Genmark Diagnostics Inc
Q4 2017 Earnings Call Transcript

Published: 28 Feb 2018

[Operator:]

Good afternoon, ladies and gentlemen, and welcome to today's conference call to discuss GenMark Diagnostics' Fourth Quarter 2017 Financial Results. My name is Joey and I will be your operator on this call. After the presentation, we will conduct a question-and-answer session. Instructions will be provided at that time. [Operator Instructions] Please note that this call is being recorded today, Tuesday, February 27, 2018 at 1.30 Pacific Time and will be available on the Investors section of GenMark's website at www.genmarkdx.com. I would now like to turn the meeting over to Johnny Ek of GenMark. Please go ahead.

[Johnny Ek:]

Thanks, Joey, and thank you all very much for joining us today. Before we begin, I would like to inform you that certain statements made by GenMark during the course of this call may constitute forward-looking statements. Any statement about our expectations, beliefs, plans, objectives, assumptions or future events or performance are forward-looking statements. For example, statements concerning our 2018 financial guidance, the development, regulatory clearance, commercialization and features of new products, plans and objectives of management and market trends are all forward-looking statements. We believe these statements are based on reasonable assumptions. However, these statements are not guarantees of performance and involve known and unknown risks and uncertainties that may cause the actual results to be materially different from any future results expressed or implied by such statements. Important factors which could cause actual results to differ materially from those in these forward-looking statements are detailed in GenMark's filings with the SEC. GenMark assumes no obligation and expressly disclaims any duty to update any forward-looking statements to reflect events or circumstances occurring after this call or to reflect the occurrence of unanticipated events. I will now turn the conference call over to Mr. Hany Massarany, President and CEO of GenMark. Hany?

[Hany Massarany:]

Thank you, Johnny. Good afternoon and thank you all for joining us. I'm joined on the call today by our CFO, Scott Mendel as well as our Founder, Dr. Faiz Kayyem. Last year, we made significant advancements toward our mission of making multiplex molecular diagnostics accessible across oral health care settings, not just the most sophisticated and specialized molecular labs. In 2017, we received FDA clearance to market ePlex system and respiratory pathogen panel in the US and we introduced our ePlex family of CE-marked blood culture ID Sepsis panels in Europe. Late in the year, we also released our ePlex NP system designed to address the needs of lower test volume sites and the centralized near patient settings. We also fully implemented an additional ePlex manufacturing line and automation, which more than doubled our manufacturing capacity of ePlex test cartridges, allowing us to keep up with the strong demand of our respiratory pathogen panel so far this quarter. As a result of these and other initiatives, we closed 2017 with an installed base of 196 ePlex placements and generated revenues of $52.5 million. Now, turning to our financial highlights. Revenues were $16 million in the fourth quarter of 2017, an increase of 8% over the fourth quarter of 2016. ePlex contributed meaningfully to revenues in the quarter, largely due to the growing number of customers utilizing ePlex for routine clinical testing as well as the increased respiratory testing volumes, resulting from the onset of the aggressive flu season in early December. In Q4, we expanded our ePlex installed base by 49 analyzers and closed 2017 with 196 ePlex placements in the US and European labs. We are especially pleased with the continued strong momentum of ePlex in the US, which represents the vast majority of our revenue base and the world's largest market for our product. Our US commercial team delivered excellent results in the second half of 2017, displacing key competitors in some of the largest and most strategic accounts who have now adopted ePlex for the routine clinical use. During the same period, ePlex placements in the US represented 75% of our total placements. We expect this percentage to increase in 2018 with a more meaningful upside towards the end of the year once we receive FDA clearance to market blood culture ID panels in the US market. While we do not expect to continue reporting this split between US and European placements, we feel it's important for investors to appropriately understand the impact of the US market on our ePlex business in the near term. Moving to our business highlights, as many of you know, we developed ePlex as a modular and scalable platform to meet the testing needs of various types of laboratories from small decentralized sites that may require only one six cartridge analyzer or tower to large hospitals or reference labs that may need as many as four six cartridge towers. We are very pleased with the customer feedback, which continues to underscore the high quality of ePlex results as well as its ease of use, intuitive user interface and comprehensive reporting capabilities compared to available alternatives. And to address even lower volume hospitals or decentralized sites, we developed a lower capacity configuration of the ePlex platform called ePlex NP, which was launched late in the fourth quarter of 2017. The ePlex NP is a three cartridge analyzer that can process up to 12 patient samples per shift and with the same core functionality as ePlex, we believe that the ePlex NP will address the needs of integrated delivery networks where smaller satellite, low volume sites can also benefit from the rapid multiplex testing. This configuration is easily upgraded, allowing customers to increase test capacity as their respiratory testing volumes grow and additional ePlex panels are launched. We're very encouraged by the early market response to the ePlex NP. As I mentioned earlier, last year, we implemented an additional ePlex manufacturing line and automation that more than doubled our capacity to manufacture ePlex test cartridges. And while some customers are hesitant to bring in new respiratory testing systems, during the flu season, a significant number of ePlex analyzers placed before the peak of the flu season were implemented during the fourth quarter for routine clinical use. With the additional manufacturing capacity of ePlex cartridges and despite this being the first true stress test of our ePlex manufacturing capabilities, we have been able to keep up with customer demand for ePlex RP test cartridges even during this historically severe flu season. We expect to further increase manufacturing capacity by improving labor efficiency and yield. In addition, we are in the planning stages for a third ePlex manufacturing line with completion expected toward the end of this year to help service the 2018-2019 flu season and our ongoing menu expansion. Before I move on to ePlex menu expansion and 2018 guidance, I'd like to comment on our progress in Europe. We continue to address the challenges in Europe, particularly in relation to the length of the acquisition process from ePlex placement to routine implementation and revenue generation. Over the past few months, we completed a detailed assessment of our European commercial strategy and have begun implementing changes that will enable us to navigate these challenges more effectively. We're also expect - we also expect to grow the annuity of our installed base in Europe by repositioning certain underutilized ePlex analyzers to new sites that can more readily deploy them for routine clinical testing. Therefore, we expect system placements in Europe to temporarily slowdown, particularly in the first half of 2018. In addition, we are working with several European KOLs to support scientific studies and other market development initiatives designed to demonstrate the clinic, economic and quality impact of multiplex molecular panels. We remain confident in our strategy and continue to believe that the European market will emerge as an important driver of the company's growth over the longer term. We look forward to providing additional details regarding our approach in Europe on future earnings call. Turning to ePlex menu expansion, in 2017, we also leveraged our proprietary technologies to advance our menu of multiplex molecular panels across multiple infectious disease states. Our FDA cleared RP panel has already been implemented for routine clinical testing by a broad range of customers, including some of the largest and most prestigious labs in the word that transitioned to ePlex from other competitive offerings. We continue to get exceptional feedback regarding its performance, ease of use and processing capacity, particularly in light of this year's aggressive flu season. I'm also excited about the US launch later this year of our next family of ePlex assays. Three unique blood culture ID panels that are designed to help diagnose and manage the critical condition of bloodstream infection that can lead to sepsis. We design these panels to offer the broadest pathogen inclusivity and drug resistance markers of any multiplex molecular solution on the market today and as such, we are highly confident that they will meaningfully improve the management of this critical disease and provide a new tool to help address the growing public health crisis of antibiotic resistance. We recently announced the initiation of the first of three clinical studies and continue to expect submission to the FDA of all three panels during the second and third quarters of this year and clearance by year end, subject to the FDA's review timeline. While current decisions to adopt ePlex are primarily driven by the RP panel, customers are excited about our approach to blood culture ID and are accounting for it in their decision process. Finally, we're also continuing to work on our highly differentiated ePlex gastrointestinal pathogen panel with over 30 reportable targets and controllers, demonstrating ePlex's utility with this most challenging sample type and a highly multiplex panel. Looking ahead, our strategy for 2018 centers around commercialization, menu expansion and driving gross margin improvement. Our guidance for 2018 includes; first, ePlex placement in the range of 140 to 170 net new analyzers. This broad range allows for the potential repositioning of some early underutilized European placements. Second, revenues in the range of $68 million to $72 million with annuity of greater than 100,000 per ePlex placement and $65,000 to $70,000 per XT-8 placements. And third, gross margin in the mid-30% range, with continued investment in key supply chain and manufacturing initiatives to drive cost efficiency and profitability. Before I turn the call over to Scott, I want to take a moment to announce that Faiz Kayyem is transitioning from our Head of R&D to a technical and strategic advisor to our management team and Board of Directors. As most of you know, Faiz is the inventor of our proprietary eSensor electronic detection technology and GenMark's founder. He has made a significant contribution to our company as well as the field of multiplex molecular diagnostics initially with XT-8 and more recently with ePlex. Along the way, Faiz assembled a tremendous R&D organization, which will continue to innovate and further his and our company's mission of providing high medical value, simple to perform multiplex tests that improve patients' lives. We're looking forward to Faiz's continued involvement and contribution to the company and our future success. And with that, I will now turn the call over to Scott for his financial review.

[Scott Mendel:]

Thank you, Hany. As previously mentioned, our fourth quarter 2017 revenue was $16 million, up 8% versus the fourth quarter of 2016. While XT-8 accounted for the majority of revenue during the fourth quarter, ePlex revenue is growing rapidly and becoming a larger percentage of total revenue. Our XT-8 platform continues to perform well and in line with our expectations. At the end of Q4, there were 620 analyzers installed at customer sites. The annuity per XT-8 analyzer during 2018 was $65,000. Although we only have a couple of quarters of experience with ePlex, we believe the annuity per ePlex placement will be in the $100,000 to $120,00 range in 2018 with further expansion possible as additional panels come to market. Fourth quarter gross profit was $4.7 million or 30% of revenue versus $8.6 million in the fourth quarter of 2016, which was 58% of revenue. Fourth quarter gross margin reflects the increasing proportion of ePlex revenues. Total operating expenses were $18.7 million for the quarter, a decrease of 2 million compared to the fourth quarter of 2016. This decrease was largely due to reduced ePlex development expenses. Our net loss per share for the fourth quarter was $0.26 compared to $0.27 in the fourth quarter of 2016. Moving on to our balance sheet, we ended the quarter with $72 million in cash and investments. Our cash balance includes the impact of increasing inventory levels as we prepared for the flu season. In addition, as the flu season ramps quickly in December, our accounts receivable balance at year end also increased. We are focused on minimizing working capital need by closely managing our accounts receivable and inventory balances, while ensuring we have adequate inventory to support our customer needs, which we have managed to do even in this very severe flu season. When compared sequentially to the third quarter of 2017, our accounts receivable balance increased by $2.9 million to 10.7 million, while our DSO was consistent with prior quarters at 38 days and approximately 85% of our accounts receivable balance was current. We finished 2017 with inventory of $10.9 million, an increase of 3.8 million versus the third quarter of 2017. Turning to guidance for 2018, we expect our 2018 revenue to be $68 million to $72 million. Gross margin for 2018 is expected to be in the mid-30% range, reflecting the increasing proportion of ePlex revenue, relative to XT-8. We believe that our gross margin is stabilizing and expect to see margin improvement as we move into the middle part of this year. The main drivers will be increased overhead absorption as ePlex volumes ramp, direct material cost reductions that our team is implementing and process improvements that will drive direct labor efficiency. Because 2018 is a transitional year for GenMark from a financial perspective, we are providing our expectation for operating expenses in the mid $60 million range, driven mainly by significant reduction in R&D expenses, offset by modest increases in SG&A. The expected decrease in R&D expense is primarily driven by the reduced cost to manufacture ePlex test cartridges, which in turn decreases the cost associated with ongoing menu development and clinical studies. Therefore, the expected revenue growth, our gross margin improvements and operating expense reduction should result in a significant step towards profitability. And finally, as Hany noted, we expect to finish this year with global ePlex placements in the range of 140 to 170 net new analyzers. I'd now like to turn the call over to Faiz. Faiz?

[Faiz Kayyem:]

Thank you, Scott. We've continued to make progress on developing robust clinical evidence to support the adoption of ePlex RP globally, most notably our US clinical study results for the RP panel were recently published in The Journal of Clinical Microbiology with Dr. Esther Babady of Memorial Sloan Kettering as the lead author on the paper. Investigators in the Netherlands also recently published a peer reviewed paper demonstrating the clinical utility of ePlex RP compared to a batch processing method. In their pilot study, they showed that ePlex RP reduced time to result by over 23 hours and that this more rapid result led to a reduction in isolation room time and the potential for more appropriate use of anti-viral and antibiotic therapy. As Hany mentioned, in addition to our focus on the commercialization of the ePlex system and RP assay, we are also driving internal and external studies of our blood culture ID family of tests in support of US FDA submission. Specifically, we're making excellent progress on the first of three blood culture ID clinical studies. While we cannot discuss the details of the study until it is completed, we're extremely pleased with the results to date and remain on track to complete the submissions of all three BCID panels during the second and third quarters of this year. We also continue to produce real world performance data and clinical utility evidence for the BCID panels with our early adopter sites in Europe. There are currently five abstracts and posters related to our BCID panels accepted for presentation in April at ECCMID, the largest microbiology meeting in Europe. These results are demonstrating that this family of assays meet our design goals of broadly inclusive panels that provide a rapid, accurate, comprehensive results that can change the management of patients with bloodstream infections. Before I turn the call back to Hany, please allow me to elaborate on my transition this month from head of R&D to a technical and strategic advisor of the management and the board. In this new role, I will endeavor to add value in new ways beyond ePlex, while the best in class team we've assembled continues to focus on ePlex system improvements, menu expansion, cost of goods reductions. I had this transition in mind for many years and I'm delighted that GenMark's Board of Directors and I feel that this is the right time for this transition as the company has moved beyond conquering important technical challenges to driving global ePlex commercialization and rapid menu expansion. And we're certain that our current R&D leadership team is highly capable of executing on our ambitious plans. I'll now turn the call back to Hany.

[Hany Massarany:]

Thank you, Faiz. We are energized by the positive customer feedback we continue to receive on ePlex and excited about the opportunity we have to drive commercialization with the robust and expanding mention of tests, covering a wide variety of life threatening diseases. 2017 was a very important year for us, as we laid a foundation and made the investments necessary to move confidently into execution to realize this tremendous opportunity, both in terms of global commercialization and future expansion of our business. We will now open the call to questions.

[Operator:]

[Operator Instructions] Our first question comes from the line of Tycho Peterson.

[Tycho Peterson:]

Hany, I want to start with the system placement guidance. I think the street had basically been taking a 4Q run rate and coming out around 200. You're guiding a bit below that. Can you maybe talk to the magnitude of the repositioning in Europe, even if we assume all 40 systems are repositioned, you're still a little bit below where the street would be for placements this year?

[Hany Massarany:]

And I want to sort of start by first reminding you that this is the first time that we actually guide to 2018 placements. I do understand that there are expectations out there, but it's based on certain assumptions. But I think taking the Q4 or even the second half of 2017 placement number as a run rate is probably a little bit over the top since we had some pent up demand as we have said before and we executed a really strong launch of ePlex, where we had a lot of customers waiting to get systems upon sort of availability of ePlex in the US market. Also, I want to remind you that the range that we're guiding to is a net number. So we do expect to place more systems, either gross number but with the repositioning of some of the systems that are in European sites, where they've been stuck with this sort of lengthy acquisition process that we talked about previously, with taking no systems out and moving them to sites that can actually utilize them and generate sort of revenue on these systems, that becomes a sort of - that's netted out against that gross number. So there's a certain percentage or a certain number that we're allowing in our guidance range, but we do believe that the range of - that we're providing at 140 to 170 is consistent with our expectations to hit the revenue guidance of $68 million to $72 million for 2017.

[Tycho Peterson:]

Okay. And just so we're clear, what percentage of the EU systems do you expect will be repositioned?

[Hany Massarany:]

Well, we're not giving an exact number on that, Tycho. We are seeing improvement in Europe for sure based on some of the actions that we've taken. So I can say that more than 50% of our placements in Europe are already - have already generated revenues in the fourth quarter of 2017. So we're not certainly expecting, I think, you've said even if we reposition every placement in Europe, well, that's not of course what we're expecting, but there will be a number of systems that need to come out of sites and be placed in other sites that can utilize them more productively.

[Tycho Peterson:]

Okay. And then one last one, can you provide any color on what your expectation is around mix in terms of NP versus the regular ePlex and I know you're still assuming about a third of capital placement.

[Hany Massarany:]

Yeah. I just want to add one other point to your previous question regarding Europe and that's to say that importantly, Tycho, the biggest opportunity for ePlex and certainly in 2018 will be in the US, which is the largest market for our product and we're very excited about the opportunity ahead of us in 2018, being the first full year of ePlex in the US market. NP is definitely going to play a role in that. So NP has already contributed to our placements in Europe during the fourth quarter. And in the US, we have multiple opportunities already in the funnel, standalone in smaller volume accounts, but also as part of broader solutions for larger integrated delivery networks. So we believe that NP will contribute to the placement number and certainly to the annuity in the US market as well and I think that number of about one-third is sort of consistent with what we've said in the past.

[Operator:]

Your next question comes from the line of Doug Schenkel.

[Doug Schenkel:]

Hey guys, good afternoon. I guess I just want to go back to Tycho's first question. Over the past two quarters, you've made changes to optimize European commercial efforts. You've become more flexible with placement terms. You introduced the NP format, which expand your addressable market into relatively smaller sites. If anything, it seems like you're swapping out more XT-8s than was expected, a trend that probably could continue this year and your salesforce should be getting more efficient. On top of that, I think we still believe this is a rapidly growing market that's pretty under penetrated. So especially with your track record, Hany, on the sales side, I'm just confused by why placements would drop by around 40 year-over-year at the midpoint of your guidance. I heard your response to Tycho, but I feel like that's a number that, especially given your track record, you'd be pretty disappointed with. Are we missing something here?

[Hany Massarany:]

Well, thank you very much, Doug and you've sort of laid out all of the sort of drivers of placements across the board and that's how we see the market opportunity as well. And I - like I said, we are planning to place the gross number of placements will be higher than the range that we're providing and sort of as we work through the strategy for Europe and reposition some of the placements, I think we'll obviously have a better prediction or be in a position to have a clearer picture on how many additional net placements we'll be able to place in Europe during 2018. So we have taken a sort of a conservative view in relation to Europe. Also, we expect that the number of placements to increase in the second half of the year, especially sort of as we prepare to launch for the blood culture ID panels in the US market as well. We certainly have an opportunity to exceed that number and if we do, we'll certainly come back and provide an update to that.

[Doug Schenkel:]

Okay. Relatedly, where is sales force headcount at the end of 2018 or 2017? Where was it?

[Hany Massarany:]

Yeah. We ended up with sort of around 30-ish, low 30 number of sales sort of professionals in the field globally and with the ratio that we communicated before, which is about two-thirds of those are in the US and one third in Europe, we are going to add sales people during 2018, more likely sort of in the second half of the year in preparation for the BCID launch in in the US.

[Doug Schenkel:]

Okay. So maybe one more and it's really a longer term growth outlook question. You've got 2018 revenue guidance pretty close to where consensus stands today. In spite of much slower than expected ePlex placement assumptions, that said, mathematically at a real basic level, there's a hangover associated with low placements this year on, simply put, if the installed base is expanding at levels well below Street expectations, it gets a lot harder to hit the long term revenue growth expectations. Yeah. The goal here at a basic level would seem to be to get as many instruments out there as quickly as possible to drive long-term consumable growth and your guidance doesn't suggest that's happening and it actually sounds like you've really scaled back your sales, but at least the pacing of when you're going to expand the sales force, which by extension holds back your ability to place more boxes. So, right now, the street is looking for around 30% revenue per year growth. And, the combination I'm describing seems to render that pretty aspirational. So, again 2018 revenue looks relatively okay, but I feel like with this guidance, it really heightens concerns about the outlook for growth in 19 and 20. Would you agree with that and if not can you help us get more comfortable with the longer term outlook?

[Hany Massarany:]

Yeah. Well, no, I don't agree with that, Doug. I believe that especially with menu expansion, we are going to see higher annuity per installed system than perhaps your modeling. So, we're actually already seeing that, Q4 was in the sort of 120,000 plus per ePlex system in the field compared to sort of expectations that are sort of around 100 and with the increased menu over time, I think you'll see that the annuity per ePlex placement will be higher than what perhaps the expectation is out there. And then also, as we increase, as we expand our menu, we expect to be placing more systems in future years, sort of starting later in 2018 with the introduction of blood culture ID in the US and then beyond that, as we expand menu in the future. So, I believe that the combination of those two factors will certainly enable us to achieve the growth numbers that you've quoted.

[Doug Schenkel:]

Okay. That's helpful and it probably is a logical transition to gross margin guidance, but I'll leave that to somebody else to ask.

[Operator:]

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

[Brian Weinstein:]

So the guidance for placements, just sort of following up on the first couple of questions here, the 140 to 170, did I hear you right Hany that you think that most of those are going to be kind of greater in the year? I would have thought more kind of Q2, Q3 from that? And then can you talk about the kind of visibility that you have here and where these are actually kind of in the funnel? And then also, third part of the question would be, can you talk a little bit about the placement mix in the US between competitive wins versus cannibalization versus entirely new users of multiplex technology that you guys expect?

[Hany Massarany:]

Yes. Thank you, Brian. Look, yes, we did have a strong second half of 2017 in terms of ePlex placements and with the severity of the current flu season, we sort of expected and we still expect that the first quarter of 2018, we'll have a fewer placements than we did in Q4 and certainly Q3 and Q4 of 2017. So as you know, when labs are dealing with peak volume of testing during a severe flu season, they're less willing or able to bring in new systems to sort of change technologies during that time. We have had a lot of success placing systems in the first quarter, but as expected, not as many as we did in Q4 and certainly Q3 of last year. So, you're right to expect that, as we go into Q2 and 3 and then of course depending on the flu season, the 2018-19 flu season, we'll see how we go in the fourth quarter as well. But also with the introduction of blood culture ID later in the year, which is not a seasonal disease, we expect to be placing more systems in the back end of the year as a result of the menu expansion. So that's why I think it's important to communicate that we expect more placements to come later in the year than necessarily - than certainly not in the first quarter and maybe the second quarter as well. What was, remind me again the second part of your question was to do with competitive placements. So we continue to see the vast majority of ePlex placements have been in new addresses, not upgrading or sort of replacing XT-8 systems and that the vast majority of those new addresses have been competitive wins, so in other words, displacing an existing alternative or competitive system in the field. And by the vast majority, I mean more than 70%, 75% of the time.

[Brian Weinstein:]

So what you should say about the overall market opportunity than - we've talked about how underpenetrated multiplex really is, but it seems that you guys are between some cannibalization and swapping out competitive accounts that maybe the overall market may not be growing as quickly as people have thought. Does that play a role here and how you guys are thinking about placements and what do you think that overall multiplex market is growing at, at this point.

[Hany Massarany:]

Well, look, when we talk about the multiplex market, we definitely see it beyond respiratory. As you know, Brian, the respiratory panel is the most established. That market is really developing over the past seven, eight plus years and is certainly much more established compared to other areas of multiplex testing, they're going to get there for sure. We're already seeing sort of blood culture ID, making good progress along those lines and GI after that. So I would say that across multiple disease states, definitely, the market is underpenetrated and there is significant room for upside. But even in RP, there - in respiratory testing, there are still a significant number of labs not performing this test and we expect to continue to access those labs. The ePlex NP will certainly help in that regard. As I mentioned earlier, we designed it to sort of meet the needs of the smaller volume labs. So many of the labs that have already adopted multiplex molecular panels for RP tend to be sort of the larger ones, but the smaller labs now with access to this technology and that configuration that better fits their needs, we believe that we'll be able to expand the sort of the pie, the number of labs and the volume of tests done on multiplex panels as well.

[Brian Weinstein:]

Okay. I've got some more, but I'll jump and let some other people ask some questions.

[Operator:]

Your next question comes from the line of Anne Edelstein from Bank of America.

[Anne Edelstein:]

Just a question on gross margins for the year. Are you expecting margins to be depressed because of the additional line capacity that you're adding or I guess strategically, how are you thinking about bringing down your unit costs on the ePlex cartridges?

[Scott Mendel:]

Hi, Anne. This is Scott. I'll answer that. So from a gross margin perspective, like I said, we do think it's stabilizing and that will have increasing gross margin as we move throughout 2018, driven by a couple of things. First, what we'll see as our repertory volumes take off in the first quarter, given the severe flu season, you'd expect overhead absorption to play a part in improving that aspect of the cost of goods sold. The second and third aspects to how we're going to drive gross margin improvements are around direct materials. So we have a long laundry list of direct material improvements or cost reductions that we're employing and we have visibility to that will take an effect as we move throughout 2018 and kind of across the whole year. And then the last leg of that stool is really on the direct labor efficiency and we have many different areas that we're going after from a manufacturing process perspective to drive direct labor efficiency. Some of those will probably be implemented as we move throughout the year. Our priority in the first quarter especially is to serve our customers and our patients from a respiratory panel perspective. So, doing any experimentation with new process improvements or taking down the line to do that is probably something we would deprioritize and so that direct labor efficiency will probably occur as we move throughout the year and that's why I'm saying I believe gross margin has stabilized and as we move throughout the year, we'll see an increase because of those three things; better direct labor absorption, or sorry, better overhead absorption, direct material improvement and then lastly direct labor efficiency as we move throughout the year.

[Anne Edelstein:]

And then just the second question, I mean, given the unprecedented severity of this flu season, can you just provide us with some thoughts on the linearity of revenue over the course of the year. I mean, just give us some confidence that you'll be able to, I mean, obviously, there'll be a sequential step down in Q2, but I guess just - can you just help us to kind of frame how large that kind of step down will be.

[Scott Mendel:]

Sure. It's Scott again. So from a total revenue perspective, we feel good about the range that we provided from a guidance, overall guidance perspective. We have good visibility to our revenue streams now that we have a larger installed base, much more predictability than we typically would. From a quarterly split perspective, you're right, there is a severe flu season going on and that should drive additional consumable revenue in the first quarter, but as Hany mentioned, there's also additional hesitancy to adopt new systems and so any capital revenue that we might be expecting in Q1 is probably offsetting somewhat the higher consumable revenue that's being driven from the flu season. So we'll see a sequential step up, most probably from Q4, but you've got to keep in mind that placements and capital revenue obviously are the other side of that coin from a severe flu season. You're exactly right Q2 is typically kind of starts to taper off. Q3 is the low point, again, being a total respiratory business, that makes sense and then revenue starts to take off again in the fourth quarter. So, we'll have typical seasonal patterns with the exception just a little bit more strength here in the first quarter offset by capital placements.

[Anne Edelstein:]

And then maybe just if I can sneak in a third one, just segueing off of the last question and just thinking about this flu season, I mean, have you seen your customers and large health systems change their kind of approach or thinking about multiplex testing over the course of this season. I mean, I know that the number of hospitalizations has increased dramatically over the flu season versus prior ones. Just wondering if this flu season has kind of like woken up health systems at all to the potential benefits of using more multiplex testing.

[Hany Massarany:]

Yeah, hi, Anne. This is Hany. I think in general, the answer is yes, I mean obviously, we are in the middle of it. So there will be additional sort of information and learnings as we come out of the flu season and have a better chance to sort of know what our customers are thinking, but in general, we believe that that's true. We believe that the severity of the flu season has actually been a driver for many customers that perhaps were sitting on the fence a little bit on - in relation to making decisions to bring in sample to answer technology to be able to better handle their volumes of - for respiratory testing, but also making them think about other areas of testing as well that can certainly benefit from the multiplex sampled approach. And that's that time will tell as we sort of come out of this flu season and do a little bit of a post-mortem on it as well.

[Operator:]

Your next question comes from the line of Mark Massaro from Canaccord Genuity.

[Mark Massaro:]

The first one is on the transition of Faiz. I guess I would be curious to know if you're expecting to hire or appoint someone to Senior Vice President of R&D, is there someone internally or are you conducting a search and related to that, I would love to hear just a little bit more about Faiz's comments about GenMark looking at new ways beyond ePlex. Is there potentially another system that you're contemplating a launch in the future?

[Hany Massarany:]

All right. So, thank you, Mark. We're very fortunate that Faiz over the past and plus years, has assembled a very strong R&D organization with leaders that have sort of been with us now for multiple years. So we are not hiring from the outside and that sort of continuity that we have with existing leadership in the company with two individuals that have been sort of with us since ePlex was just an idea and between them have managed all aspects of the assay side as well as the platform side. And those two individuals will now directly report to me and we're not going to bring in someone from the outside and sort of teach them everything that we already know here. I will let Faiz chip in of course and talk about his vision for his new role, but Mark, as you know we're always looking to add value to improve our value proposition in this space. So our focus remains on multiplex molecular testing, but as you know, there are opportunities always out there with technologies that may be sort of can augment what we are doing with the current solutions that we have. But also opportunities for Faiz to sort of help in other areas as well. The industry initiatives with key opinion leaders both here and in Europe or other similar types of activities. And perhaps Faiz can sort of add to that if --?

[Faiz Kayyem:]

Sure. Hi, Mark. Yeah. I mean, it's - the most effective way that GenMark is going to impact patients' lives right now is by expanding the menu on ePlex and continuing the commercialization efforts with ePlex as well as the efforts that were just highlighted to improve cost of goods and drive improved margins. That's how we're going to impact a lot of patients. But in addition to that, it's in our blood to innovate here or to be looking for ways to innovate and I'm just delighted that things are stable and up here, we're technically - the major challenges are behind us right now and we have this excellent team driving menu and platform expansion, so that I can have the opportunity really the luxury mark of thinking about other ways that we can innovate here and I don't expect that to dramatically impact the business in the short term, because we really do have a clear path ahead of us right now, but perhaps, a little bit more long term.

[Mark Massaro:]

My second one is on, I was hoping to get a little more context about the launch of the ePlex NP. Some might think that the NP, obviously as a market expansion opportunity, certainly is logical. On the other hand, launching a smaller configuration might suggest that some of the larger opportunities might be locked up already or perhaps maybe more penetrated than you initially thought, but can you just speak to the rationale to launch NP and related to that, can you speak to the annuity per analyzer on the NP relative to the larger configuration.

[Hany Massarany:]

And NP will make ePlex accessible to low volume sites in a more cost effective way. So, it really isn't about competing or cannibalizing opportunities that would otherwise be ePlex sort of opportunities because really the volume is what drives the best configuration for a customer. And therefore, whether you have a tower with a capacity of six cartridges or three cartridges, that's not going to change the volume of testing, but it would rather make the solution more cost effective if the customer doesn't have to either acquire a more expensive system or if it's a reagent rental that we're not amortizing a more expensive system on a smaller volume. So, NP enables us to access to lower volume testing sides while not giving away profitability. So - or while making - not making the solution sort of too expensive or not affordable to some of these sites. And our expectations for annuity takes that into account. So when we talk about annuity in the 100,000 plus, that really includes NP placement as well as sort of regular higher capacity ePlex placements.

[Mark Massaro:]

And just one last one from me, I wanted to ask about your OpEx assumptions, mid-60, that is a little higher than that. Can you just speak to some of the R&D dollars dropping off? I understand that you're still obviously developing the GI panel and you expect to submit three more panels to the agency this year. So can you just provide a little more context to some of the buckets as it relates to OpEx?

[Scott Mendel:]

Sure. So the main driver of the decrease is research and development expense and within research and development expense, it's really driven by the cost to develop and perform the clinical trials. So, as our cost of goods sold comes down on producing an ePlex consumable, so does the R&D team enjoy that reduced cost and therefore their operating expense comes down, Mark. That's the main driver. It's pretty plain and simple, but that's what is driving it.

[Operator:]

Our next question comes from the line of Andrew Cooper from Raymond James.

[Andrew Cooper:]

A lot of my questions have already been asked. But just a quick one, if you could give any thoughts on sort of cash burn as we think about 2018 and in to the future, I think it was a little bit heavier in 4Q than we had expected obviously, the flu probably played a role there, but any sort of color on how you're thinking about that, especially with some of the moving parts, that will be great. Thanks.

[Scott Mendel:]

Sure, Andrew. This is Scott. So while we're not going to guide specifically on cash burn, I think some of the building blocks are laid out in the prepared remarks. First and foremost, I talked about what revenue is going to be and gross margin associated with that revenue, but I also, for the last couple of questions, talked about operating expense reduction versus prior year. So that gives you a pretty good idea that we're expecting something like 30% improvement or improvement in profitability, i.e., a little bit less of a lost starting off in 2018 versus 2017. I don't anticipate a big difference in our non-cash items in 2018 versus 2017. And as I said, we're certainly laser focused on managing our working capital pretty efficiently. Net-net, I do expect a much improved cash burn rate or reduction in cash burn rate in 2018, even if not specifically guiding to it, you can kind of get an idea of what we're expecting in 2018.

[Operator:]

There are no further questions at this time. I'll turn the call back over to the presenters.

[Hany Massarany:]

All right. Well, thank you very much, everyone for your continued support. We're very energized about 2018. We believe that we have tremendous opportunities ahead of us, not just with the RP, but also future menu on ePlex platform. We look forward to reporting our progress on a quarterly basis going forward and also look forward to seeing you all at some stage out there at various meetings. So thanks very much and have a good afternoon. Bye-bye.

[Operator:]

This concludes today's conference call. You may now disconnect.