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Meridian Bioscience's (VIVO) CEO Jack Kenny on Q4 2019 Results - Earnings Call Transcript

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About: Meridian Bioscience, Inc. (VIVO)
by: SA Transcripts
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Earning Call Audio

Meridian Bioscience, Inc. (NASDAQ:VIVO) Q4 2019 Earnings Conference Call November 7, 2019 10:00 AM ET

Company Participants

Bryan Baldasare – Chief Financial Officer

Jack Kenny – Chief Executive Officer

Conference Call Participants

Bill Quirk – Piper Jaffray

Brian Weinstein – William Blair

Catherine Schulte – Baird

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the Meridian Bioscience Fiscal Fourth Quarter and Full-Year 2019 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised that today’s conference is being recorded. [Operator Instructions]

I would now like to hand the conference over to your speaker today Bryan Baldasare, CFO. Thank you. Please go ahead.

Bryan Baldasare

Good morning, everyone, and welcome to Meridian’s 2019 fourth quarter and year-end conference call. Our apologies for the slight delay, we were trying to get riveting down as quickly as we could before we got started here. By now, you should have access to a copy of the earnings press release that was published earlier this morning. If you have not received a copy, please go to the Investors Relations section of our website to access a copy of the press release and this morning’s presentation.

Before we begin today, let me remind you that the Company’s remarks include forward-looking statements. Forward-looking statements are subject to numerous risks and uncertainties, many of which are beyond the Company’s control, including risks and uncertainties described from time to time in the Company’s SEC filings. The Company’s results may differ materially from those projected. The company undertakes no obligation to publicly update any forward-looking statements.

Additionally, throughout this presentation, we refer to non-GAAP financial measures, specifically operating expenses, operating income, operating margin, net earnings and earnings per share each on an adjusted basis. A reconciliation of these non-GAAP financial measures with the most directly comparable GAAP measures is included in our press release, which is available on our website.

Let me turn this over to Jack.

Jack Kenny

Thanks, Bryan. Before we get to the financial results, I’d like to take a minute to highlight a few of Meridian’s major accomplishments from Q4 this past year. Let’s start with Diagnostics. In Q4, we took significant steps forward in our execution of our diagnostic strategy. Our commercial team under new leadership is executing well and has made great progress in the turnaround of our Diagnostics business.

In Q4, the Diagnostic business stabilized, which is a key first step to returning back to growth. Our integration of the GenePOC business and revogene product line has gone better than anticipated. Our commercial team has executed well and customer acceptance of the product has exceeded our expectations. We have placed approximately 60 revogene systems in Q4 and many of the customers have already implemented and are live within 30 days of receiving the system.

Another key element of our Diagnostic strategy was the redesign of our new product development process. We started this in late fiscal 2018 and had been making significant progress to building a strong pipeline of products. One key success for the quarter was the completion of our clinical trials and the FDA submission for our Curian instrument and the first assay using fluorescent chemistry for rapid immunoassays, a stool-antigen test for H. pylori.

Let’s turn our attention to the Life Science segment next. Our Life Science business turned in a record quarter for revenues and profitability with strong contributions from both our global IVD customers as well as strong growth from China. Importantly, we are seeing very good customer demand for our Lyophilization ready molecular reagents as these products have advantages in room temperature, shipping and storage as well as extended shelf life versus wet reagents.

We also made further changes to our cost structure in both business units in order to refine the customer focus and prepare for a much heavier investment in diagnostic new product development spending over the next 24 months. We will share more on that later when we discuss our 2020 guidance.

Now I’ll turn it back over to Bryan to walk through Q4 2019 and the full year financial results.

Bryan Baldasare

Thank you, Jack. Let’s move right into our fourth quarter results on Slide 6. As we reported earlier today, consolidated revenues for the fourth quarter of fiscal 2019 were $50.8 million as compared to $53.1 million in the fourth quarter of fiscal 2018. This represented a 4% decrease or about a 3% decline excluding the impact of foreign currency exchange rate changes. On a segment basis, our Diagnostics business revenues were down about 9% and our Life Science business revenues were up 7% for the quarter.

Gross profit margin declined 330 basis points during the quarter with both our Diagnostics and Life Science segments experiencing lower margins. Similar to our third quarter for our Diagnostic segment, product pricing particularly for H. pylori products had an unfavorable impact on margin. And for our Life Science segment, product mix between immunoassay reagent products and molecular reagent products had an unfavorable impact on margin.

In addition, gross profit margin for our Diagnostic segment was also affected by manufacturing ramp up activities in our newly acquired Quebec facility for revogene molecular diagnostic instruments and test devices are made. On an adjusted or non-GAAP basis, fourth quarter operating income was $7.6 million and a margin of approximately 15%. Adjusted operating income and margin include approximately $3.5 million in operating costs related to the revogene molecular diagnostic platform acquisition.

By operating costs, I mean costs of manufacturing as well as research and development and SG&A spending. Our operating expenses during the quarter, absence those related to the revogene molecular diagnostics platform acquisition trended similar to earlier periods in 2019, reflecting reductions in our cost structures in both business units from 2018 restructuring activities.

Also on an adjusted basis, net earnings were $5.4 million and diluted EPS was $0.13. On a GAAP basis, operating income was $5.8 million including acquisition related restructuring and selected legal costs of approximately $1.7 million in this quarter, compared to combined restructuring and selected legal costs of approximately $4.6 million in last year’s quarterly results. Also on a GAAP basis, net earnings were $4.1 million and diluted EPS was $0.10.

Now let’s turn to the next slide, which highlights our operating segment results for the quarter. Starting with Diagnostics, as previously mentioned, Diagnostics revenues declined 9% to $33.4 million predominantly driven by continued competitive pressure in our molecular products, most notably C. difficile and also our Foodborne product with both experiencing significant volume declines. And although expected and planned contract pricing changes done in 2018 for a number of customers including our two largest national reference laboratory customers contributed to a 7% decline in our H. pylori products for the quarter.

For our respiratory products, we have had lighter shipments in advance of the upcoming season this year compared to last year. Our LeadCare product revenues were flat for the quarter as favorable pricing offset volume declines. Diagnostics operating income was $3.2 million on an adjusted basis and a margin of 9.5%, expectedly this level of income and margin compared to 2018 were affected by the operating costs related to the revogene molecular diagnostics platform acquisition of $3.5 million, including $0.9 million of purchase accounting amortization.

As I stated previously, by operating costs, I mean both manufacturing costs as well as research and development in SG&A spending. Also affecting operating income and margin on an adjusted basis were the effects of lower pricing for H. pylori products in our reference lab channel as well as volume declines in our molecular products.

Now moving onto Life Science, Life Science revenues were up 7% in the quarter to $17.4 million or up 9% on a constant currency basis. Revenue contributions for immunological reagents with IVD customers were strong in the EMEA region as well as China. Customer order activity in China remained robust during the quarter and actually a bit stronger than in our third quarter. Revenues for our molecular reagents during the quarter continued to be affected by the transition of our academic business to independent distributors.

Life Science adjusted operating income increased 26% in the quarter to nearly $6 million, as a result of the higher revenue level and significantly lower costs overall, realizing the effects of restructuring and organizational streamlining activities in 2018. Adjusted operating margins for Life Science in the quarter were 34%, up over 500 basis points from a year ago.

Now let’s move into our full fiscal year results on Slide 8. As we reported earlier today, consolidated revenues for fiscal 2019 were $201 million, as compared to $213.6 million in fiscal 2018. This represented a 6% decrease, or about a 5% decline excluding the impact of foreign currency exchange rate changes. On a segment basis, our Diagnostics business revenues were down about 9% and our Life Science business revenues were up 2% for the year.

Gross profit margin declined 230 basis points with both our Diagnostics and Life Science segments experiencing lower margins. Similar to our fourth quarter comments for our Diagnostic segment, product pricing, particularly for our H. pylori products had an unfavorable impact on margin. And for our Life Science segment, product mix between immunoassay reagent products and molecular reagent products had an unfavorable impact on margin.

In addition, gross profit margin for our Diagnostics segment was also affected by manufacturing ramp up activities in our newly acquired Québec facility, where revogene molecular diagnostic instruments and test devices are made.

On an adjusted or non-GAAP basis, operating income was $38.9 million and a margin of approximately 19%. Adjusted operating income and margin include approximately $4.6 million in operating costs related to the revogene molecular diagnostic platform acquisition. Again, by operating costs, I mean both costs of manufacturing as well as research and development and SG&A spending. Our operating expenses absent those related to the revogene molecular diagnostic platform acquisition were down substantially from last year, reflecting reductions in our cost structures in both business units from 2018’s restructuring activities.

Also on an adjusted basis, net earnings were $29.1 million and diluted EPS was $0.68. On a GAAP basis, operating income was $32.7 million including acquisition related restructuring and selected legal costs of approximately $6.2 million this year, compared to combine restructuring and selected legal costs of approximately $13.1 million last year. Also on a GAAP basis, net earnings were $24.4 million and diluted EPS was $0.57.

Moving onto Slide 9, which highlights our operating segment results for the year. Starting with Diagnostics, as previously mentioned, Diagnostics revenues declined 9% to $136.7 million, predominantly driven by competitive pressure in our molecular products most notably C. difficile and also our foodborne products, with both experiencing significant volume declines. And although expected and planned, contract pricing changes done in 2018 for a number of customers including our two largest natural reference laboratory, customers contributed to a 7.5% decline in our H. pylori product for the year.

For our respiratory category, the lighter 2018-19 season contributed to buying declines in flu and group A Strep products. Our LeadCare product revenues were flat for the year. Revenues from sales of LeadCare analyzers were down for the year as a result of several bulk purchases for new accounts in 2018. Favorable pricing offset a slight volume decline in consumables. Diagnostics operating income was $25.8 million on an adjusted basis and a margin of nearly 19%.

Expectedly, this level of income and margin compared to 2018 were affected by the operating costs related to the revogene molecular diagnostic platform acquisition of $4.6 million, including $1.2 million of purchase accounting amortization. As I stated previously, by operating costs, I mean both manufacturing costs as well as research and development and SG&A spending. Also affecting operating income and margin on an adjusted basis were the effects of lower pricing for H. pylori products and our reference lab channel as well as volume declines in our molecular products.

Now moving on to life science. Life science revenues were up 2% for the year to $64.3 million after a strong fourth quarter. Revenue contributions for immunological reagents with IVD customers were strong in the EMEA region throughout the year and rebounded in China during the second half. Revenues for our molecular reagents were affected by the transition of our academic business to independent distributors, particularly in the Americas region. Life science adjusted operating income increased 38% to nearly $21 million as a result of the higher revenue level and significantly lower costs overall, realizing the effects of restructuring and organizational streamlining activities in 2018. Adjusted operating margin for life science in the quarter were 32%, up 850 basis points from a year ago.

Next, I would like to move on to our guidance for fiscal 2020 starting on Slide 10. Importantly, we are planning for 2020 to be a year of major investment in new product development for our diagnostic segment, and this is reflected in our guidance. We expect to begin clinical trials for six assays across three instrument platforms, revogene, Curian and PediaStat. Certain of these clinical trials will cross over into fiscal 2021 in terms of timing of completion with any related new product launches also occurring in fiscal 2021.

For revenues, we are guiding 2020 to be flat to down 3% with our diagnostic segment down 3% to 5% and our life science segment, up 2% to 6%. For our diagnostic segment, this revenue guidance takes into consideration that our revogene placements over the next 12 months are expected to predominantly be conversions of our existing Alethia installed base and also continue competitive pressures, including further price erosion in H. pylori products.

For our life science segment, this revenue guidance takes into consideration a longer selling cycle and converting current IVD opportunities to bulk orders. For our adjusted operating margin, which excludes selected legal spending and additional restructuring activities that carried over from our fourth quarter of fiscal 2019, we are guidance to 9% to 10%. This adjusted operating margin takes into consideration new product development spending of $27 million to $28 million predominantly in our diagnostic segment. Adjusted earnings per share on a diluted basis, which also excludes selected legal spending and additional restructuring activities that carry over from our fourth quarter of fiscal 2019 is expected to be $0.28 to $0.34 per share and assumes a tax rate of 23.5% to 24.5%.

Given the nature of our selected legal spending, we are not providing GAAP based guidance for operating margin or earnings per share on a diluted basis. In addition, our guidance excludes the medical device excise tax, the moratorium, for which is due to expire December 31, 2019, unless Congress chooses to again extend such moratorium or altogether repeals it. I would also like to point out that although we do expect our Diagnostic segment revenues to be down low-to-mid single digits for the whole fiscal year, we expect revenues for our diagnostic segment for the first fiscal quarter to be down high-single digits in line with the second half of fiscal 2019. Our revenue expectations for our Diagnostic segment for the first quarter along with current customer order patterns for our Life Science segment indicate our consolidated revenues for the first quarter could be down mid-single digits.

I would like to – I would like next to move to Slide 11 to provide further detail on the expected change in year-over-year adjusted operating income.

So, on to Slide 11. This graphic is intended to show you our expected change in adjusted operating income during fiscal 2020, our investments to reinvest our former dividend to transform the company to sustainable revenue and profit growth, began in fiscal 2019 with the acquisition of the revogene molecular diagnostics platform and the development of the Curian rapid immunoassay instrument and first assay. We intend to invest heavily in new product development for the revogene Curian, PediaStat platform simultaneously in order to accelerate our move to sustainable revenue and profit growth in 2021.

Incremental new product developments mainly in fiscal 2020 is expected to approach $11 million with a largest portion allocated to revogene followed by Curian and then PediaStat. Importantly, a majority of this incremental spending is in clinical trials. We also intend to invest in our employees as we work to reshape our culture to a high performance organization to deliver on our goals. The $4 million investment in incentive compensation includes both our cash bonus program and our equity award program. Importantly, the restructuring activities that we’ve executed during the last two years and the related cost savings have partly provided funding for the investments we wished to make.

I will now turn it back over to Jack to update you on our business turnaround numbers for both business units.

Jack Kenny

Thanks, Bryan. As those, who follow Meridian now in late fiscal 2018, we went through a comprehensive strategic planning process for Meridian Bioscience in both of our businesses. We want to spend a few minutes this morning to refresh you on the focus and share the status of where we are in the process.

As shown on Slide 13, there are three overriding elements driving our strategy as a company. First, we aim to reshape the financial profile of the company with the new emphasis on driving the growth that is critical to creating sustainable value in the business. Second, we are committed to increasing the investment in the business to drive this growth with a disciplined focused approach that would include both higher levels of internal spending in R&D and proactive acquisition activity.

Lastly, with the rising competitiveness in the industry, driving organizational fitness with higher levels of performance, speed and efficiency will be increasingly important for our future success. Our goal with our strategy is to create a more balanced investment profile and to reposition the company as a higher growth business with strong profitability and returns and an improved risk profile that addresses the competitive risks of an aging product portfolio.

Let’s move over to Slide 14. We started the transformation process of our business in fiscal 2018. We drove a detailed strategic planning process to help set the course for where we want to take the company and our two primary businesses. We knew the risks that we faced with our largest product HpSA being off patent and our product portfolio with need of investment and it was clear that we had to become more efficient.

Our organizational changes and cost reduction efforts in 2018 and 2019 took over $12 million of costs out of our business, which we have used to offset the pricing risk and to invest back into our business.

We made significant changes within the organization to maximize the current talent and to bring in seasoned professionals to help us build a new stronger Meridian. We have made great progress in 2018 and 2019, but we still have work to do. Fiscal 2020 is a year of heavy investment in our product pipeline, developing new products across our three main platforms, Curian, PediaStat and revogene. At the same time, we are building a stronger commercial team that can fully leverage the breadth of new products we plan to bring to market over the next 18 to 24 months.

Now, let’s spend a few updating you on some of the results of this process and the key elements of the strategy for each of our business units. We’ll start first with our diagnostics business.

Let’s move to Slide 16. In our strategic process, our goal is to become the trusted partner to IDNs, also known as health systems for gastrointestinal testing and pediatric point of care. In order to achieve this goal, it was critical for us to improve our position in the molecular side of our business. This led us to our acquisition of the revogene system in June of 2019.

one of the attractive features to revogene molecular platform acquisition was the perfect fit between the revogene system and its current menu for FDA-cleared assays and the imminent need to convert our existing alethia customer base that has been under competitive attack. Over 80% of our current alethia revenue comes from group A Strep, Group B Strep and C. diff assays. The ability to immediately go to our installed base and offer them a state-of-the-art sample to answer molecular system will enable us to build a strong reference base and provide us a platform for future growth. This is a key part of our focus and we are moving aggressively on this execution.

After the first 120 days, we are actively converting customers from our alethia system to the revogene system and the results to-date are ahead of expectations. We see fiscal 2020 to be focused on stabilizing and protecting our base, building a strong installed base will enable us to increase competitive conversions and enable us to leverage the installed base as we bring new assets onto the system in fiscal 2021 and beyond.

Let’s move over to Slide 17. this slide provides a little bit more detail on how we are doing with the commercial execution. During the first 120 days under Meridian’s ownership, we installed approximately 60 instruments above the limited installed base that we purchased. Our goal is to be at 250 or more instruments in our installed base by June 30 of next year. As we previously mentioned, we expect these placements will have predominantly conversions of existing Alethia accounts. However, we have seen success with new accounts adopting the revogene platform and adding assays to existing accounts as part of the conversion of the revogene platform.

Moving to Slide 18. our employees in Québec, who manufacture our revenue in instruments and reagents, are actively working to increase production capacity to meet the strong customer order demand. They are transitioning from an organization that largely manufactured to meet new product development needs to an organization that also needs to manufacture to meet commercial needs. The good news on this front is that our capacity has significantly improved since the acquisition date and we are implementing plans to continue to ramp up of both instruments and reagents.

Turning to page 19. In our strategic plan, we committed to increasing investment into our diagnostics business. After the acquisition of the revogene product, we also eliminated our shareholder dividend. This was done to enable us to further invest in strengthening our diagnostic business. Historically, Meridian’s investment into diagnostics R&D would light with mid to high single-digit spend into R&D. After we overhauled the new product development process to improve its effectiveness, it was critical for us to increase our investment. We started to do that in fiscal 2018 and further increased it in fiscal 2019. in fiscal 2020, we have multiple active development programs across all three of our platforms: Curian, PediaStat and revogene.

this has us investing nearly 20% of our revenue back into R&D in fiscal 2020. In fiscal 2020 we will have more than doubled our historic investment into R&D as we refresh our product line and develop several new exciting products. We expect R&D investment as a percent of revenue to come down in fiscal 2021 somewhere in the neighborhood of 15% and likely be consistently in the 10% to 12% range over time. We believe this investment will enable us to build a more sustainable and growing diagnostic business going forward.

Moving now to slide 20, on the previous slide I spoke to – our increased investment in R&D in the near term. The investments over the past 18 months have started to pay dividends as we worked to bring several new products to market. The spiking investment in fiscal 2020 and some in fiscal 2021 is related to significant increases in our clinical trial spending.

Successful clinical trials are the last step before bringing products to market. We have been making good progress, the acquisition of revogene molecular platform provided us four FDA cleared assays and as previously mentioned, we’ve completed clinical trials for our Curian instrument and its first assay, a test for the detection of H. pylori antigen and stool. And we submitted this in September of 2019.

Importantly, as we look forward to the next two fiscal years, we anticipate two new products to launch in fiscal 2020, the Curian instrument and Curian HpSA and have a strong pipeline of products we anticipate will launch in fiscal 2021 and fiscal 2022. We have built a team to focus on our new product development processes and are committed to delivering new products that align with our business strategy around gastrointestinal testing and pediatric point of care.

While we anticipate continued business challenges for diagnostics in the near-term, we have built a new strong team that is focused on stabilizing this business in the next 12 months to 18 months in building a sustainable growth engine for the business on a long-term basis.

Next, I’d like to provide some comments on our life science business beginning on slide 22. Progress on our strategic plan for life science is further along than it is for our diagnostic business. Over the last 18 months we have reshaped the cost structure and management team and the results are evident in the significant improvement in profitability as measured by an adjusted operating margin of over 30%.

Our focus is now on commercial execution to move this business to consistent high-single digit revenue growth while also improving operating margin through leverage of higher sales levels. Resident in this strategy is our strong relationships with the major IVD companies around the world, which we look to further leverage with our new molecular products.

We have built a more profitable life science business that we now look forward to accelerating the growth through improved commercial execution and portfolio selling across our immunoassay and molecular product offerings.

Wrapping up here on slide 23, we are well into this and in the midst of transforming Meridian. Over the past two years, we make continue – continual positive progress and we see the next 12 to 18 months as critical to live to delivering on our strategy. We have invested heavily in both – in our business both financially and in developing our talent. We are leveraging the synergy across our two businesses, while each business remains focused on what they need to get done to realize their business potential, we will make this happen.

With that said Lisa, I’d like to open it up now to any questions that our listeners may have.

Question-and-Answer Session

Operator

[Operator Instructions] And our first question comes from the line of Bill Quirk from Piper Jaffray. Your line is open.

John Kenny

Hi, Bill. Good morning.

Bill Quirk

Hi, good morning everyone. Thanks and good morning. So I guess a couple of questions, right. So on the immunological assay, obviously really nice growth number here, recognizing your comments that core trends may have slowed down a little bit. Can you tell us, I mean, how much of this is kind of selling through into the R&D process versus maybe some stocking from some of your customers?

Jack Kenny

So I’m assuming you’re referring to the life science side, which I’m...

Bill Quirk

Yes. I’m on the life science side.

Jack Kenny

I just want to conform. So on the life science side, we do have trends in that business that there’s some ordering patterns, that Q4 – our fiscal Q4 is typically a bigger quarter in our life science business versus Q1, partially because many of the diagnostic manufacturers end of fiscal year – at the end of December, and they always manage their inventory on their stocking levels. So we typically do see higher Q4 for us and lower Q1 and we do believe that trend is likely to continue from previous years.

We did not go through any process to stock IVD manufacturers. These large diagnostic companies that we sell to are very, very measuring their working capital very aggressively. So it is based on true customer demand, but they typically do manage their working inventories and many of them like Abbott and others have fiscal years that end, so that December timeframe, we very often see that they manage their inventories.

We have good trends on the immunoassay side. We’re building the momentum on the molecular side as well. But those – it takes 18 months to 24 months for new products to go through the FDA process typically. So for example, in China on the molecular front we have a number of customers in China that intend to put our molecular key components into their assays that are working their way through CFDA approvals. So very strong immunoassay in Q4 for sure. We have good growth trends, we believe as we go forward, but we expect a little bit lighter in Q1. And if you look historically, I think that’s been pretty consistent for our business over time.

Bill Quirk

Understood. And then a couple of quick questions here. So first is, how should we think about guidance vis-à-vis the flu season? You had some comments about a relatively modest start to that? Secondly, how should we think about timing in terms of the Québec plant scaling up and becoming a little less of a drag in gross margin? And then thirdly just on LeadCare again, how should we think about that trending throughout the year? Thanks guys.

Jack Kenny

I’ll start off the flu season. It has been a slow start for us. September, lot of times you’ll have the distributors ordering in material for the flu season. We did not see any uptake. It was a relatively light September for us from a respiratory product standpoint. And we have not seen significant lift early – early on as well. So we are starting to see the data from the CDC that it’s creeping up, but we have not seen any impact from that.

Bryan, I’m going to ask you to talk briefly about the scale-up from the revogene standpoint?

Bryan Baldasare

Sure. On the scale up for Québec manufacturing facility, you could expect to see essentially margins incrementally getting better with each quarter as we scale up the manufacturing process throughout 2020 to meet customer order demand. We do think that there will be – you’ve got higher margin business on Alethia because it’s an older product and from a margin standpoint you have higher margins on that. It will be lower when we first convert to the revogene as we build-up the capacity. So we’re going to feel some bleed from that in fiscal 2020, which we plan for.

Jack Kenny

And then the last question that you had there, Bill was related to LeadCare. Our LeadCare business – we do see that we do believe that that business will grow again in fiscal 2020. And we believe that we’re off to a solid start with that product line overall. We have changed a bit of our commercial focus on that. We have reorganized our commercial team a little bit with dedicated focus from a point of care specialists as well as an inside sales team dedicated to focus to work with them that we think will help drive it. Our lead business typically is a little bit lighter in the winter months and picks up and get heavy in the spring and summer just from the historical patterns from when people are getting that testing done. But we do look to a return to growth in our lead care business as we head into fiscal 2020.

Bill Quirk

Got it. Thanks, guys.

Jack Kenny

Thanks, Bill.

Operator

Our next question comes from the line of Brian Weinstein from William Blair. Your line is open.

Andrew Brackmann

Hi, guys. Good morning, this is actually Andrew Brackmann on for Brian.

Jack Kenny

Hi, Andrew.

Andrew Brackmann

Sorry for the background noise here.

Jack Kenny

No worries.

Andrew Brackmann

Maybe we can just talk on the R&D increase this year. I appreciate all the commentary and color that you provided there, but maybe it was just more broadly speaking and strategically thinking how do you guys evaluate sort of the return there? Can you maybe talk about the philosophy of how you guys are determining what projects to go after first? Thanks.

Jack Kenny

Sure. So a couple of different things. When we went through our strategic planning process, Andrew, if you go back in time, you remember, Meridian was building products and there really wasn’t much of a strategy to it. It was – we think we can make something, we think we could sell it. We are really focusing our team’s energy and efforts on things that only fit clearly into the strategy that we have built.

So a very focused effort. In that process, we implemented some processes and procedures to vet out investment that we want to make a new product development. We have our commercial team Tony Serafini-Lamanna who runs that element of it. He had worked for a number of years at Siemens and other places, brought some new processes into our organization where we really assess the market size and the market opportunities for any investment that we plan to make from an R&D perspective.

I will also say that to a certain extent, I would characterize our R&D spend as a bit of a half and half. Half of it is based on refreshing and trying to improve the competitiveness of some of our existing products. Many of the things on Curian, HpSA is a good example of that. We have a rapid immuno HpSA tests, but moving over to Curian and be able to put a fluorescent HpSA with better performance as well as being able to integrate it in onto a system.

We do believe will add relevance to our IDN and health system customers. So kind of some of our R&D money has gone towards protecting the key assays in our current product portfolio and updating and taking them to the next level. And then, which we know those businesses pretty well, so we can plan for that pretty easily in our spending and the spending plans we have. The other areas where we really do a market analysis and determine the opportunities for investment we want to make.

Example I would give you there would be C. diff, the rapid immuno C. diff area, we do have a few million dollars worth of business in that area. However, we believe that there is a significant market opportunity there with the changing algorithms. The guidelines are changing for how the testing is being done for C. diff within many of our customers.

And we believe a highly competitive product there can compete with the [indiscernible] of the world very effectively. And so that one is requiring, it’s a pretty intensive clinical trial for example. But when we ran our protocol to look at the investment that we need to make to bring their product to market we believe that that was a very attractive product for us to put onto Curian. So that would be the second product that we intend to bring in the Curian system. Brian, unless there’s anything else you want to add from an R&D perspective on that.

Bryan Baldasare

Yes, I think hopefully the message is clear that we are starting with a market analysis for the particular product involved. And again, some of it may be very offensive where it’s a new product kind of in our bag, particularly for revogene with the two panels that we’ve been talking about. Those are clearly very offensive products for us to put in the portfolio. And then, as Jack had indicated particularly with Curian, you’re looking at a set of assays that is probably geared more towards protecting our existing base of business.

Andrew Brackmann

Got it. Thanks guys. That’s helpful color. And then just one on guidance, the GenePOC contribution for the year, appreciate sort of the placements that you expect through the year, but maybe on a revenue basis, how much revenue do you think will be coming from that system? As we go through 2020? Thanks guys.

Jack Kenny

I’ll start this. Bryan, you can clean, he asked if you need to.

Bryan Baldasare

We anticipate the revogene product, because we’ll be converting over Alethia – many Alethia customers to be in that mid-to-high single digit million dollars in fiscal 2020. So, in that $6 million to $9 million range I would say is a fair assessment. Much of that will be at the expense of our Alethia because we’ll be transferring that. However, we are also getting competitive conversions and many of the customers that we’re running Alethia have decided to maybe add another test. They were running C-Diff or Group A Strep and they’ve added Group B Strep with us when they moved over to the revogene product.

So we are kind of looking at that overall business as a combined basis and we do expect stabilization of our molecular business. As we headed into fiscal 2020, you’ll start to see the mix of Alethia reagents coming down and revogene reagents coming up. But the overall net of that is we are anticipating generally flat molecular business in 2020.

Jack Kenny

And also please recognize that, we are ramping this business up, so it’s not a straight line look at the revenues from quarter one, two, three and four. It is definitely a stair-step throughout the year as we get accounts live and their purchasing kits.

Andrew Brackmann

Got it. Thank guys.

Jack Kenny

Thanks, Andrew.

Operator

[Operator Instructions] Our next question comes from the line of Catherine Schulte from Baird. Your line is open.

Jack Kenny

Hey, Catherine.

Catherine Schulte

Hey guys. Hi. Thanks for the questions. It’s first. Jack’s made a number of organizational changes this year. Are there any other refinements that you think you need to make in fiscal 2020?

Bryan Baldasare

We just went through a process over the last 60 days and made the changes that we felt that we needed to make to refine. From a commercial standpoint, one of the big things was carving our LeadCare business and our focus from a sales standpoint out specifically instead of diluting the efforts of our sales reps that are calling in the hospital base. We are really carving that out into a separate group. So we’ve implemented those changes as of October 1. We have made other modifications in the organization.

I would foresee that we will evolve and change as the Meridian Bioscience [indiscernible] or our revogene product expands. That’s going to force us to continually to kind of look at the infrastructure and what we have built there. And do we need to make investments along the way. But we basically implemented from the summer we worked through things and on October 1, we fully implemented the major plans that we have in place for 2020 right then. And then ultimately it’ll depend on how quickly the ramp up is in our molecular space before we see any additional changes.

Catherine Schulte

It sounds like the transition from Alethia to revogene, it seems to be going well. At what point do you think you’ll transition to going after new customers rather than focusing on transitioning existing customers?

Bryan Baldasare

So I don’t want to characterize it that we aren’t going after new customers. Let me start with that. Our sales team is calling on existing as well as competitive conversions. And we have seen approximately 10% or so of our closest the competitive. So we are getting competitive conversions. I think the message in my 25 years of leading commercial teams in diagnostics would be the percent of the sales that you have, the mix will change over time. We’re kind of envisioning a very high percentage of the mix being the existing customers converting. But I would also say we’re not just trying to convert those customers, we’re trying to go get competitive assays, pickup Group A Strep and things like that.

So our team is doing that, but what you really want to do is build momentum, our competitive – our customers are typically conservative folks, and so being the first one in your town with the new system is challenging, we’re going to leverage the relationships and trust we have with the years we’ve worked with those customers to put a lot of systems in each town, so you don’t have to be the first one in town, you’re the sixth or seventh or 10th person in town.

And so, I think you’re going to see that mix evolve over time, but we’re kind of anticipating a 90%, 95% range in the near-term being conversion because it is a competitive marketplace and we want to make sure our good loyal customers get our most advanced best product as quickly as we can. So that’s – there is a lot of energy from our commercial team their first.

Catherine Schulte

All right, that makes sense. And then last one from me. How should we think about gross margins in fiscal 2020? And where do you think they’ll settle over time with all these new product introductions?

Bryan Baldasare

So I think gross margins for fiscal 2020, we would expect to be in the high-50s, is what we have planned for. And I think certainly in over time, I wouldn’t expect them to be that different than that, unless something dramatically changed in the reimbursement environment or something like that. We are still targeting gross margins, when you look at our product portfolio in that high-50s, low-60s range on an overall basis.

Jack Kenny

Yes. Let me throw a couple of comments on that. From a diagnostic standpoint, we’ve done a pretty good job of holding our margins with the exception of H. pylori, as competitive has come in, we fully planned that we were going to have to step down pricing over time, we’ve worked with the Quest and LabCorp of the world to put contracts in place to do that. But a lot of our gross margin decline is really planned and we know it. And we don’t see declines in our margins across the entire diagnostics, I would say it’s primarily in that space. With the exception of moving Alethia to revogene in the near-term is affecting it, but we believe that the revogene margins can be very, very positive, very similar to Alethia over time, as we get volume on that system.

Bryan Baldasare

Yes. I would add to that, particularly on the revogene side is that, as we had the panels come through the commercialization process, those should have a higher ASP than the single asset, and that will help our margins as well.

Jack Kenny

And then one more comment on this is a hot topic for us obviously. I would also say that our life science business is – you’ve kind of been in that mid-50s kind of merchants is where we are, I mean the operating margin at the bottom is great, but the gross margins have been in the mid-50s. We do believe over time that we can maintain or increase that over time as we build scale. So I think you kind of see our diagnostics, we see a little bit of going down as the HpSA kind of bleeds out, if you will, the new pricing for that is it’s more competitive, but we think that’ll stabilize and then kind of start turning back up over time. In our life science, we do believe we can hold and/or grow. So I think in general we are optimistic that the high-50s types of margins are very attainable and beyond as we go forward.

Catherine Schulte

Great. Thank you.

Jack Kenny

Thanks, Catherine.

Operator

I would now like to turn the call back over to Jack Kenny for closing remarks.

Jack Kenny

Well, thank you very much for joining us today. We appreciate you taking the time to spend a little bit of your day to learn more about Meridian. We know that we are a company that is in the midst of a significant change. We have high confidence in the path that we’re taking, but we know that we’ve got significant work on the road ahead of us. So, we appreciate your support and we look forward to talking to you again soon. Thank you and have a great day.

Operator

Ladies and gentlemen, this concludes today’s conference call. Thank you for participating, you may now disconnect.