Luminex Corporation
Q4 2013 Earnings Call Transcript

Published: 4 Feb 2014

[Operator:]

Good day, ladies and gentlemen. Welcome to Luminex Corporation's Fourth Quarter and Full Year 2013 Earnings Conference Call. My name is Cilia, and I will be your coordinator for today. Today's call is being recorded. At this time, all participants are in listen-only mode. Following the prepared remarks, there will be a question-and-answer session. (Operator Instructions) I would now like to turn the presentation over to Harriss Currie, Senior Vice President and Chief Financial Officer for opening remarks. Please proceed.

[Harriss Currie:]

Thanks Cilia. Good afternoon. And welcome to Luminex Corporation's conference call to review fourth quarter and full year 2013 financial and operational results. Today, Pat Balthrop, our President and Chief Executive Officer; and I, will discuss the results that were released today after market close. In addition to the audio portion of our conference call, we’ve prepared a slide presentation that’s on our website at www.luminexcorp.com and will be available for six months. I would remind everyone that certain statements made during the course of this presentation may not be purely historical and consequently may be forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. 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, 2012, and our quarterly reports on Form 10-Q for subsequent periods, filed with the Securities and Exchange Commission. We encourage you to review these documents and the cautionary language we have included at the beginning of the slide presentation we are presenting today. We undertake no obligation to update these forward-looking statements. Also, certain non-GAAP financial measures, as defined by SEC Regulation G, maybe covered in this presentation. 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 the presentation and be available on our website in accordance with Regulation G. I'll now turn the call over to our President and CEO, Pat Balthrop.

[Pat Balthrop:]

Thank you, Harriss. Welcome to our fourth quarter and full-year 2013 earnings call. Over the next few minutes, we will review our performance. First, I'll summarize the fourth quarter and 2013 corporate highlights, Harriss will review the financial performance and our 2014 guidance, and I’ll conclude with a review of our 2014 priorities, after that we'll open the call for your questions. We finished 2013 with record revenue for the full year of $213.4 million within our guidance range. In the partnership stream, we had a solid quarter driven by an increase in system sales and 23% growth in royalty revenue. In the assay stream after adjustments for unusual items associated with our transition to a direct molecular diagnostic sales force in 2013, we experienced a slight decline in assay sales primarily due to macroeconomic factors such as the reimbursement headwinds that we have discussed previously which continue to impact our customers through year-end. We expect these macroeconomic factors to subside in 2014, more on this topic later. Outside of assays, other product lines showed continued strong growth. We shipped a record 327 multiplexing analyzers, which is the highest number of system shipments achieved in a single quarter in the history of the company and higher than our historical quarterly average range of 200 to 250 shipments. This number included a strong quarter for MAGPIX shipments with 162, representing continued success of this system in the marketplace, as well as a strong quarter for FLEXMAP 3D, as we pointed out to our investors that this system being cleared by FDA in 2013 will facilitate penetration in some of our key segments. Other highlights to this quarter’s income statement include strong gross margins at 67% and GAAP net income of $5.1 million or $0.12 per diluted share. On a non-GAAP basis, we earn $0.21 per diluted share. In the midst of a number of unexpected circumstances, 2013 was another year of progress here at Luminex. Some of our key accomplishments include shipping over 1,000 multiplexing analyzers in the year, surpassing 10,000 total systems sold to date. We're pleased with this overall trend, including its strategic implications and are optimistic heading into 2014. We continue to expand our clinical assay menu, receiving FDA clearance for our innovative GPP product in early 2013. We continue to be on track with customer additions, closing some key accounts during the fourth quarter. Given the novel nature of this first-to-market molecular assay, we are pleased that accounts are closing at the rate we planned. As we’ve discussed, however, validation is taking slightly longer than initially expected due to the uniqueness of the assay. The good news is that customers are converting, and we expect GPP to be a key growth driver in 2014. We also made significant progress with our pharmacogenomics assay portfolio in 2013 with the FDA and European Clearance for an updated 2D6 assay in July, and FDA and European Clearance for new comprehensive genotyping assay for 2C19 in September. Luminex has also made significant progress on our long-term strategic initiatives. Regarding ARIES, we transitioned from an advanced prototype in 2012 into an alpha testing in 2013 and are moving into beta. We unveiled the ARIES system to both customers and investors at the Association for Molecular Pathology Annual Meeting in November. As a reminder, ARIES is a next generation molecular diagnostic system of hardware, proprietary testing chemistries, and best-in-class software that has received an enthusiastic response from customers. It’s highly flexible and addresses the important customer priority of bringing lean management principles to the molecular testing clinical lab, solving the practical challenges that our lab customers face. We remain on schedule with ARIES. Lastly, we completed a full conversion of our molecular diagnostic business to a direct sales model. In 2014 and beyond, we expect to realize the full benefit of this valuable and important strategic move. We’re excited about the future as well. For the company, 2014 is expected to be a key year and an exciting year as we position ourselves toward accelerating growth. In the molecular market, the reimbursement headwinds of 2013 that attracted our customers are subsiding. For 2014, the areas of priority for the company include continuing to execute on our key strategic products and programs including building momentum with a full year of direct sales force in the molecular market, continuing to penetrate the market with our new GPP test, executing on the emerging opportunity in pharmacogenomics with our recently FDA cleared test, and in addition in an increasingly competitive respiratory viral panel segment to execute our various new programs in areas such as automation and others to maintain our share in the high-volume accounts that are the company’s strength. Looking at sources of future growth, in the coming months, we’ll be preparing the launch of several new products that are in the final stages of development, including readying for launch of ARIES in Europe in the second half of 2014 and preparing for a U.S. launch in early 2015. We are convinced that ARIES is going to be successful and a major growth driver for the company in future years. We designed this platform with input from our customers and are convinced that it will solve many of the practical challenges those customers’ face, which up to this point have remained unaddressed by the industry. With differentiated features such as the ability to automate LDTs, both random and batch testing capability, minimal footprint and universal protocols, the response from customers has been enthusiastic. In addition, by introducing the robust assay menu at launch, consisting of five assays, both novel and [workhorse] (ph) assays will be strategically poised for rapid adoption of this platform by the marketplace. Finally while ARIES will allow us to expand into an adjacent opportunity by entering the low plex market, we also plan to address our customers needs for a simplified workflow in the high flex and high throughput markets where we have traditionally been strong with our technology. We’ll continue making progress on the development of our next tag multiplexing technology, and we’ll continue with our strategic goal of expanding product lines with products such as ARIES v2 which will be a real game changer as the first system to offer both real-time and multiplexing technology. Now I’ll turn it over to Harriss to review the financial data. Afterwards, I'll return to discuss our 2014 Outlook.

[Harriss Currie:]

Thanks Pat. Let’s begin the financial review with a look at revenue. Total revenue for the fourth quarter decreased slightly from the prior-year period by 1%. However, for the full year, total revenue grew by 5%. For the quarter, systems and royalty revenue grew by 40% and 23%, respectively. As Pat mentioned, we sold a total of 327 multiplexing systems in the fourth quarter and 1078 for the full year, increasing cumulative shipments of multiplexing systems from the prior year by 11% to 10,737. For each quarter in 2013, with the exception of the first quarter, we performed above our expected range of system placement but experienced an expected shift in the distribution of systems between LX and MAGPIX systems. In 2012, LX and MAGPIX systems represented 52% and 43% respectively of total multiplexing system placements. And as unexpected, LX and MAGPIX systems represented 47% and 46%, respectively of total multiplexing systems placed in 2013. System revenues were up 40% for the quarter, primarily due to the impressive number of total multiplexing systems and some significant incremental sales of our FLEXMAP 3D product, which has a higher price point. System revenues for the year were up slightly by 2% as a result of the 10% increase in symptoms shipments, the couple with the percentage shift from LX systems and MAGPIX systems which have a lower price point. Royalty revenues were up for the quarter and full year by 23% and 19%, respectively, representing total end user sales on xMAP technology of $110 million and $443 million respectively. In the aggregate, our higher margin items, consumables, royalties and assays comprised 75% with total 2013 revenue. Consumable revenues were down 3% for the quarter and relatively flat for the year reflecting continued stabilization of purchase volumes from our largest customer and some headwinds from our LSR focused partners, through the lower research budgets in the U.S. and with the implementation of sequestration earlier in the year. There are 17 bulk passes of consumables in the quarter, totaling $9.6 million or 80% of the total, ranging from our $122,000 to $3.3 million. After revenue decreased by 24% from the quarter and 1% for the full year, due to a number of factors including the reimbursement headwinds which continue to affect our customers ordering partners at the end of 2013 as well as a later start to the 2014 flu season which began to pick up in January. In addition, if you recall the prior-year quarter, we shipped over $2 million in orders to our distributors as part of our going direct transition. If you adjust for the orders, the adjusted rates are declining, 18% for the quarter and an increase 4% for the full-year in assay revenue. Looking briefly in our revenue growth by segment, our partnership segment or TSP revenues grew by 20% for the quarter and 9% for the full year. Our assay’s related products segments or ARP revenues decline for the quarter by 25% and we’re flat for the full year. For the quarter, infectious disease assay sales comprised 75% of total assay sales with genetic testing sales comprising 25%, compared to the distribution of approximately 68% for infectious disease assays and 32% for genetic assays in the prior year fourth quarter. Now let’s turn to the income statement. As discussed previously, revenues contracted by 1% from the quarter, but grew at 5% for the year-to-date period. Gross margins for the quarter and full year were 67%, down from prior year balances of just over 70%, primarily as a result of impairment charges related to our restructuring plan of approximately $400,000 in the fourth quarter and $2.6 million for the year, coupled with the sales mix with higher margin items, decreasing slightly as a total percentage of revenue for both periods. We remain confident in our ability to maintain gross margins in the high 60% to low 70% range on an ongoing basis. GAAP operating expenses decreased 2% for the quarter and increased 16% for the year-to-date period. However, there were a number of one-time items included in the 2013 GAAP OpEx. Including, $7 million associated with the termination of our distribution agreements, $3.9 million for the write-off of the NMTC receivable, $2.4 million in restructuring costs and $700,000 in litigation fees. A couple of other items of note with respect to the composition of our GAAP operating expenses for the current quarter and full year are, R&D expenses for the quarter were down 12% over the prior year period and represented 18% of revenue, primarily as a result of the GenturaDx acquisition costs incurred in the prior year quarter, offset slightly by increased spending related to development of our ARIES system and assays in the current quarter. For the full-year, R&D expenses were up 5% compared to 2012, largely due to the additional expenses related to the development of our ARIES system and assays. But for both years, R&D expenses as a percentage of revenue remained steady at 21%. SG&A costs were relatively flat for the quarter, representing 36% of revenue. For the full year, SG&A expenses increased approximately 20% and represented 41% of revenue compared to 36% of revenue in the prior year. Of the components of SG&A, sales and marketing constituted a significant portion of the increase, growing 21% for the full year as a result of taking full control of our molecular diagnostics channel. G&A costs were also up 20% over the prior year, primarily attributable to the $7 million expense associated with the resolution of our molecular distribution agreements and a $3.9 million of bad debt expense recorded for NMTC in the third quarter, partially offset by a reduction attributable to acquisition costs incurred in the prior year. In our comments today, we referenced certain non-GAAP operating measures. We believe that adjusting for certain items and their related tax effects reflects operating results that are more indicative of the company's ongoing performance, while improving comparability to prior periods and as such, they provide our investors enhanced understanding of the company's financial performance. For the fourth quarter, consolidated GAAP operating margin was 10%, a three percentage point decline from 2012 GAAP results. On a non-GAAP basis, fourth quarter operating margin approached 18%. On the year-to-date basis, GAAP operating margin was 2%, a 9 percentage point decline from 2012 year-to-date GAAP results, largely driven by the $7 million resolution of our distribution agreements from the first quarter, a total of $5 million in the restructuring costs recorded in the third and fourth quarters, and the charge in the third quarter associated with the allowance from the NMTC accounts receivable balance of $3.9 million. This increase in charges was modestly offset by $4.3 million in acquisition-related expenses incurred in the prior year associated with the GenturaDx acquisition. On a non-GAAP basis, the year-to-date operating margin was 15%, down from the prior year and also inclusive with the allowance for bad debt expense related to NMTC. The effective tax rate for the full year 2013 was 38%, compared to 46% in the prior year. For the quarter, we generated GAAP net income of $5.1 million or on a diluted basis, $0.12 per share compared with income of $0.10 per share in the fourth quarter 2012. For the full year, we achieved GAAP net income of $7.1 million, or on a diluted basis, $0.17 a share compared with net income of $0.30 a share in the prior year. On a non-GAAP basis, we generated net income of $8.8 million or $0.21 per diluted share for the quarter and net income of $26 million or $0.62 per diluted share for the year. The allowance for the NMTC receivable contributed almost 100% of the decline in EPS on a non-GAAP basis for the year. Now turning to our two core segments, GAAP operating profit of our Technology and Strategic Partnership segment was an healthy 29% of TSP revenue for the quarter and 26% for the full year, an increase of eight percentage points from the prior year quarter, and an increase of 3% over the prior year. The increase in TSP GAAP operating profit is primarily due to the increases in systems and royalty revenue as well as a shift of research and development resources towards development activities within our ARP segment. The GAAP operating loss of our ARP segment increased for the quarter and for the full year, driven by the reduction to revenue from the previously mentioned restructuring costs, bad debt expense and charge for setting our molecular distribution agreements, offset somewhat by non-recurring acquisition costs expensed in the prior year, that are not present in the current year figures. We ended the year with $72.4 million in cash and investments, up $9.7 million from the September 30th balance. For the quarter, we generated $12.3 million in operating cash flow, net of the excess benefit of stock-based awards. We had minimal share repurchases during the fourth quarter as we substantially completed our plan from the prior quarter. You recall that our share repurchase program was intended to offset dilutions from our equity plans and weighted shares outstanding. At December 31st, both DSO on accounts receivable days payable standing had decreased compared to the prior year to a DSO of 52 days and days payable of 54 days. And finally, we had 1.7 forwards quarters of inventory on hand at December 31st. This slide summarizes our 2013 cash investment flow. The takeaway here is that, we had strong operating cash flow during the year, which funded the majority of our share repurchase program and purchases of PP&E. Additionally, due to the acquisition of Advanced Liquid Logic, for which we held an ownership stake, we received cash proceeds of $9.5 million during the year on a sale resulting in a $5.4 million gain. Overall, we've added approximately $13 million in cash and investments during the year Now on to 2014 revenue guidance, today, we announce our 2014 revenue guidance of between $225 million and $240 million, representing expected growth of between 5% and 12% over 2013. From a macro level perspective, we remain cautious but optimistic about the life science research market, while experiencing continued favorable trends with respect to overall demand from our clinical customers. With respect to assays, we anticipate growth in our GPP, CF and PGx product lines along with continuing positive momentum in our LDT strategy. We believe that the benefit of having a direct molecular diagnostic sales force in place for the entire year will provide significant momentum in 2014. For modeling purposes, please be aware of the typical seasonality in hardware sales. In other words, historically, first quarter system sales have been the weakest quarter of the year. Major factors that could affect where we fall within our guidance range, including the timing of planned product launches, revisions and approvals, and the related velocity achieved with our new product introductions. The timing of and continuation of market conditions that we experienced in 2013 coupled with ongoing headwinds related to full resolution of the uncertainty associated with the macro reimbursement environment including the effect of the Affordable Care Act on patient behavior. And finally the pace of further traction within our LDT strategy prior to the launch of ARIES. While we manage our business for the long-term and ask investors to judge our performance over that period, we understand that quarterly performance is important. To address this issue, slide 16 provides detail that how our total revenue has been distributed by quarter over the past four years. Occasionally, Luminex experiences a year such as 2011 or 2013 where the distribution of revenue intra-year is less typical. How we're looking at 2014, we expect the quarterly revenue distribution that is similar to a more typical year with the first quarter and back half of the year falling within the historical ranges. I'll now turn the call back over to Pat for some final comments.

[Pat Balthrop:]

As we enter 2014, readying for the launch of our key high-growth drivers, the management team and I are very optimistic about the future and we'll focus on the following priorities. Executing our razor and blade model that has been so crucial to the company's financial success, we continue to see strong demand for our technology especially MAGPIX. Executing on our new product development programs we're very excited for example about the planned launch for ARIES in the second half of 2014, within assays our to priority will be expanding penetration in molecular diagnostics including adoption of GPP, the emerging opportunity and pharmacogenomics, and we also expect to continue to deliver growth opportunities within our LDT strategy. And we expect to realize the benefit of a full year with our direct sales force in the molecular market. Financially in 2014, we expect to deliver another solid revenue growth year and maintain our industry-leading margins. We anticipate delivering excellent P&L leverage by dropping through majority of the new gross profit dollar generated and to generate strong cash flow. Building our cash balance of course will give the company maximum flexibility as we continue to manage the business with an eye on our strong financial position and our responsibility to shareholders. This ends our formal comments, Celia, please open the line for questions.

[Operator:]

Thank you (Operator Instructions) The first question comes from the line of Dan Leonard, Leerink. Please proceed.

[Dan Leonard:]

Thank you. I was hoping Pat or Harriss, if you could offer more color around your expectations specifically for the technology business and assay business in 2014?

[Pat Balthrop:]

Hi, Dan. Could you clarify your question a little bit?

[Dan Leonard:]

Yeah. So far, maybe it would really better asked in two separate questions, so for the technology business, do you expect the growth rate from this 9% growth we saw in 2013, do you think it would accelerate, decelerate, any color your could offer?

[Pat Balthrop:]

Well, on the technology business, we really don't, as you know, Dan, I'll answer your question but at least in directional terms. We don't provide line item guidance, our official guidance is only our full-year revenue, and I know you know that. But to add some clarity if you look at the installed base and the royalty growth rates and so on, somewhere in the high-single digits would be a reasonable way to think about that.

[Dan Leonard:]

Got it. Thank you. And then the placements in FLEXMAP 3D in the quarter, can you offer some color on where those are going?

[Pat Balthrop:]

Well, we've provided some qualitative comments through the year about the importance of FLEXMAP 3D in some expanding markets, and I think I made some comments about that during my formal remarks. For the quarter, we shipped 33 FLEXMAP 3Ds; and for the year, that number was 73. So, obviously, the significant number in the fourth quarter, and obviously that's going into our partnership business and more specifically moving into the diagnostic portion of our partnership business. Historically, almost all FLEXMAP 3Ds or I should say, historically all FLEXMAP 3Ds have been moving into the life science research portion of our partnership business. And so, the FDA clearance that we experienced earlier in 2013 is benefiting FLEXMAP 3D placements in that diagnostic portion of our partnership business.

[Dan Leonard:]

Got it. Thank you.

[Operator:]

The next question comes from the line of Dan Arias, UBS. Please proceed.

[Dan Arias:]

Good afternoon, guys. Thanks. Pat, I wanted to ask about GPP, it sounds like you're still positive on that opportunity. Can you just sort of offer some color on the accounts that you have won there, just in terms of whether or not those have been competitive wins from individual commercial culture tests or more conversion of homebrew assays? And then Harriss said he expects growth on that product line, I wonder, if maybe you could just be a little bit more specific just in terms of a contribution there for 2014?

[Pat Balthrop:]

Well, on the second -- the second question will be difficult, Dan, just because of the kind of line item guidance issue. But I'll do my best to answer your question. The -- what we've experienced in 2013 with GPP is not really surprising in that it requires validation to be done across a wide variety of targets, which includes, as you know, parasite targets, bacterial targets, and viral targets, which incorporates the coordination across multiple departments in a clinical lab and that's a very -- it has turned out to be a very difficult thing for us to forecast regarding that validation. I would characterize the validation part or the challenge there is being more political and administrative inside a particular account rather than science. And so as we go about coordinating that customer by customer, most of the customers we've added have been large university-type teaching hospitals, large hospitals that have 600 ,700, up to 2000 beds, dealing with very complex cases where differential diagnoses of these types of illnesses has the most clinical value. Downside of that is that a lot of those large institutions are -- can be very bureaucratic in nature, and I'm not blaming the customer here. I'm just dealing with the reality of the challenges associated with getting these large institutions to coordinate across multiple, multiple departments in the clinical lab. In contrast, for example, with RVP, when we launched that product a few years ago, it was really just virology that we had to work with. In this case, it requires three or four different departments, but we believe that we have that accounted for on our guidance range, and we expect it to be a continued growth driver for the company, and we're confident as we look toward 2014 and 2015 that we'll continue to benefit from the growth from GPP.

[Dan Arias:]

Okay. Thank you for that. Maybe on project ARIES, anything in guidance for that product line at the end of the year, and I guess, are you able to give us your assumptions for the timing of that launch, we'll be thinking more like December than anything in a 3Q, early 4Q timeframe?

[Pat Balthrop:]

I would say, on the second half, the way you should think about that is we'll update our comments here as the year progresses, but you should not be thinking July, so more toward the second half of the second half so to speak, and there are some assumptions in the guidance range but they are beyond immaterial.

[Dan Arias:]

Got it. Okay. Thank you.

[Operator:]

A question from the line of Brian Weinstein, William Blair. Please proceed.

[Unidentified Analyst:]

Hi guys this is Matt in for Brian. Good afternoon. Just quickly on the assay sales, I think, after adjusting out for transitioning the molecular sales force, I think, still down in the back half of the year in double digits. I wondered if you could parse out dynamics in terms of the pressure there whether it’s [NNTC] (ph) or reimbursement generally speaking competitive, if you could just give us a little bit more color on assays in the back half?

[Pat Balthrop:]

Well, let's start here. If you look in the fourth quarter, one of the key numbers that Harriss mentioned during his formal remarks was that fourth quarter versus fourth quarter. Infectious disease assay sales made up 75% of the assay sales in the quarter with genetic testing sales comprising 25%. So product like GPP and RVP are obviously in the infectious disease category. The genetic testing category or primarily CF in the pharmacogenomics assays. Those same numbers for the prior-year quarter were 68% and 32%, with 32% being for genetic assays. And so a lot of the headwinds that we experienced in the quarter, in the back half of the year or in the quarter where that genetic assay category as opposed to infectious disease, those are the areas that were most dramatically affected by some of those reimbursement changes. And what we experience with our single largest customer, which obviously is a big genetic testing user. And so as we look toward 2014 given what we know about reimbursement and in some of those problems that we have to deal with, our customers have to deal with in 2013. We’re comfortable and confident that as we move through the year that those headwind that we encountered our subsiding and will be relatively speaking a non-issue.

[Unidentified Analyst:]

Okay, thanks, Pat and then just quickly here on ARIES moved into beta testing. Are there any key remained technical challenges or hurdles that our crucial free guys move in to launch there?

[Pat Balthrop:]

No, it’s a beauty of beta testing. So I think, in my formal remarks I mentioned that standard of the industry is to go from prototype to advanced prototype, to alpha, to beta and then obviously for launching the system. So we’re well down the track and so we manufactured in our manufacturing facility dozens of these systems. We have them in departments around the company like customer training and reliability labs as well as an assay development et cetera. And so the way in which -- the way we approach these types of problems is not unique to the company but we're pretty good, we feel pretty good about our skill level there. And so we’re in development mode here from this point forward as opposed to trying to make any significant changes to the system as it works mechanically or what have you. So we’re very comfortable and confident that we’re kind of an execution mode with not a lot of technical barriers and promise.

[Unidentified Analyst:]

Thanks Pat.

[Operator:]

The next question comes in the line of Zarak Khurshid, Wedbush Securities. Please proceed.

[Zarak Khurshid:]

Yeah Zarak, Wedbush Securities. Thanks for taking the call guys. Curious if you could just give us a little bit more flavor for the disruptions in the assay business with your large customers. I guess more specifically what is your sense for kind of their commitment to the platform for CF and infectious disease testing with some of the, I guess, kind of confusion and new technologies are coming out.

[Pat Balthrop:]

Well, our sense of the commitment for our larger customers, including our largest customer which as lab core continues to be very strong. One of the benefits that our technology has for that particular -- for any customer but especially those large customers, is its ability to manage very high volumes and to do so in a very cost-effective way. And so as we look at the categories that I mentioned in response to an earlier question regarding the genetic assay category, both CF and PGX. Those are typically done in high -- in those high volume labs, the big reference labs for example, including some of the emerging specialty labs and pharmacogenomics. And so our technology is extremely well positioned there and extremely well-suited. I’m inferring from your question that you were talking about some of the announcements around sequencing and CF assays and so, is that right?

[Zarak Khurshid:]

That’s right.

[Pat Balthrop:]

Yeah. And so the way -- I can only convey to you what our customers convey to us and that is -- as I’m sure you're aware, sequencing is widely used in clinical labs today and has been for some time. CF in particular is a highly competitive market. I can't remember how many different applications are there that are available from different companies but there's a lot of them. And any method will be attracted to a customer, if they can just meet the customers basic requirements which are things like is it faster, better, cheaper or easier. And its our opinion based on what we know today that in this highly competitive CF category that we’re very well positioned because we are faster, better, at least equivalent that should -- as maybe a better way to say that and a lot easier and we’re also extremely cost-effective particularly as it relates to sequencing. So, what we've experienced in 2013 as little to do with the competitive issues in that genetic testing category and more to do with customers’ behavior regarding their uncertainties around some of the reimbursement factors that we’ve mentioned on previous calls.

[Zarak Khurshid:]

That's great color and just a kind of a quick follow-up on that. Do you have the sense for their end-market for CF, are those growth businesses for them or they perhaps losing share to some other specialty diagnostics lab service companies?

[Pat Balthrop:]

Well, I don’t want to speak on behalf of another publicly traded company. So I can only give you my own point full review based on what I know about what's happening in the market. The CF market, as you may recall is highly concentrated in two customers in the United States. Those two customer are quest in lab core. Question is relatively minor purchaser of our CF products, lab core is our single largest customer including CF. The rest of the competitors are more or less fighting over the remaining 10% or 15% of the market, that’s not in those two big customers. It continues to be a growth market for those customers and also from a reimbursement perspective, assuming that it kind of returns to normalcy so to speak. It also fits into what those big labs refer to the esoteric testing category, which is the highest source of gross margin. And so the reimbursement and the gross margin that those big labs enjoy in those categories end up being up a key strategic issue which is why the -- in response to your question about competition, one of things that's a really important thing to understand is the reimbursement rates and what the prevailing price points are for the different methods, right, whether it's sequencing and other more traditional methods. And so the growth rate there is less about competitive takeaways based on my perception and my conversations with our customers. But more about steadily increasing, although not-- I would say not double-digit levels, increasing adoption or volumes of tests.

[Zarak Khurshid:]

Okay. Great. Thank you.

[Operator:]

Next question is from the line of Bill Quirk, Piper Jaffray. Please proceed.

[Dave Clair:]

Hi, good afternoon everybody. It's actually Dave Clair here for Bill. First question from me, I was just hoping we could get a little bit more clarity on the reimbursement environment. Did you -- do you believe the things got progressively better in the quarter and I know that you kind of alluded to a potential headwind, I guess in 2014, I mean when do you think you will be completely past those issue?

[Pat Balthrop:]

Well, from our understanding of discussions with our customers. 2013, of course was incredibly unusual year. But part of the reason for that was because of really two factors. One was for certain types of tests like pharmacogenomics for example. They were reimbursement rates that were set that were fluctuating through the year. And the good news is that, if you look at some of the key tests that we're focusing on for growth, including the ones, that we received clearance for last year, which will include test like 2D6. If we look at the 2014 national limit amount for that particular test, it's a very healthy number in excess of $400. And so that's in terms of our customer’s perception of that, that’s something that they are very encouraged about. And in 2013 there was -- the number was moving around a lot and they were a lot of regional reimbursement authorities that were paying delaying payment or had significantly lower numbers and all that's been kind of resolved. The CF issue was also unusual but in a different way. CF, of course had been reimbursed in 2012 and all prior years. And then it kind of ran into some unusual circumstances with the implementation with the MAX with CMS. And some of the MAX were not paying because Medicare doesn't pay for CF and of course, Medicare would never pay for CF and never has because Patient 65 and older, they will all get CF test done. And so as those issues will resolved through the year, so our understanding that there is still some uncertainty there. But our customers are telling us, they expect that to be resolved in early part of the year, hence our comment.

[Dave Clair:]

Okay. Thank you for that. And then I was just hoping, you could give us an update on the RVP competitive environment. Do you think you are kind of maintaining or gaining share with that test?

[Pat Balthrop:]

Yeah. So, I would say that, I would characterize our market share situation as being stable. We have some significant advantages in very high volume accounts. And so as we look at the external market data, which to be perfectly candid is less than accounting grade accuracy. But as you might imagine, we work pretty hard to understand what's happening. There have been some market share changes and it's been what we’ve described previously as on the fringes and what we really mean by that is, that in kind of lower volume accounts. And so we've had some customers that were RVP-only users who now use RVP, but also use other more automated methods. In most cases that's been BioFire. And so in some other lower volume more distributed locations, but can still continue to use RVP in the core lab. So two years ago, we might have had a 100% of that business. Now maybe we have 85%. And so that's been what we've experienced. I want to be clear to say there have been some accounts losses. On the other hand, we've also picked up some. And so as we evaluate the market, it's our perception that it's relatively stable. Our market share position is relatively stable at the moment. The good news is, it's a traditional competitive situation as opposed to some of the factors I was just mentioning regarding reimbursement. So we don't expect -- we don't typically count on RVP as a growth driver from one year to the next just because of its seasonal nature of that particular product and of course it represents in our case, significantly less than 10% of our total revenue. So for us, it's not really a driver one way or the other even if it's growing -- even if it's a robust reason or if we are experiencing market share gains or losses. But obviously we want to hold on to every customer we can and we believe that with the fact that the market share is stable at the moment and some of these programs that I mentioned in my formal remarks in these high volumes accounts that we're implementing that we're confident we will be able to maintain our position there.

[Dave Clair:]

Okay. And then just maybe one real quick one here for Harriss. Thank you for the 2014 revenue guidance and you kind of address gross margin too. But I was just hoping maybe we could get some clarity around your operating expectations for '14?

[Harriss Currie:]

What we're expecting to deliver in 2014 and gross margins and again within our ranges as we discussed before in the high-60s to low-70s, the contribution from those higher margin items, consumables, royalties and assays. As that absolute number gross and it stabilizes as a percentage of revenue, it starts to really make that gross margin number stable number. We also expect to begin to deliver on additional leverage in the financial statements. Again, we mentioned G&A absent. The one-time costs that we incurred were roughly flat. Sales and marketing grew, made a big investment in sales and marketing in prior year. We won’t have to make another investment like that in 2014. So the way to think about it is that the rate of growth will not be at the same pace as it was in the prior year, and as a result we’ll begin to deliver from those incremental gross margin dollars through the operating profit line and increased operating profit as a percentage of total revenues.

[Dave Clair:]

Thank you.

[Operator:]

Next question from the line of Dana Walker, Kalmar Investments. Please proceed.

[Dana Walker:]

Thank you. Good afternoon. Could you talk about what was behind the strength and royalties in the quarter, or there are any one-timers in that and any meaningful royalty adjust or group royalty rate adjustments?

[Pat Balthrop:]

So, on the second part of your question, Dana, they were some rate adjustments in the quarter. On a year-over-year basis -- quarter-over-quarter basis, there were some benefit from rate adjustments, but no rate adjustments from the third quarter to the fourth quarter. So if you are comparing the fourth quarter of '13 to fourth quarter of 2012, they were some rate adjustments. The portion of the increased that would have been driven by rate adjustments would have been maybe a quarter of the total. The rest was a combination of end user sales. I believe there was a one-time item in there that was for couple of hundreds thousand dollars or so. And that was just kind of the timing of the contract for that particular customer.

[Dana Walker:]

Pat, are you seeing any improvement in life science research related product takeaway?

[Pat Balthrop:]

We are. If you look at that royalty number that you just mentioned, Dana, as well as the record number of instrument systems that we shipped in the quarter. As with FLEXMAP 3Ds in response from an earlier question where I mentioned we shipped a record number of FLEXMAP 3Ds, but to be candid, a lot of those were going into diagnostics channel but everything else for the most part was going in the life science research channel. And so some of the things that Harriss mentioned during his remarks regarding cautious optimism that we have in 2014 and in the future, it varies into what we’ve accounted in 2013 for some of our partners looking at the sequestration and some other things that made them and the customer -- the life science research customer little nervous. We don't really see those same factors in 2014. But those two things, the large installed base with the increase in the installed base year-over-year, the royalty numbers and the end user assay sales all make us optimistic about life science research market going into 2014.

[Dana Walker:]

Should that suppose a truism, a hope for truism, improve the tone to grow your bid in the consumable business?

[Pat Balthrop:]

Well, we would hope so. We are being cautious about that just because for obvious reasons, but obviously that number as you know can be from your experience with our company and as a shareholder. That number can fluctuate because of significant bulk purchases. So, we are optimistic about the consumables and in 2014 and continued to expand beyond that.

[Dana Walker:]

You have a couple of tests for the ARIES platform that were described as -- to be announced later. In what timeframe would you expect to provide more information on what those happen to be?

[Pat Balthrop:]

I would say more likely to be closer to the middle part of the year. And the only reason for that by the way is competitive. So those assays -- we have five assays that we are working on in development now. They're all more or less neck and neck in terms of their development progress. And so we expect the two assays that we have not announced yet to be available more or less when we launch the system just like the other three. And so we believe it gives us a competitive advantage to delay the full disclosure of what those assays are and we expect to do that in a few months.

[Dana Walker:]

If I were to take the midpoint of your revenue guidance that would suggest growth in the high single digits. You provided some color on where you thought the partnership business might be for the year, everything else balancing as potential of being a high single-digit number. Would that suggests that you expect your assay business to grow at a similar cliff?

[Pat Balthrop:]

Well, we obviously would expect our assay business to grow with a faster rate than our in our partnership business for sure.

[Dana Walker:]

Even this year, given some of the hurdles and truly in the year?

[Pat Balthrop:]

Yes.

[Dana Walker:]

And one last thing, I believe Harriss said that the flu business got off to a late start and you wouldn’t have benefited from that necessarily in the fourth quarter. Are you seeing enough activity to where it requires the type of reordering activity that would be helpful?

[Harriss Currie:]

I mean that -- we benefited from flu season in the fourth quarter, kind of part of our results. So we did realize some revenue there. The reordering patterns are beginning to occur now. How much of that will total in the first quarter, we’ll have to wait and see and report our results. But certainly we are -- we continue to get orders from our customer base, that’s because we don’t provide line item guidance there. I really can’t given you more than that.

[Dana Walker:]

Final question from me, you’ve talked about working away out of this NeoPlex business. What would your update be on the status of that intent today?

[Harriss Currie:]

Only that we’re continuing to work on it with outside parties. And so once we have more detail there, it will obviously provide some additional information?

[Dana Walker:]

Good luck and thank you.

[Harriss Currie:]

Thank you.

[Operator:]

Question from the line of Brandon Couillard, Jefferies. Please proceed.

[Brandon Couillard:]

Okay. Thanks. Pat or Harriss, could you give us the sense exactly how CF grew for you in 2013 and your qualitative expectations for ‘14?

[Pat Balthrop:]

I can’t give you the specifics, except to say that the CF growth through the year was modest or perhaps flat, primarily driven by some of the reimbursement related factors that I mentioned earlier. As that returns to normal in 2014, we expect that to be a growth driver primarily because of the comparable issue for 2013 and 2014. We don’t expect a lot of share movement there. For reasons I mentioned in response to earlier question. So the CF business is stable for us.

[Brandon Couillard:]

Thanks. And then any chance you are in the position to be able to elaborate or talk about sort of your pricing strategy for the initial ARIES assays?

[Pat Balthrop:]

No. Except that we understand -- we have an appreciation for the competitive nature of the market and so we expect to be competitive. We believe we have a product that will be significantly attractive to the customer and we will deliver value that the customer cannot get from anybody else. So we expect to be competitive, but and reflect that value to the customer. But we don’t expect to be the price leader nor do we expect to be the low price leader nor do we expect to be significantly -- have a significant premium over the prevailing prices.

[Brandon Couillard:]

Okay.

[Harriss Currie:]

I would like to remind you, however, that one other things that we have been pretty consistent about and it’s important we think for our investors to keep in mind was that, we as a company operate right about 70% gross margin, that’s true for our partnership business, it’s true for our current assay business, which is mostly molecular multiplexed assays today and we expect ARIES as a standalone revenue stream also to operate at 70% gross margin. So that’s a really important thing to keep in mind.

[Brandon Couillard:]

Thanks. And Harriss, one more for you, could you give us a view on your expectations for the tax rate for next year and should we expect the share base to be flat, you think you’ll -- these are buyback program to offset the dilution there?

[Harriss Currie:]

We -- if you look back over the past few years since we have had a share buyback in play you know that our share count has remained pretty flat when we started giving the buyback, we certainly would expect that our share count will remain flat again. From effective tax rate, we expect that effective tax to continue to come down as we establish profitability and all jurisdictions in which we operate that we did have some modest losses and some of our foreign jurisdiction against which we have full valuation allowance. We don’t get credit -- tax credit for it and as a result our rate creeps up. Our U.S. tax rate is significantly below that rate that we reported this year and that’s the source or majority of the profitability in the company today, as a result as the rest of the jurisdiction are said to be unprofitable, we would expect that rate to walk further down, down into the 30% below level.

[Brandon Couillard:]

All right. Thank you.

[Operator:]

Ladies and gentlemen, at this time we are going to turn the call back over to our President and CEO, Pat Balthrop for final remarks.

[Pat Balthrop:]

Thanks for tuning into our call today. We appreciate your attention and we look forward to having conversations with you one on one during 2014. Thanks again.

[Operator:]

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