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Nanosphere, Inc. (NASDAQ:NSPH)

Q3 2012 Earnings Call

November 7, 2012 5:00 PM ET

Executives

Bill Moffitt – President and CEO

Mike McGarrity – VP, Sales and Marketing and Chief Commercial Officer

Roger Moody – VP, Finance, Treasurer and CFO

Analysts

Brandon Couillard – Jefferies

Matt Dolan – Roth Capital Partners

Bill Quirk – Piper Jaffray

Frank Barresi – Ameriprise Financial

Operator

Welcome to the Third Quarter 2012 Nanosphere Earnings Call. Nanosphere would like to state that certain statements made during this conference call, which are not based on historical facts, may be deemed to constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.

Because these forward-looking statements involve known and unknown risks and uncertainties, these are important factors that could cause actual results, events or developments to differ materially from those impressed or implied by these forward-looking statements.

Such factors include those described from time to time in Nanosphere’s filings with the United States Securities and Exchange Commission. Please note that Nanosphere undertakes no duties to update this information.

I would now like turn the presentation over to your host for today, Mr. Bill Moffitt, Chief Executive Officer. Please proceed.

Bill Moffitt

Thank you, Darcel. Good afternoon everyone, and thanks for joining us for Nanosphere’s Investor Conference Call covering the third quarter of 2012. In a few moments I’ll turn the call over to Mike McGarrity, Chief Commercial Officer and Roger Moody, Chief Financial Officer, who will provide you additional insights into our third quarter results. But first I’ll give you my perspective on our progress.

There are four primary points to make today. First, our U.S. business is robust as evidenced by placements in Q3, our building customer pipeline moves traffic in attendance at our workshop at the annual meeting of the Association for Molecular Pathology and customer interest in our growing pipeline of new products.

Of the nearly 100 systems placed in the U.S. in the last year 90% are running or validating the blood stream infection assay and nearly half are running or intend to validate our respiratory virus assay this flu season. Second, we expect U.S. placements to continue to ramp in successive quarters. But we are experiencing softness in Europe as both macro and microeconomic factors are affecting our entire industry.

Over the past four quarters we’ve seen the mix of international system placements fall as a percentage of total placements, dropping from an average of about 35% of placements to a low of 20% during this third quarter. We expect this softness in the markets in Europe to continue. Therefore we are guiding expectations to around the low-end of our previously stated ranges for placements, until such time as we have clearer visibility to the market in Europe and to our timing for entry into additional markets in the Asia Pacific region, where we are in discussions with potential partners.

Our third quarter revenue is reflective of lower instrument sales in international markets and the 90 day customer validation lag for our blood stream infection assay. Instrument revenue is affected as a greater percentage of placements are in the U.S., where reagent rental agreements are more prevalent than outright sales, which is the predominant method of international placements through distributors.

Installations of the blood stream infection assay only commenced in the first week of July. With an approximately 90 day cycle from placement to usage as customers work through training and the validation process, we expect to see early customer revenue from our blood stream infection assay in this fourth quarter.

My final point is that our product pipeline continues to grow and create significant customer interest. Early in the third quarter we submitted our C. difficile assay to the FDA. We would expect to hear initial comments and questions from the FDA sometime later this quarter. Our gram-positive assay and our enteric assay are both coming along well through internal verification studies.

External clinical studies on the enteric assay have started and we expect to bring up additional study sites over the coming weeks. Our goal is to CE Mark the gram-positive assay right after the first of the year and submit the enteric panel to the FDA in the New Year as well.

Now, I’ll turn the call over to Mike, to expand further on our commercial progress. Mike?

Mike McGarrity

Thanks Bill. We had 50 new customer placements in the third quarter. Bringing our install base to more than 200 and we continue to make progress in building our customer pipeline, driven by our gram-positive blood culture assay. The pipeline is also fortified by those awaiting our gram-positive C. difficile and enteric panels. While it is traditionally difficult to project respiratory season dynamics we would also expect to see initial usage in our respiratory customer sides.

Q3 consumed our commercial organization focusing on upgrading software and beginning to move blood culture customers through the training and validation process and into live utilization and implementation. We have stated that we believe this process will take an average of 90 days. Our validated customers have so far met this expectation since our launch in early July and the remainder are entering or moving through that validation process.

Our commercial team is organized to support the customer through this process in order to ensure timely and successful implementation. We recently attended the Association for Molecular Pathology meeting, where we hosted a workshop featuring presentations of data related to our blood culture assay, as well as early clinical experience with our C. difficile and enteric panels by Cedars-Sinai Medical Center and Medical College of Wisconsin respectively. These presentations highlighted the accuracy, clinical utility and economic impact of our microbiology menu, and we are well attended, and well received.

We also attended the Infectious Disease Society of America Annual Meeting where the Cleveland Clinic presented data from their validation study of our blood culture assay from both in accuracy and ease of use standpoint. We are very encouraged by the response to these presentations by a range of hospitals, from community-based to larger regional centers, serving to build our local and national reference base.

We expect to continue publication of data and validation of our microbiology menu from additional centers of excellence with which we are currently working. As a result of this initial market response and the significant opportunity it presents we are in the process of expanding our direct U.S. sales force as well as the technical and clinical resources to support our customer base.

Our international sales and marketing efforts are advancing I’ll be at more slowly than the U.S. as Bill commented in Europe we are facing some macro and microeconomic factors that are affecting our initial sales and marketing traction. But we are optimistic that our partners have identified considerable market opportunity, it will probably take a little longer to see meaningful revenue contribution as they work through extended adoption timelines. Indications are that our gram-positive assay which should be available on Europe in Q1 will serve as the catalyst for that progress.

In Asia Pacific, we continue to work through the regulatory and reimbursement process and would expect to see returns on those efforts in 2013. It is clear that the near-term driver of placements and associated revenue will largely be U.S. based. While this puts near-term pressure on our Q4 and Q1 2013 placement projections, we expect to see consistently accelerating placements in the U.S.

Addition of the C. difficile assay, a full enteric panel, and a gram-positive panel to our menu offering will fuel growth in placements and drive customer utilization worldwide in the coming quarters. All of our global geographies are engaged in building a world class commercial organization focused on delivering timely and clinically actionable information enabled by the Verigene SP. Now, let me turn the call over to Roger.

Roger Moody

Thanks Mike. This afternoon I will summarize Nanosphere’s third quarter 2012 financial results. For additional information on our third quarter please refer to the related news release and 10-Q filing, both are on our website www.nanosphere.us. As Bill and Mike described our U.S. customer base is growing faster than our expectations, driven primarily by our blood culture gram-positive test. The growth in customer placements, we yield revenue growth from test utilization trailing by about a quarter.

Encouragingly, the first gram-positive customers installed in July have recently completed their validations and we are beginning to see utilization in line with our expectations.

Now let’s dive into the third quarter results. Third quarter revenue was $900,000, most of which was driven by consumable sales. This compares the $600,000 in the third quarter of 2011 and $1.3 million in the second quarter of 2012. This sequential reduction was driven by weakness in European market described previously by Bill.

This is important to note that systems for international placement are purchased up front, while U.S. placements are predominantly reagent rentals. Consumable revenue was approximately flat sequentially. However, it included a shift in cartridge mix. Second quarter included respiratory cartridge volume from the tail-end of the flu season and the third quarter included gram-positive sales from the first customers that completed their validation. Turning to spending, research and development expenses were $4.6 million in the third quarter of 2012, as compared to $5.8 million in the same period of last year. This decrease was due to the timing of clinical trials.

Selling, general and administrative expenses in the third quarter of 2012 were $4.4 million, compared to $3.8 million in the third quarter last year. The increase in SG&A was due to sales and customer support expansion, partially offset by reductions in equity compensation expense. Overall total operating expenses in the third quarter were $9 million, as compared to $9.7 million in the third quarter of 2011. Net cash increased in the third quarter by $18.2 million due to the net proceeds from financing activities of $26.5 million, offset by operating and investing activities of $8.3 million.

Operating cash flow in the third quarter included $1.3 million of inventory for systems to support our growing customer demand. As anticipated our spending has begun to shift from operating expenses to working capital associated with accelerating customer growth. We believe that our cash is sufficient to fund the business through positive cash flow.

To maintain a strong balance sheet and maximize our flexibility, we are accessing various alternatives to finance this working capital need. We ended the third quarter with $41.9 million in cash. We are encouraged by the growth we are seeing in our U.S. customer base. This growth will translate into revenue although it will take at least a quarter as we complete installations, training and validation. The challenge is we see in European markets will shift systems’ revenue from upfront sales to reagent rental agreements, where we recognize system revenue over the term of the agreement. However this dynamic is largely offset by higher consumable revenue and margins from U.S. customers. The bottom line is that we believe our clear past of profitability remains intact.

Now, let me turn the call back over to bill.

Bill Moffitt

Thanks, Mike and Roger. Before moving on to take your questions, let me reemphasize my key points. With the clearance to market our blood stream infection gram-positive Assay at the end of June, our business has achieved an inflection point that will enable us to fulfill the promise of this technology and our company.

We, like others in the industry are experiencing softness in the international markets and must adjust our expectations accordingly. But our U.S. business is robust with both customer and new product pipeline is growing.

We expect continued acceleration in new customer placements in the U.S. As those customers come through the validation process, revenue growth will commence in this fourth quarter. The strength of our product pipeline and critical infectious disease testing and the capital generated from the recently closed financing will enable us to drive this company to profitability and generate significant shareholder value.

Now we’d be happy to take your questions and I’ll turn the call back over to Darcel.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Jon Wood with Jefferies. Please proceed.

Brandon Couillard – Jefferies

Thanks, good afternoon. This is Brandon Couillard in for John. Roger, could you break up the U.S. versus international revenue in the third quarter and perhaps give us the similar metrics for the second?

Roger Moody

We don’t break it out by line item, but what I can share with you maybe is the placement, because that’s what really drives the revenue. And as Bill mentioned, those placements have been shifting. If you go back to our second quarter, the placement we had were 25 of which about 40% were – the trailing number was about 40% of those placement had been international and the remainder were U.S. In the third quarter that amount, that percentage came down dramatically to about 20% and so, that’s – that is a break up that we can share. In terms of revenue, it’s just too early to breakout our U.S. versus our international revenue, I would say that the large majority of the revenue in the third quarter was U.S. driven now.

Brandon Couillard – Jefferies

All right, I will come at bit of a different angle, I guess, I mean could you give us a sense of the actual instrumentation revenue versus consumables?

Roger Moody

I’ll give you a rough guide on that, the consumable revenue of the $900,000 was about more than two-thirds of it.

Brandon Couillard – Jefferies

Okay. What were the most significant assays in terms of contributing to revenue in the third quarter?

Bill Moffitt

The largest single revenue driver was from our Hyper-Coag on our regional Verigene one followed by, as I mentioned, we have some revenue being contributed from our earliest validated customers under gram-positive.

Brandon Couillard – Jefferies

Alrighty, and then could you give us a sense of how you see the current flu season shaping up?

Bill Moffitt

I’ll differ that to Mike, since he’s spending more time with a boarder set of customers.

Mike McGarrity

Yeah, Brian, it’s early. I think that there is really no projections yet from, I think we look to pipe three types of sources, one is the CDC which hasn’t yet put out anything meaningful from the standpoint of early and then we start, we look to start to see positive is coming up through customers that run, more suspected cases and then our third data point is our ability for our customers to begin their validations on a season-to-season basis. So it’s still it is too early to project we haven’t seen a meaningful signal from any of those three sources.

Brandon Couillard – Jefferies

Bill, on the recent moderate complexity designation for the BSI test, I mean would you characterize that as is in line with expectations would you hoping for more of a low complexity designation just some thoughts on that?

Bill Moffitt

Yeah, Brandon, there is no lower complexity rating other than waived. And that the waived status is I would venture to say for quite sometime to come perhaps years and years not going to be applicable to these kinds of molecular assays. The complexity rating has essentially two trains of thought in it, questions that must be answered. One of them relates to how simple the product is to use, how much user skill is required, that generally goes to things like manual mixing steps pipetting steps, the number of steps that are critical to the assay that the user interfaces with the product if you will. And then the other arm of that is how much risk there is of an inaccurate answer and what downstream risk that inaccurate answer would pose for patient care.

In a waived test, the lowest possible rating, it is presumed that the devices virtually say foolproof and that even if you get a wrong answer, it sort of really doesn’t matter. I mean, I am taking shortcuts here with the language and the regulations, but trying to paint a category for you. So waived status you are going to find things like you are in dipsticks. diabetes, home, self-test glucose meters that sort of thing.

The next level of complexity up from waived is in fact the moderately complex ratings. The script there is that came in the complexity rating letter from the FDA essentially said in so many words, we find this device to be very easy to use, not complex at all. And therefore, we also sort of pass the other test which is the one of risk of inaccurate results. The highest, there is only one more complexity rating and that is high complexity. And the high complexity designation typically goes to systems, products that take a lot of hands on tech time, a lot of interactive steps. And it would be presumed that very easy to make a mistake, it could leave to an accurate result and therefore downstream patient complications.

So, it’s been interesting to watch the FDA and the industry. Early, early on a few years ago, virtually all molecular assays came out with a high complexity rating, just because of the natures of the technologies in the sort of underlying PCR stuff. If I’m not mistaking, I could be, but if I’m not mistaking the first sort of moderate complexity rating that ever got assigned to a molecular assay was to Cepheid’s GeneXpert and I believe it was the MRSA assay. And that was reflecting the simplicity of the use of a cartridge-based system that was reasonably fail-safe.

What we see in this rating for us is a continuation of that, you may recall that our respiratory virus assay is also rated moderately complex. The high level message here for the industry is that the technologies that are bringing brought to bear a molecular diagnostics are in fact very robust. And therefore, I think continue to underwrite the notion that molecular testing can be further decentralized. And I think that is an important message for the industry in general. And of course, we are very pleased to have such a critical assay as bloodstream infection be designated as moderately complex.

Brandon Couillard – Jefferies

Understood, thank you.

Bill Moffitt

Thank you Brandon, I appreciate it.

Operator

Your next question comes from the line of Matt Dolan with Roth Capital Partners. Please proceed.

Matt Dolan – Roth Capital Partners

Hey, guys good afternoon how are you?

Bill Moffitt

Hey, fine how are you?

Matt Dolan – Roth Capital Partners

Good. So I wanted to follow-up on your commentary around the placement environment you set out some goals earlier in the year, all the way I think the Q1 of 2013, so where are we relative to that? And if you wouldn’t mind layering in any competitive influences you are seeing out there as well into that question, I would appreciate it.

Bill Moffitt

Sure, absolutely Matt. We recall, we put out guidance in the 40 to 60 range for the third quarter. We in fact did 50; we put out guidance for Q4 at 60 to 80 and guidance for Q1 at 80 to 100. We set all along the Q4 guidance 60 to 80 and in fact Q1 guidance are the spread there is really driven largely by what kind of visibility we have to the end markets. We have good visibility here in the U.S. We have poorer visibility in international markets, notably Europe.

We have also said that historically our placements have been about 65% U.S., 35% international. What we are seeing and then therefore if you look at the mid-range of these projections call it 50 in Q3, call it 70 in Q4 and 90 in Q1. If you look at the mid-range of these and think about 35% of the top, you get down to what we would expect to see as visibility to U.S. based placement, so 65% of those numbers if you will. Seeing the softness that we see, we don’t expect Europe to go to zero that don’t miss to read our message here. But we are seeing weakness which signals something significantly less than the 35% kind of number we’ve been counting on.

And that’s why we are simply saying that we believe it’s appropriate now to look around the low end of those previous ranges or what we can expect going forward. I mean add one layer of incremental thought on to that and that is the Q1 has also had vacant to it some expectation on a flu season or some incremental placements driven by a flu season. It’s yet to be seen whether or not that flu season materializes (inaudible) answer to the earlier question from Brandon.

Matt Dolan – Roth Capital Partners

Yep.

Bill Moffitt

So we are just feeling I think it would be wise to look around the low end of those previously established numbers.

Matt Dolan – Roth Capital Partners

Okay. That’s helpful.

Bill Moffitt

But I’m sorry Matt for the interruption, but I do want to underscore here that we are not seeing softness in the U.S. at all.

Matt Dolan – Roth Capital Partners

Okay. Any competitive comments to tie into that?

Bill Moffitt

Competitions out there, but we don’t see any competitive inroads being made that would cause us to come back and down state or restate the guidance. This is purely an international mixed issues thus far.

Matt Dolan – Roth Capital Partners

All right. And you gave us some detail on, on the menu pipeline Mike, maybe you could respond to this, I know earlier in the year you saw some placements results, the expectation of the gram-positive test coming on the market. Are you starting to get any of that those rumblings from the field that might stimulate some incremental placements prior to unofficial clearance and launch?

Mike McGarrity

Hi, Matt. What we’re seeing which we feel good about as far as the comments on the U.S. pipeline is that we have I think on slide three, again maybe a couple of different types of customers in our pipeline that the blood culture, gram-positive customers that are looking to move forward with gram-positive and then dark gram-positive when it comes out, there are some in the pipeline that are going to wait till we have gram-positive and then bring them both up which is fine that that kind of sustains the pipeline as we go forward.

And then we obviously there are significant interest in our enteric panel. And I think that falls into the same category, we have a number of them that are current blood culture, installation customers that are saying we are really excited for the enteric and we want to adopt that and then we have a number of customers in our pipeline that are paced by enteric. So we think it’ll serve to continue to build the pipeline as we go forward.

Matt Dolan – Roth Capital Partners

Okay. And the last thing I wanted to touch on was the consumable side, Roger I know you mentioned that you kind of went through why it was flatter even down sequentially, but it was down on absolute basis and guess what I’m wondering is going forward once we get past the lag of the validation phase, are you seeing full-blown usage at these sites. I think the consumable level on annual basis that you were looking for per test was around $50,000, is that what you are seeing in the early days from these sites that are now validated and up and running or are they taking a more gradual approach? Thanks.

Roger Moody

We are, it is early and I would caution you that our data is somewhat limited, but the customers who first validated support our assumption in how much revenue we expect to produce per customer for gram-positive.

Matt Dolan – Roth Capital Partners

Thank you.

Bill Moffitt

Thanks Matt.

Operator

Your next question comes from the line of Bill Quirk with Piper Jaffray. Please proceed.

Bill Quirk – Piper Jaffray

Great, thanks guys and sorry, if I am going to ask something that’s been covered. I end up – I did – I am jumping on a little bit late, but can you guys, Roger perhaps talk to the assay bring up time and it’s five months, my math here, roughly the right time to using is only reason to think that would tighten up as you guys get subsequent approvals, in other words, that initial gram-positive account may take five, six months initially, to bring the original assay up, it takes a couple of months for example on the gram-positive. Thanks.

Bill Moffitt

Yeah, Bill I’ll take that. We commented that for the blood culture assay we are modeling 90 days from essentially installation for training validation and to go live. We are so far based on the set launch, essentially the end of June, beginning of July, when we start upgrading software, that holding, we’re seeing customers come off live and we have reason to believe that, that’s a reasonable assumption. Obviously, as our end gets bigger, we can better predict and we would expect it to follow somewhat of a normal distribution.

As far as additional assays coming into pipeline gram-positive would obviously follow that same and enteric, it’s just too early to tell those validations will go in this new little market trends, but we wouldn’t expect that to be any longer than that 90 days that we’re building in.

Bill Quirk – Piper Jaffray

Okay, got it. And then second question for me, just relates to overall Europe and in terms of the – how you are placing instruments. I guess, it is a little surprise by the comment that you tended to historically sell them into Europe. I guess, I had perhaps mistakenly long thought that Europe was more of a reagent rental market and perhaps you could elaborate on that? Thanks.

Roger Moody

Yeah, Bill. This is Roger. We sell through distributors in Europe and the distributors provided the reagent rental agreements to the end hospitals and so traditionally all of the sales we had in Europe have been outright sales and our distributors have handled the working capital needs associated with any rentals that are conducted with hospitals.

Bill Quirk – Piper Jaffray

Understood. And maybe I could twist the question a little bit Roger. In terms of inventory asset distributors, can you talk to where we are now versus say where we are at the end of last quarter? Thanks.

Roger Moody

I’m sorry, I didn’t quite get your question...

Bill Quirk – Piper Jaffray

Inventory...

Roger Moody

There is little to no inventory at distributors only anything that’s in transit, when the – because of the distributor has to carry that capital cost, they are identifying a customer first and then ordering the equipment. Clearly, they hold it for some period of time to take it through customs and then get it into the hospital site, but they are not stocking up in any way that we are aware.

Bill Quirk – Piper Jaffray

Okay, got it. Thanks guys. I appreciate it.

Bill Moffitt

Thanks, Bill.

Operator

(Operator Instructions) Your next question comes from the line of Frank Barresi with Ameriprise Financial. Please proceed.

Frank Barresi – Ameriprise Financial

Hey, Roger. Yeah, I just want to make sure I understand this right. The $50,000 is what you expect from the blood stream infection that’s – what you’re thinking you’re getting around that now and that about 90%, did I understand it correctly about 90% of the install base is doing the blood stream infection at this time or trying to test it?

Roger Moody

Yeah, your numbers are right, but the timings are a little bit off. The $50,000 is what we expect and have seen some evidence is occurring with gram-positive customers and that’s $50,000 of revenue per year with those customers. The 90% is when you look at the U.S. based microbiology customers. So this would be customers who have adopted our products either for respiratory virus or for gram-positive either are validating have validated or intend to validate the gram-positive test. So we are in the process of getting all of those customers up and running.

Frank Barresi – Ameriprise Financial

Okay. And then about 65% of the installed base is U.S. microbiology is that right or is that?

Bill Moffitt

Hey Frank, this is Bill Moffitt.

Frank Barresi – Ameriprise Financial

Hi, Bill how are you doing?

Bill Moffitt

Fine. How are you doing?

Frank Barresi – Ameriprise Financial

Good.

Bill Moffitt

Let me clarify that bit for you. So when I spoke to the percentages of customers that we’re going to use gram-positive assay as well as the respiratory assay, I was speaking specifically to the one – about 100 systems we have shipped, placed in the U.S. in the last four quarters.

Frank Barresi – Ameriprise Financial

Okay.

Bill Moffitt

So it wasn’t speaking to the entire installed base, because some of that installed base is the original Verigene one system which is running hyper-coag and Warfarin. And some of that installed base of course is international, but when we look at the – about 100% just, I don’t know the exact number, just so I have a 100%, but when we look at that number that were have been shipped since last year’s Q3, Q4, Q1, Q2, that kind of timeframe, there were about 100 instruments in there and about 90% of that 100 or so are actually validated in the process of validating or about to start their validation for the blood stream infection. And about half of them are respiratory virus.

Frank Barresi – Ameriprise Financial

Got it, and with the state of things now those numbers you have for your goals what you expect to happen pretty much all those that you’re going to be shipping are going to be for the clinical application.

Bill Moffitt

That is correct.

Frank Barresi – Ameriprise Financial

Okay, and so it’s okay and then and you’re going to – or is it you’re going to double your sales force isn’t that from you had I believe did you say early or nine or that you had about nine reps and you expect to double it over the next couple of quarters or?

Bill Moffitt

Yeah, we went from six and we reported nine and we’re currently at about 12, so that acceleration is a continuing and ongoing.

Frank Barresi – Ameriprise Financial

Okay and...

Bill Moffitt

Well, to support organization.

Frank Barresi – Ameriprise Financial

Okay, in the support organizations beyond, I mean those are the people that, okay.

Bill Moffitt

Correct. Those are the technical and clinical support people that support the customer.

Frank Barresi – Ameriprise Financial

Okay. Okay and but the enteric from what, the enteric in the U.S. while the C. difficile I don’t know how you expect to hear from the FDA I think you said at the beginning of the first quarter. And the enteric in the U.S. you just expect to get approved sometime in 2013 is that what you’re saying or?

Bill Moffitt

That is correct. We submitted the C. difficile 510(NYSE:K) to the FDA at the beginning of the third quarter. And so typically we would expect to hear from them about 65 days after they receive it, so sometime before the end of this quarter, we’d expect to hear from them with their initial set of questions and comments on our package that’s been submitted. And then the enteric, we expect to submit sometime in the New Year and we’d expect to get that one clear in 2013 as well.

Frank Barresi – Ameriprise Financial

Okay, great, great. And then and with that 50,000 it’s like there – you’re more or less the way they are going to use it is, they are going to test when they suspect a bloodstream infection they would be testing everyone that’s all in that category with the system.

Bill Moffitt

Right. They typically would run a blood culture bottle and if that bottle turns positive, then they will run a Gram stain on it and run the assay.

Frank Barresi – Ameriprise Financial

Fantastic, well. Thanks. It sounds exciting.

Bill Moffitt

Thank you, Frank.

Frank Barresi – Ameriprise Financial

You’re welcome, Bill.

Operator

And your next question comes from the line of Jon Wood with Jefferies. Please proceed.

Brandon Couillard – Jefferies

Thanks, Roger, it’s Brandon again. Just a follow-up, could you give us a sense of how you see operating cash flow trending in the fourth quarter and then perhaps an update on where you stand in terms of transitioning over to the lower cost up straight?

Roger Moody

Sure. The operating cash as I described in my talk earlier is coming down a bit and it’s being replaced by working capital expense, which were continuing to ramp up the number of instruments that we have that we then place into the field. And so I would expect total cash consumption to be about on par with where it was in the third quarter, again in the fourth quarter and the gross profit margin really starting to kick-in in the beginning of 2013 and lowering the operating cash consumption.

In terms of the substrate, internal substrate we have completed the set up of internal manufacturing of our substrate and coding of our substrate. And that is going very well, we are in the process of converting over assay-by-assay, each substrate at a time and we’ve converted over several of them already and we’ll continue to do so. I would expect that sometime in the first half of next year, we’ll have completed the work to get all of our assays over to the internal coded substrate.

Brandon Couillard – Jefferies

Thank you.

Operator

There are no further questions at this time. I would now like to turn the call back over to Mr. Bill Moffitt for closing remarks.

Bill Moffitt

Thank you, Darcel and thanks to everyone for joining us, we appreciate your continued interest and support in the company and look forward to visiting with you and continuing to update on our progress. And would remind everyone that there are a number of financial conferences coming up between now and the end of the year and we will be participating in several of these, so we look for the opportunity to meet with you and get out to visit you in-person. Thanks again for joining us for the call today. Everyone have a good evening.

Operator

Ladies and gentlemen that concludes today’s conference. Thank you for your participation. You may now disconnect. Have a great day.

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