding to crossing the caseum that John referred to previously you know, we clearly have moved to a different profile customer, we’ve moved from the pioneers or early adopters. Into the early saddler mode or the early majority mode and in doing that what we have found is that the sales process has become much more complex. And in recognizing that we’ve had to modify our sales approach, our sales tools and our sales process. We’ve analyzed the situation, we’ve e taken action to be able the rectify it and I think that we’ve put the right impact the market on a go forward basis.

Brian Weinstein

Can you maybe explain and go through what is more complex about this, what are the issues that people are raising in one of the tool that you have equipped your sales force sports with to go and address those issues?

Robert Koska

Well, early on we have identified keeping in leaders that were champions that had credibility within the organization that allow them to implement at their will. At this point we have to gain consensus much among a larger user base, and we are also finding that more proposals have to reach the board level then previously before.

Brian Weinstein

Alright. Are you seeing any prospect on capital spending from house versus reagent rentals, what’s going on here?

Robert Koska

Money is continue to be readily available, we have not seen a shift in purchases verus reagent rentals versus any other modality of acquisition, it has just a taken us a little bit of time to analyze the complexity of the sale situation and take that action. And we expect that it’s rectified at this point.

Brian Weinstein

And then last question for now is, can you give us some idea what the contribution in rough terms is from the national accounts on the total number of instruments sold and what are your expectations qualitatively for national accounts going forward, in fact they’re going to start meaningfully impacting the numbers that you guys report?

Robert Koska

Well, they are meaningfully impacting the numbers that we have it becomes a complex analysis because a number of these account has been on board prior to the signing of the national agreement and subsequently that we’ve been able to bring on board further accounts within those national accounts. What I think is important is that collectively with the group purchasing organization agreements with, they control 11,000 collective hospitals both on the primary basis and a sub primary basis and those contracts continue to open doors and once again that shortened the negotiation process necessary to successfully place GeneXpert’s within those accounts.

Brian Weinstein

All right, thanks a lot.

Operator

Your next question comes from the line of Bruce Jacklin of RBC Capital Market. Please proceed.

Bruce Jacklin

Hi now you going to be moving up the CRE and C-diff clinical trials. Is that going to impact the anticipated long states?

John Bishop

Well, yes we do anticipate getting them released earlier in '09 then what we had anticipated in the US. We do anticipate them to be released as a CE mark product in Europe before the end of the year, this year which is as per schedule. So the key issue was to advance the release in '09 as much as we can. So it’s going to be very helpful that we finish the clinical trails this year per our expectation and then get the filing into the FDA. One of the big issues that we’re seeing there I think you may be seeing some of the same is that C-diff is right now getting almost as much attention as MRSA, big difference here. One of the issues that Robs group is facing on MRSA is that this is something that as we know accounts are now used to doing and simultaneous with testing we’ve got to put in place their barrier and hygiene programs. So those add time to getting the whole program set up. C-diff is not in that same situation there we have basically a pint up demand for leading a better diagnostic product to give a rapid result very quickly. So that’s reason why we are pleased by the fact that we’re advancing those forward, and we felt that even though it impacted the bottom line and there was smart move to take the incremental R&D investment this year and get that into the market as early as possible on '09.

Bruce Jacklin

Okay. And then turning over to MRSA what was the mix between the domestic and international revenues?

John Bishop

A big bulk continues to be in the US as compared to international, internationally right now we do have quite a number of accounts in Germany, one of the largest opportunity is still developing and that’s in the UK, you know, what their national testing initiative really is expected to get underway in January that could bring online potential opportunities of about 11 million test events in the UK. Now we will be talking more in the analyst day, we did finish a very interesting study over there that we’ve mentioned before where one of the institutions put GeneXpert right in the admissions department, and wanted to get the direct correlated with the laboratory and got a 97% correlation and they’re looking to figure that and how they deploy units so that they’re minimizing the time of the result so they can maximize bad utility, that’s something else what we’ve seen in the US. Separately we’ve got some other activities that I am hoping to talk about very near term in other parts of the world that we really haven’t mentioned up until this point. So as that becomes a little more clear we will look to discuss that as well.

Bruce Jacklin

Okay. And then moving over to the Postal Service this year Jason, I am clear on the numbers here when you say one million unit is that for their fiscal 2009 or is that the run rate that you’re currently experiencing?

Jason Spark

No actually we’re cutting off our run rate. Their fiscal commitment for their fiscal 208, so the period starting October 1 of 2007 running through September 30th 2008, their cartridge purchase volume was 2 million cartridges staring in October 1 this year 2008 and running through September 30th 2009 that expected purchase commitment will be 1,100 test spread over the four quarters. So you are looking about 250, 000 tests per quarter.

Bruce Jacklin

Okay. And then just want to follow up the question you’ve got a pricing grid with that contract, correct, so how does the pricing flex with the units?

John Bishop

Okay, with the volume step down against the pricing metrics, their price per test will be moving up. But then what happens also with the metrics as you extend out at the future years they do get the benefit of that year and there is a slight step down. So what’s you are going to see happen relative to their fiscal '09 the price per test that they will be paying will be going up then if their purchasing that the exact same level which if there are no minimum. So they need to-- then that price point would step down slightly for the fiscal '10 and 11 years.

Bruce Jacklin

Okay, great thank you.

John Bishop

You are welcome.

Operator

Your next question comes from the line of Amrou Almanaseer of 36 Capital, please proceed.

Amrou Almanaseer

Hi guys. Now, I mean, VA admission has watched basically from what you are seeing with cartridge sale to them and their daily admission. What percentage of admission do you think are currently being tested?

John Bishop

Rob, do you want to take that?

Robert Koska

Yeah, let me refer to data on that. As you know they embarked on that program that they announce the last year to be able to test all higher risk admission and then at the beginning of fiscal 2009 they expect it to be able to do approximately 1.6 million task based on all admission, discharges and some transfers. What we see is we see a trend moving towards that number, although currently realized at this point. Now 60% -- and this is based on purchase records that we have, 60% of our VAs are clearly doing more than just higher risk patients at this point.

Amrou Almanaseer

Okay. Now with regard to the sales prices getting more complex, I mean, is this basically you’re hearing a lot more notes and do you start to regroup the strategy or you kind of slowly building a pipeline that we can expect future sales to materialize from?

Robert Koska

We’re growing the pipeline and it’s a matter of being able to have the touch base with more decision makers in the process then what we’ve had previously versus that single champion that was able to drive something true the President’s approval, and it’s a matter of being able to gain consensus coordinate schedules and foresee decision.

Amrou Almanaseer

Okay. Thanks guys.

Operator

Your next question comes from the line of Derik De Bruin of UBS, please proceed.

Dan

Hi this is Dan in for Derik.

John Bishop

Hi Dan.

Dan

Just looking at the VRE and C-diff availability, is it somewhere you can give some color around the way you go about thinking about the distinguishing characteristics that might be seen from those that are looking to add VRE to a surveillance program and C-diff to a diagnostic program versus those that may be less like you did yourself?

John Bishop

Yeah, absolutely I mean, one of the big differentiating factors and I am going to let Dave Persing who is here really address that because we’re really pleased with that product, because what we will be able to give is an immediate rapid diagnostic which is a problem today, there is some testing around there but the overall level sensitivity is not great. But what Dave’s group has put together is a design where we will be able to make a therapeutic decision as a result of having the information as well. Dave?

David Persing

Yeah, so the – for VRE and C-diff, the VRE is a surveillance test and we think that the -- -- the hospitals that are currently doing and interested in MRSA surveillance are also going to be interested in VRE surveillance. Certainly they will be interested in VRE surveillance for the similar compromised patient populations, maybe the first patient population to be sprint. For C-diff that affects areas of the hospitals even effects our nursing homes to a great extent and there is this is visual of C-diff occurring in this country and internationally, and lot of it due to a drug resistant strain that’s called BI NAP or 027 that’s been found in think 37 states now in the US by the CDC, its responsible for hospital heath break at a very severe that I have high mortality, and our test will be able to distinguish that strain from the strains that are less likely to be drug resistance and that are also – this will also enable infection control to really jump on these outbreaks much more quickly no whether going within your hospitals because you will get tracking capability. The biggest benefit we think is the time result because these are infections, the most cases of hospital based diarrhea are not due to C-diff, but when they are, you really want to know it quickly because that patient has to go into isolation and so -- and they also need to be treated quickly. So on demand availability round the clock with a highly accurate test is really sort of the dream solution for this diagnosis.

Dan

Okay, I appreciate that. I think the rest of my questions have been answered. Thank you.

John Bishop

Thank you.

Operator

And your next question is a follow up from the line of Bill Quirk. Please proceed.

Bill Quirk

Hi. Just a quick clarifying question. You guys said that amount of biothreat revenue should go from 9.4 to about $1 million less in the third quarter and 2 million by the fourth. I assume that at that point since we hit a steady state in terms of volumes that we should expect that that revenue rate should continue in 2009, 2010?

John Bishop

Yeah, 2009 and 2010, that's correct Bill, yeah.

Bill Quirk

Okay, very good. Thank you.

John Bishop

You are welcome.

Operator

And your final question is a follow up from the line of Zarak Khurshid. Please proceed.

Zarak Khurshid

Hi. Thanks for taking the follow up. Pretty surprised that the BDX would curtail its for purchasing of SmartCyclers. Could you just kind of describe for us what you think might happen come the judgment day and what actually will happen in the marketplace. Will they have access to SmartCycler for their genome product?

John Bishop

The short answer is will they have continued access to the SmartCycler on purchase product from us, the answer to that is no. So what that will mean come November is that they will have to work off of their existing inventories in the US as well as their inventories in Europe. So I can't speak for them but I can imagine their management is looking at their total inventories and then deploying those total inventories on a worldwide basis.

Zarak Khurshid

Thank you.

John Bishop

You are welcome.

Operator

And that does conclude the question and answer session. I will now turn it back to Ms. Ross for closing remarks.

Jacquie Ross

Thanks Michelle. This concludes today's call. As a reminder, a telephone replay of the call will be available for seven days beginning at 6:30 pm Eastern Time today. The webcast of today's call will also be available on the company's website at www.cepheid.com for 90 days. Please refer to today's press release for details on accessing the replay. Thank you for joining us today. Good bye.

Operator

Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the presentation. You may now disconnect. Have a great day.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Cepheid Second Quarter 2008 Earnings Call Transcript
This Transcript
All Transcripts