Luminex Corporation
Q3 2018 Earnings Call Transcript

Published: 6 Nov 2018

[Operator:]

Good day, ladies and gentlemen, and welcome to Luminex Corporation’s Third Quarter 2018 Earnings Conference Call. My name is Sonia and I’ll be your coordinator for today. Today's call is being recorded. At this time, all participants are in a listen-only mode. Following the prepared remarks, there will be a question-and-answer session. [Operator Instructions]. I would now like to turn the call over to Harriss Currie, Senior Vice President and Chief Financial Officer for opening remarks. Please proceed.

[Harriss Currie:]

Good afternoon, and welcome to Luminex Corporation's conference call to discuss our third quarter 2018 financial and operational results. On the call with me today is Homi Shamir, President and Chief Executive Officer. We’ll be following our standard agenda. Homi will review our corporate highlights, I'll review the financial performance and after that, we’ll open the call up for your questions. As a reminder, today’s conference call is being recorded and a replay will be available for six months on the Investor Relations section of our Web site. Certain statements made during the course of today's call may not be purely historical and consequently may be forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and the company claims the protections provided by Section 21E for the Securities Exchange Act for such statements. These forward-looking statements speak only as of the date hereof and are based on our current beliefs and expectations and are subject to known or unknown risks and uncertainties, some of which are beyond the company’s control, that could cause actual results or plans to differ materially and adversely from those anticipated in the forward-looking statements. Factors that could cause or contribute to such differences are detailed in our Form 10-K for the year-ended December 31, and our quarterly reports on Form 10-Q filed with the Securities and Exchange Commission. We encourage you to review these documents and we undertake no obligation to update these forward-looking statements. Also, certain non-GAAP financial measures, as defined by SEC Regulation G, may be covered on this call. To the extent that any non-GAAP financial measures are covered, a presentation of and reconciliation to the most directly comparable GAAP financial measures will be included in our earnings release, which is available on our Web site in accordance with Regulation G. I’ll now turn the call over to our President and CEO, Homi Shamir.

[Homi Shamir:]

Thank you, Harriss. Good afternoon, and welcome to our third quarter 2018 earnings call. I would like to cover three topics in my remarks today. First, the health of our businesses post the LabCorp transition; second, our recent announcement that we have signed a definitive agreement to purchase the flow cytometry asset of MilliporeSigma; and third, some broad-based expectation about our future growth and direction. Before we get into those topics, I would like to say that we continue to be very pleased with the overall performance of our diversified businesses. However, for the first time under my leadership, we fell just short of our revenue guidance in Q3. This is mainly due to the fact that several molecular diagnostic orders that we have been expected to receive in Q3 were actually received just two days after the quarter end. If they had been received as planned, third quarter revenue would have been in the middle of the range of the expectation that we have previously communicated. With respect to our overall businesses, third quarter revenue was down by about 2% but when we adjust for the LabCorp departure, revenues grew by 7%. This growth was driven by several factors. Our LTG revenue stream has returned to growth mode as expected, growing by 7% quarter-over-quarter. This was driven by more than 10% growth in both consumables and royalties. Our MDx franchise revenue declined by 10% but when adjusting for the LabCorp departure, it actually grew by 6%. Sample-to-answer assay revenue grew by 20% for the quarter, and we have contracted an additional 81 systems during the quarter. As a reminder, a contracted system is usage requirement for three or more years. Utilization of both ARIES and VERIGENE system per customer increased nicely at 28% and 7%, respectively. At the end of the quarter, we had about 560 active customers and an increase year-over-year of almost 35%. Another exciting development this quarter was the signing of a definitive agreement to acquire the flow cytometry asset of MilliporeSigma. This acquisition, our first in life science research space and probably not our last, will provide an opportunity for us to sell directly to customers who adopted our xMAP technology. We believe that their ability to purchase additional analytical tool that fit within existing customer and workflow from a name that they’ve trusted for so long will increase their confidence in the Luminex name for production and delivery of state-of-the-art products. As we mentioned in the call announcing the acquisition, we will accomplish a number of strategic objectives with this transaction. We will diversify our product offering. We will acquire product in attractive growth markets. We will add strong new product development pipeline. And finally and probably most importantly, we will be bringing into Luminex quality people and experienced management team. As an innovator in flow technology since our inception more than two decades ago, the opportunity to expand our footprint within the flow space is both compelling and exciting. We believe that this acquisition could add between $40 million and $50 million of revenue to our top line next year and be accretive. Finally, I would like to briefly discuss my thoughts on growth as we head towards the end of 2018 and begin 2019. Overall, we are on track to deliver approximately 5% growth in our LTG with a system placement in 2018 exceeding those in 2017. And consumable and royalty are expected to grow just above the market growth rate for the year. We expect our MDx revenue as a whole to be down slightly as a result of the LabCorp departure but up in the double digits when adjusted for the departure of the NuSwab product for approximately $20 million. Sample-to-answer assay sales are expected to finish up almost 40% for the year with approximately 250 new systems contracted during the year solidifying the foundation for both recurring revenue and growth. As a matter of fact, we anticipate that revenue from our sample-to-answer portfolio in the fourth quarter will exceed 80 million [ph], up from approximately 30 million [ph] in the fourth quarter last year. We remain on track to meet our targeted run rate of 100 million by the end of 2019. And as we have mentioned, the addition of the flow cytometry portfolio of MilliporeSigma should add between $40 million and $50 million to the top line next year. We will talk about specific 2019 assumption and guidance when we announce our 2018 year-end results. Now, Harriss, will review our financial results in my details.

[Harriss Currie:]

Thanks, Homi. As Homi mentioned, we had another good quarter with consolidated third quarter revenues, absent the effects of the LabCorp departure. Consolidated revenue was 72.4 million, down 2% for the quarter and up 7% when we exclude LabCorp. And for the year-to-date period, revenue was up 3% or 5% when we exclude LabCorp. Our LTG revenue stream was 36 million for the quarter, up 7% compared to the prior year quarter, driven by double-digit growth both in consumable and royalty revenue. For reference, consumable revenue was up 11% versus the prior year quarter and royalty revenue was up 10% versus the prior year quarter. Our molecular diagnostic revenue stream was 35.7 million for the quarter, down 10% primarily driven by the LabCorp departure. Excluding LabCorp, this revenue stream was up 6% for the quarter with the performance driven by the continued success of our sample-to-answer franchise, which was up 15% and 31% for the quarter and year-to-date period, respectively. For our sample-to-answer products both the number of active customers and the utilization per customer has continued to increase each quarter. For the third quarter, the annual utilization rate per customer for our VERIGENE products increased to 104,000, up 7% from the prior year quarter. And for our ARIES product line, average annual utilization was 55,000, up 28%. Turning to our revenue line items. During the third quarter, we sold or placed 284 multiplex systems, which do not include ARIES and VERIGENE system placements, above the high end of our communicated range of between 225 and 275 per quarter. Included in the system revenue are sales of our xMAP systems, sales of both our ARIES and VERIGENE systems and reagent rental allocations for those systems placed under reagent rental. Consumable revenue growth was 9% for the quarter, driven primarily by higher bulk purchases by a large HLA partner compared to the prior year quarter. Royalty revenue grew 10% over the prior year reflecting an increase in royalty minimums, audit findings and other adjustments. End user sales reported by our partners and recognized in conjunction with audit findings for the quarter were up 14% and 9% year-to-date. Consistent with our molecular diagnostics revenue stream, assay revenues were down 11% for the quarter primarily driven by the reduction in LabCorp. Excluding this impact, assay revenue was up 6% for the quarter with a 20% increase in our automated assay products. As we’ve communicated previously, LabCorp has confirmed that their last order for their proprietary women's health panel, the foundation of their women's health portfolio was placed in the second quarter after meeting their contractual minimums. Orders for other ancillary products have also declined significantly and currently are expected to continue through the end of 2018 with a de minimis contribution in 2019. Now turning to the income statement. We posted gross margins of 61% for the quarter, down 1 percentage point from the third quarter of 2017. This decline is primarily attributable to the reduction in LabCorp women’s health products as these assays typically carry a higher gross margin. We continue to focus on improvement of our sample-to-answer margins through both volume increases and cost efficiency. We also continue to control our operation expenses with declines in both SG&A and R&D in the quarter relative to our planned levels and up only modestly from the prior year. Operating profit declined 2.8 million for the quarter to 3.8 million or 5% operating margin primarily because of the aforementioned revenue decline in gross margin compression. Our effective tax rate for the third quarter of 2018 was 54% as compared to a benefit of 170% in the third quarter 2017. The 54% is impacted mainly by the Tax Act provision of foreign intangible income and our mix of earnings in the U.S. and Canada. This compares to the prior year which included a discrete benefit item of 12.4 million related to the release of our Canadian valuation allowance. Our estimated full year consolidated tax rate for 2018 is 25% to 30%, including the new 21% federal rate and GILTI or global intangible low-taxed income, but this full year rate is expected to be approximately 23% to 25% after incorporating other discrete items related to quarter four 2017 tax reform updates. Our balance sheet remains strong with no debt and 147 million in cash and investments. We generated nearly 8 million of cash in the quarter even with the payment of dividends of 2.7 million. As communicated previously, our DSO increased relative to the prior year due to the adoption of the new revenue recognition standard which required us to record an estimated receivable for unbilled royalties each quarter to more closely coincide with the timing of the end user sale by the partner. Prior to the revenue recognition changes, we had no royalties in our accounts receivable as they were recognized when paid. DSO was 54 days for quarter three. Excluding the royalty accrual, it would have been about 40 days comparable with prior periods to the revenue recognition change. Looking into the fourth quarter 2018, we currently expect fourth quarter revenues to be between 77 million and 79 million and expect to fall in the middle of our guidance range of 310 million to 316 million for the full year. Three factors have settled us in the mid range of our guidance. The first, a more modest flu season that expected contributing to lower than planned respiratory related revenue. Second is underperformance of our VERIGENE products in Japan as a result of reimbursement challenges. And three, slightly lower than expected consumable growth. Now, I’d like to turn it back over to Homi for some final comments.

[Homi Shamir:]

Thanks, Harriss. In closing, Luminex continues to demonstrate the power of its diversifying businesses. Our model continues to drive meaningful growth and we remain committed to investing wisely in product pipeline development across our entire businesses. As I have said many times, continued growth will be achieved through both organic and inorganic means. We’re never losing focus on the bottom line. I believe the announcement of our deal with MilliporeSigma support this. In addition to our exciting and robust R&D pipeline, our balance sheet remains strong and we will continue to search for additional attractive and synergetic M&A opportunities to further accelerate our current organic growth projection. This ends our formal comments. Operator, please open the line for questions.

[Operator:]

Thank you. [Operator Instructions]. Our first question comes from Dan Arias of Citigroup. Your line is now open.

[Dan Arias:]

Good afternoon, guys. Thanks. I wanted to start if I could on, hi Harriss, pull through rate for the VERIGENE, I believe is 104,000 which is up quite a bit from a few quarters ago but down a touch from last quarter which I think was a pretty light respiratory quarter. So just wondering how you think we should model pull through for the next coming quarters there? Does it pickup, backup with the respiratory season or is there some dynamic that would keep that from happening?

[Harriss Currie:]

As you know, we’re in the – not in the midst, we’re beginning a rather light respiratory season, so any pickup you might see relative to respiratory season on a per-customer basis could actually year-over-year be a little lighter this year than it was last year because of the extent of the flu season. I recognize the flu season last year really didn’t pickup until January, February, March months, but it was a lot heavier then than it is right now. Now I don’t know what’s going to happen over the next couple of months, but to be honest, my expectation would be that it would be flattish relative to the prior year. Number of active customers we’ve added has increased because we measure this on an average per customer. I think the likelihood is that it’s flat or modestly down a little bit in the fourth quarter. I hope that helps.

[Dan Arias:]

Yes, it does. Okay. And then on Millipore, I know you guys want to talk about assumptions there when you guide to 2019, but I just want to go back to the outlook there if I could. You said on the call a few weeks ago that the acquired asset sales were €40 million, which is about 45 million USD and that the outlook for the next year is 40 million to 50 million USD. So, just wondering if you can clarify what the growth expectations are that you have in 2019 there, either dollar wise or percentage wise?

[Homi Shamir:]

Dan, it’s Homi. It’s a good question because one of the things we would like is we would like to understand better the portfolio when we get it into our range, and we have to remember one thing. In their €40 million or €41 million, they’re expecting to do the sale, there is about $3 million that is not going to recur. So it’s actually taking it from 37 to whatever we are thinking. Also I would like to make sure that within the portfolio there is no items that maybe we at Luminex don’t want to carry the product to our customer. I can tell you that two-thirds of their business which is the Amnis, it’s basically the imaging flow cytometry is going very nicely growing in double digit numbers. So we need to really spend more time and understand the Guava and which one in the product line on the Guava, especially on the low end, the Muse, it makes sense to us to continue with that. Also, they are launching a new product and revamping the Guava product line, so we need a little bit more time to understand it and that’s where we are trying to guide around between the 40 million to 50 million, but as I said, two-thirds of the business is growing double digit, which is the imaging business.

[Dan Arias:]

Okay. I appreciate that. Maybe if I could just sneak one more on Harriss, the SG&A decline versus plan, is there anything there that was sort of timing related and that will have the number up again in 4Q, or are you just sort of managing tighter than you thought you would earlier?

[Harriss Currie:]

We’re managing pretty tight as a result of the departure of the higher margin LabCorp revenue. So we’re squeezing at any place that we can to protect profitability to the extent we can. So the fact that we’re little less than plan is important. I think what’s more important is relative year-over-year we’re pretty much flat. So that on a bigger revenue base year-over-year even including the departure of LabCorp is I think what is most important to pay attention to.

[Dan Arias:]

Okay. Thanks a bunch.

[Harriss Currie:]

You bet.

[Operator:]

Thank you. Our next question comes from Sung Ji Nam of BTIG. Your line is now open.

[Sung Ji Nam:]

Hi. Thanks for taking the questions. Maybe a couple of clarifications for Harriss and then one for Homi. Harriss, could you clarify in terms of the LabCorp business that’s remaining? You talked about that being de minimis next year. Is that also pretty small this year? Are you further managing that away next year or is that what you were referring to?

[Harriss Currie:]

So let me tell you how to think about it, Sung Ji, is that in 2017 LabCorp did about $61 million of revenue. In the current year, the expectation is that total LabCorp contribution to Luminex is going to decline by about 15 million to 20 million. It’s going to drop by a lot. And then next year, there’s going to be an additional loss of about 35 million or so next year leaving the 10 million or so of CF-only revenue in 2019 with a de minimis contribution in those ancillary products that we were talking about. So the overall LabCorp contribution itself 10 million on 300 million plus itself is not de minimis, but the ancillary products that will be purchased will definitely be de minimis as we’re left with LabCorp in 2019 of really nothing but the CF product.

[Sung Ji Nam:]

Okay. That makes sense. And then for reporting purposes next year for the flow cytometry business, are you going to be breaking that out separately or will it be incorporated into the LTG business?

[Harriss Currie:]

Most likely the flow cytometry business will be separate revenue line items but it won’t be a reportable segment. It will be integrated significantly in order to avoid segment reporting as we use a lot of the back office functions and others to support the business. Certainly will have its own sales force generating revenue, likely of a lot of the field service folks will be devoted to those instruments. But besides that, we won’t provide visibility all the way down to like a business unit level. So I would tell you that revenue will certainly be carved out separately.

[Sung Ji Nam:]

Okay. And then, Homi, I guess with the recent Palmetto decision, could you talk about what percentage of your syndromic panels might be exposed to that and kind of what you’re hearing from your end markets, you customers in terms of how they’re preparing for that? Thank you.

[Homi Shamir:]

As I keep saying, I think the Palmetto decision can be an opportunity to Luminex mainly because of our pricing, the Flex pricing strategy in our current pricing that we are selling. I think basically, they adopted, what I can say is most of our recommendation into their decision giving us competitive edge here. And obviously I think we will be able to gain here compared to our competitors who don’t have Flex pricing or almost selling double the cost than us. So I think it’s well demonstrated and you have been part of that in AMP. We – obviously if you look at the number system, the new contracted system that we placed this quarter, 81, and we are targeting or focusing to be close to 250 systems. Our customers are adopting our Flex pricing and behind that they are adopting our offering for them. So we feel and again that’s going to – Palmetto is going to help us in achieving larger market share here.

[Sung Ji Nam:]

Great. Thank you.

[Operator:]

Thank you. Our next question comes from Brian Weinstein of William Blair. Your line is now open.

[Brian Weinstein:]

Hi, guys. Thanks for taking the questions. On the sample-to-answer business, I just want to make sure that I understand kind of what’s going on. So I think we started the year with $70 million is the target. You brought that down to 64 to 66 and it seems like we’re going to be like 62.5 if I take that $18 million that you talked about there. So I just want to have an understanding of kind of as we look back at the year, sample-to-answer, where were we off from the original expectations? And then as a follow up, $2 million roughly that fell from Q3 to Q4, you said molecular but could you be more specific about where that fell? Was that also in the sample-to-answer side?

[Homi Shamir:]

I’m not sure where you got the 70 million. I more recall that on the 65. And again, I think the slightly reduction here is that our anticipation, as Harriss said earlier, that is going to be below moderate respiratory season. So we are a little bit cautious there. If the moderate season – let’s assume we have a strong season, then we will be on track. Our modeling showing that will be around 62 to 63.5 with sample-to-answer taken less, leave a few dollar here. And also, as Harriss mentioned, in Japan we thought with Hitachi we will be achieving a couple of hundred thousand dollars more than what we achieving here due to reimbursement investment is not the best in the blood culture. They have some difficulty growing the business there. So that’s really where it was the adjustment. But we are taking a very precautious thinking to the respiratory season on Q4. But I don’t know where you took the $70 million, Brian.

[Brian Weinstein:]

Okay. We’ll go back and check the comments on that. As far as some of the pipeline stuff goes, can you give us an update on the Sensiplex [ph] product and when you think that that may start to contribute and any updated thoughts on that?

[Homi Shamir:]

I don’t think it will contribute any significant revenue next year and we talked about that in the guidance. But we are planning – we are on track to invite our major partner here to Luminex in Q2, share with them the system, let them start running it on their kits and let see how that perform. As we all know, the Sensiplex should be a fully backward compatible. So we would like them to do and run it and confirm it, then we’ll start seeing when they want to introduce it to the market. But it can contribute here and there but nothing significant during 2019 in our assumption and when we talked about it in AACC, we all the time talked about contribution in 2020.

[Brian Weinstein:]

Thank you, guys.

[Harriss Currie:]

You bet.

[Operator:]

Thank you. Our next question comes from Dan Leonard of Deutsche Bank. Your line is now open.

[Dan Leonard:]

Actually Brian asked my question, so I’m all set. Thank you.

[Homi Shamir:]

Thank you.

[Operator:]

Thank you. Our next question comes from Tycho Peterson of JPMorgan. Your line is now open.

[Tycho Peterson:]

Hi. Thanks. I want to maybe go back to the Palmetto issue for a minute. Can you comment on their LTG on GI? I think maybe your comments you’ve made in the past have been really around RP, but how do we think about their latest LTG on GI panels?

[Harriss Currie:]

Sure, Tycho. So as you know, Palmetto finalized their guidance around GI as well. There’s a limit to five bacterial targets for individuals that are otherwise healthy. That cover expands a little bit for patients suspected of having C. diff and then obviously there’s full panel coverage for immunocompromised patients, transplant patients and others that may have some issues. For GI, Flex testing to be honest is really ideal for addressing all types of patients it covers and we’re going to be the only company in this market with a flexible cost effective solution for doing GI with our VERIGENE II GI. So it’s going to be priced right, it’s going to have the right coverage and a significant number of the affected patients, the offending constituent can often times be found in that base panel. Now the one thing to consider is that Palmetto has adopted this now but there are other MACs that are expected to follow. CGS has already adopted similar guidance. Meridian and WPS are expected to adopt the same guidance in the coming months. And then private payers are likely going to issue policy to explicitly cover these panels in the appropriate way. So we think overall that it was actually more positive for us than we anticipate. We acknowledge that it only impacts outpatient testing today, but ultimately we believe the hospitals are going to want consistent pricing and consistent billing for no matter where the patient resides within the hospital, the way they pay for a test. And so we think overall it should end up being a value driver for us because one size fits all panels are becoming more difficult to sell these days. And so we believe that our alternative offers a really good solution for these patients and we’re also in the process of developing some studies on clinical utility to demonstrate specifically the impact of the Flex testing model on treatment decisions. So I hope that answers your question.

[Tycho Peterson:]

Yes. Maybe just a follow up then. How do we think about utilization as more migrates to Flex and therefore kind of narrower panels? Obviously there’s a share gain story on the other side, but how do we think about utilization?

[Homi Shamir:]

We made the [indiscernible] with our customer and 93% of our customers bought our system because of the Flex. So obviously maybe it’s a little bit bias but all of them bought because of the feature of the Flex. Obviously, we don’t have a Flex to offer them now because we are in clinical. But the rationality of them is buying into the Flex model. So maybe that’s answer to the question.

[Harriss Currie:]

Yes, so there’s two components to that what Homi just said, Tycho. The first is that a significant number of the customers are buying it because of the Flex testing and those that are left are buying it because the pricing’s favorable. It’s economic value. So we’re providing 100% of the customers’ effective economic value for those who just want the base or for those that want to have the ability to Flex upward and only pay for what they need.

[Homi Shamir:]

And obviously you see from the number that we contracted this quarter, obviously they believe in the Flex. They know about the reimbursement challenges of Palmetto, but they contract. And as we said earlier, normally a contract is for three and five years. So they believe that that’s the trend that’s going to influence the market.

[Tycho Peterson:]

Okay. And then just one follow up shifting over to the flow business. I think two of the opportunities you’ve talked about are one to go after kind of a mid-tier part of the market and then two to obviously increase the recurring revenue mix and consumable stream. So can you maybe just touch on those two initiatives specifically? What strategy is there?

[Harriss Currie:]

So the primary focus of our flow cytometry business are going to expanding the imaging base, the proprietary product to which we own. There’s still obviously growth opportunities in the lower level flow cytometry systems and effectively it’s the same approach that we’ve used with molecular diagnostics which is the portfolio approach, right? We can go to the low cost guy all the way up to the high cost guy and everybody in between and offer them what they need. So with respect to growing the business, the idea is to focus on imaging and the applications to which imaging provides. Obviously – not obviously because you haven’t seen the data we have, the recurring revenue what I’ll call flow cytometry assay revenue is very low today. Now, our percentage of revenue of recurring revenue relative to what it is in the market’s significantly lower and we think there’s opportunity there to grow that as well through the additional development of products that can be run on our flow cytrometres most likely focused towards the imaging portion of the product line because it’s proprietary but there is opportunity there because it’s almost insignificant today in the revenue mix.

[Tycho Peterson:]

Okay. Thank you.

[Harriss Currie:]

You bet.

[Homi Shamir:]

Thanks.

[Operator:]

Thank you. Our next question comes from Brandon Couillard of Jefferies. Your line is now open.

[Brandon Couillard:]

Thanks. Good afternoon.

[Harriss Currie:]

Hi, Brandon.

[Brandon Couillard:]

Harriss, just a clarification. I think you said that LabCorp next year CF related revenues would be about 10 million for the whole 2019. Did I hear that right? I think that business I understood was tracking at about 5 million a quarter, so does that suggest some CF related declines built into that number for next year?

[Harriss Currie:]

No. It was tracking between 12 million and 15 million a year --

[Homi Shamir:]

From last quarter – but we have additional business that we generate from other customers, okay.

[Brandon Couillard:]

Right.

[Homi Shamir:]

But LabCorp business is 10 million to 12 million. We have contracted to end of 2019. We believe it might stay with us further beyond this period but we have additional customers in CF. If you recall, there was in the past some Logic customer. When they stay out of CF, we got some customers from them.

[Harriss Currie:]

So let me give you an example, Brandon, and I don’t want to be too specific here. But in the quarter, so LabCorp based on the numbers you’re talking about orders between $2.5 million, $3 million of CF a quarter. Our total CF revenue in the third quarter was more than twice that. So it’s – we had a lot of other CF revenue besides LabCorp in our mix.

[Brandon Couillard:]

Got you. That’s helpful. And then on more, given that the LabCorp revenue hit would likely be higher in the fourth quarter relative to the third, what should we be penciling in, in terms of the gross margin, Harriss, for the fourth quarter?

[Homi Shamir:]

No. LabCorp revenue in the fourth quarter are going to be less.

[Harriss Currie:]

So there are likely to be some additional margin compression in the fourth quarter, however, because the volumes of our overall molecular diagnostic revenue both in the non-automated and the automated for ARIES for the bead-based technology and for VERIGENE for that matter will increase – likely increase in the quarter with the onset of a flu season modest nonetheless and we’re expected to have continuing growth in royalties in the fourth quarter, good bead quarter. So those are very high margin items that offset some of that loss. So I wouldn’t expect gross margins to constrict more than a point or two in the fourth quarter.

[Brandon Couillard:]

Okay. Thanks. And then one for Homi. Didn’t hear much about the VERIGENE II development but could you just share with us an update on where some of the timeline stand and whether or not you started the RVP trial at this point? Thank you.

[Homi Shamir:]

No. We continue with the GPP trial. It’s continuing and hopefully we’ll finish with the trial or the sample part of that very shortly. And we are planning to start somewhere in the beginning of December with the RP trial.

[Brandon Couillard:]

Okay. Thank you.

[Operator:]

Thank you. [Operator Instructions]. Our next question comes from Daniel Macek of Piper Jaffray. Your line is now open.

[William Quirk:]

Great. Thanks. It’s actually Bill Quirk on. So a couple of questions I want to go back to Palmetto on if I may. So first off on Japan, is this a new issue or it’s just that reimbursement is taking longer to get on the multiplex side? And then, Homi, you referenced potential capital deployment in the form of acquisitions. I’m just trying to get a better sense as should we think about these as being more tuck-in, kind of somewhat more aligned with the core Luminex business or would you continue to look at new sources of revenue akin to what you did with Millipore? And then I’ve got a follow up. Thanks.

[Homi Shamir:]

Thanks. But no, Japan is not a new – Japan we’ve got about a year and a half ago investment on blood culture. And we’ve been working that with Hitachi. We have just not been able to bring it to the level that we anticipate initially mainly because the investment itself is – again, I don’t want to get off the point there. But it’s not highly reimbursed item compared to what the Japanese are used to and it’s taking time to take – we have like 10 or 15 active customers. We thought by this time we will have more than that and it’s taking more time that we anticipated. And again, Hitachi was here this week and we talked with them in length. But they claim that they need to apply again and try to increase the reimbursement because as you know in Japan they buy the capital equipment. It’s different than what we are doing here, the reagent rental. When you put the capital equipment, everybody want to make money also in Japan and [indiscernible] really become a tough thing to find how to get the reimbursement in the right level. But again, it’s not in the millions. It’s affecting in the hundreds of thousands dollars but again that was included in some of our assumptions. So that’s concerning the first question. The second one, we continue to seek after acquisition, I think Nanosphere was a very successful. We believe the Millipore acquisition was also a very good acquisition for us both from price and eventually from earnings and how we position ourselves in this space. So we have continued to look at things that can make us more diversified company either in the molecular diagnostic where we are operating or in our position of life science. So we don’t have anything in particular that I can say to you. We are going to do it tomorrow, the next couple of days. But we keep seeking and we keep looking. We have done couple of licensing agreements earlier this year and we continue to need some cash sometimes to those acquisition.

[William Quirk:]

Okay, got it. Thank you. And then I just want to go back to Palmetto and certain appreciate your Flex pricing and potential for some market share gains. Can you just elaborate on kind of what you’re assuming for pricing? And the reason I’m asking is because our due diligence does suggest that your competitors maybe looking at a Flex priced model, albeit maybe not a term but certainly following that approach. And it strikes us that given the changes here which I appreciate that are likely to spread into the commercial pay world, it seems fairly logical that we’re going to see downward pressure overall. And again I appreciate that you’re on the lower end here, so maybe you see less contraction, but just help kind of put that piece together for us? Thank you.

[Harriss Currie:]

So based on the expected compression of reimbursement for panels like ours which ranges from high 500s to low 600s to down into the 200s, the overall reimbursement. Our base panel that we sell today is less than $100 relative to others that are in excess if not well in excess of $100 for the products they offer. So when you think about top line price compression and in our case especially with respiratory since we already sell it in the Flex manner and all we charge patients for flexing upwards, there would be no material effect on our revenues other than growth as we place more assays to be sold on the Flex. Certainly, in GI, there would be some modest exposure to starting at a lower level and flexing up in the events they need to. But the beauty with us is our products were designed to accommodate that low base price whether others were designed to accommodate, I don’t know. You’re talking about 120, 130, all the way up to a couple hundred dollars. Our base price is about $60 and we make money at $60. So I don’t know whether others at $60 are going to make significant profit if any.

[Homi Shamir:]

Now one more thing to add to that, Bill, when you’re looking at overall revenue of our sample-to-answer coming from the VERIGENE, still substantial amount coming from blood culture. And we continue to go on blood culture. It’s a really good assay for us and on top of that we have respiratory P and the GPP that will come up as a flexing. As a matter of fact, in blood culture also if you can call it, we have Flex pricing because we’re selling the gram – positive gram, negative each of them separately. So, so far it’s working for us.

[William Quirk:]

Got it. Thanks, guys.

[Harriss Currie:]

You bet.

[Operator:]

Thank you. Ladies and gentlemen, this does conclude our question-and-answer session. I would now like to turn the call back over to Homi Shamir for any closing remarks.

[Homi Shamir:]

Thank you, Sonia, and thank you everyone for your attendance on our earnings call today. We look forward to seeing you in person in the very near future. Thank you.

[Operator:]

Ladies and gentlemen, thank you for participating in today's conference. This concludes today’s program. You may all disconnect. Everyone, have a great day.