GoPro, Inc. (GPRO) Q3 2008 Earnings Report, Transcript and Summary

Welcome, and thank you for standing by. At this time, all participants are in a listen-only mode. [Operator Instructions]. Today's conference is being recorded. If you have any objections you may disconnect at this time. Now, I would like to turn the meeting over to Mr. Michael Watts, Senior Director of Investor Relations and Corporate Communications. Thank you, sir. You may begin.

Thank you, Mary, and good afternoon everyone. On behalf of our management team, I'm pleased to welcome you to this conference call to discuss our Third Quarter 2008 Business Results. A press release announcing our results, was issued today just after 4 p.m. Eastern Time and is posted on our website at www.gen-probe.com. In our call today, Hank will first provide a deeper [ph] perspective on our performance in this difficult economic environment. Carl will cover our revenue results, then Herm will review quarterly expenses and our revised 2008 guidance. We will take your questions before wrapping up in an hour. Immediately after that, we will post our prepared remarks on our website for your convenience and reference. Before we begin, let me first review our Safe Harbor policy. Forward-looking guidance, financial or otherwise, is only provided on conference calls or in our press releases. Any statements in this conference call about our expectations, beliefs, plans, objectives, assumptions or future events or performance are not historical facts and are forward-looking statements. These statements are often, but not always, made through the use of words and phrases such as believe, will, expect, anticipate, estimate, intend, plan, foresee, could, should and would. For example, statements concerning 2008 financial guidance, financial condition, regulatory approvals and timelines, possible or assumed future results of operations, growth opportunities, industry rankings, plans and objectives of management and future economic conditions are all forward-looking statements. Forward-looking statements are not guarantees of performance. They involve known and unknown risks and uncertainties that may cause actual results to differ materially from those expressed or implied. Factors that might cause such differences include, but are not limited to, those discussed in our SEC Filings including our report on Form 10-K for the year ended December 31, 2007, and all subsequent periodic reports. Copies are available on our website at www.sec.gov, and on request from our Investor Relations department. Gen-Probe assumes no obligation, and expressly disclaims any duty to update any forward-looking statements to reflect events or circumstances after the date of this call or to reflect the occurrence of unanticipated events. With that administrative detail out of the way, I'll turn the call over to Hank Nordhoff, Gen-Probe's CEO.

Thank you, Mike, and good afternoon everyone. As you saw from our press release, Gen-Probe had a very good third quarter on the top line, and especially on the bottom line. Total revenues grew 19% to $121.2 million, and this combined with operational leverage enabled EPS to increase by 71% to $0.53. I believe our financial performance reflects Gen-Probe's enduring ability to generate consistent growth and profitability, in the face of the deteriorating macroeconomic conditions over the last few months. No company, even in healthcare, is completely immune from long-lasting economic upheaval, but we believe we are more insulated than most today, because of the vital nature of our two businesses. So before we discuss our detailed quarterly results, let me take a step back to highlight a few items from our income statement, our cash flow statement and our balance sheet, and illustrate why we believe we can be a solid investment for tough economic times. First, the income statement. Both our businesses, clinical diagnostics and blood screening showed good growth in the third quarter, even though we had a very tough comp in diagnostics due to some one-time instrument sales in the prior year period. I know there has been a lot of concern in the financial community about hospitals cutting back on capital spending, and patients deferring medical visits to save on co-pays and the like. But we have not been negatively affected by these issues to date. We believe there are a couple of reasons for this. First, the vast majority of our clinical diagnostics sales, probably 95% or more in a typical quarter, are consumables based. In fact, we often place our instrumentation in the customer's lab on a reagent rental basis, meaning a customer is not required to make an upfront capital outlay. Instead, they sign a volume based assay contract, hopefully one that's long term, through which we recover the cost of the instruments. On the blood screening side of product sales, keep in mind, that we are paid based on the number of blood donations that are screened, not based on the number of units transfused, or the number of surgical procedures done. So if, for example, patients defer elective knee or hip surgeries due to economic constraints, that does not directly affect our blood screening revenue. In addition, it's very risky to try to save healthcare dollars by taking safety shortcuts with the blood supply, considering the dire consequences of transfusing potentially contaminated blood. And finally, donating blood is, at its heart, a philanthropic act, that has been fairly insensitive to the level of economic activity. So both our clinical diagnostics and blood screening businesses showed solid growth in the quarter, despite negative economic conditions. And we did an excellent job of converting that growth into cash, because in this environment, cash truly is king. For example, we generated $67.3 million of cash from operating activities in the third quarter, more than double our net income and basically equaling our all-time quarterly record. We always focus diligently on our cash conversion cycle and our third quarter results reflected these efforts. For example, one way we achieve such strong operating cash flow was by driving diagnostics days sales outstanding down to 33 in September, which we estimate is more than 40% better than the industry average. At the same time we spent less than $5 million on new capital during the quarter, demonstrating the high incremental economic returns that we think our business is capable of generating. We have been able to achieve such high returns because we offer high value assays and instruments that satisfy important medical and customer needs better than the competition. Based on all this, our balance sheet continues to strengthen and we ended the third quarter with more than $555 million of cash and equivalents, roughly equal to $10 a share. I should mention that almost our entire investment portfolio consists of high quality municipal bonds, which have held up quite well despite the turmoil in the debt markets. This balance sheet gives us tremendous strategic flexibility in two main areas. First, we believe now is an excellent time to be shopping for tuck-in acquisitions to increase our products and technology diversity, expand our geographic base and boost our top line growth. We do see attractive external opportunities to build our business, even though completing transactions is inherently uncertain. This remains the number one priority for our cash. Second, our pristine balance sheet gives us the ability to return cash to shareholders by buying back stock, even while we search for acquisition targets. You'll see in our cash flow statement that we bought back about $10 million of stock in September, the first month after we announced our program and before the market's most recent precipitous drop. We were also passively buying in October under our 10b5-1 plan and expect to be back in the market more aggressively once our trading window reopens. So in summary, we believe our third quarter income statement, cash flow statement and balance sheet, illustrate why Gen-Probe is a good place to find shelter in today's economic storm. Now, to give more detail on our third quarter revenue performance, I'll turn the call over to Carl.

Thanks Hank, and good afternoon, everyone. I'm going to review our product sales performance in the third quarter, and report on the status of ULTRIO in the United States. Product sales were $108.3 million in the quarter, representing solid growth of 11% compared to last year. Both our clinical diagnostics and blood screening businesses were healthy. Clinical diagnostic sales were $55.5 million, 7% higher than in the prior year period. It's important to remember that in the third quarter of last year, we recorded approximately $3 million of incremental one-time instrument sales to clinical diagnostic customers. We said at the time that this was a very unusual event and in fact it has not recurred. If we strip this $3 million out of the prior year period, clinical diagnostic sales would have grown between 13% and 14%, consistent with the second quarter rate and much more reflective of the strong underlying demand we see in the marketplace for our products. We were extremely pleased with the growth of our APTIMA franchise in the third quarter, and thus far, we're having an excellent October as well. We continue to follow a winning playbook with APTIMA. First, grow the market by leveraging our automated TIGRIS platform, and by facilitating and testing from new non-invasive sample types. Second, convert customers from the non-amplified PACE product line to APTIMA COMBO 2. And third, gain market share versus our competitors through our differentiated and unique product offering. To provide you a little more detail on the success of these strategies, let me mention that we added another dozen competitive accounts in the third quarter, an impressive performance against formidable competitors. It's interesting that the majority of these competitive wins came on our semi-automated DTS systems, not on our TIGRIS platform. At this point, we know that TIGRIS provides tremendous advantages for our high volume customers, but this quarter's performance demonstrates that we can also take share among the lower volume customers with our semi-automated systems, based largely on the superior sensitivity, specificity and versatility of our assays. In addition, within the Gen-Probe product family, customers continue to upgrade to APTIMA from PACE, sales of which were down 18% compared to last year, as expected. In the third quarter, almost 88% of our STD revenue came from our APTIMA product line, but approximately 28% of our unit volume remains with PACE. So we continue to see opportunities for conversion to the higher priced assay. Before I leave clinical diagnostics, let me mention that we recently completed our annual scrubbing of our STD market share estimates and we were pleased with what we saw. Specifically, we estimate that by year-end we will have slightly more than a 60% share of the $276 million US STD market, with the good news being that the market is a little bit bigger than we previously expected. And a bigger market means even more potential sales for us. Now let me turn to blood screening, where quarterly sales grew to $52.7 million, a healthy 16% compared to last year. In the United States, we and our partner Novartis, continue to enjoy a leading market share. In the third quarter, we believe domestic sales benefited from the additional shipments of the PROCLEIX ULTRIO assay, and the continuation of our post-marketing yield studies, a portion of which were conducted in pools of eight or in individual donor testing. As we've said before, we expect these customers to revert back to testing in pools of 16, now that our post-marketing studies are completed. Outside the United States, sales of our blood screening products, mainly the ULTRIO assay on the TIGRIS system, continued to grow solidly. Since the prior year period we have picked up significant new business in Italy, Lithuania and Slovenia, among others. Based on these growing international sales, we estimate that foreign exchange benefits added about $1.8 million to blood screening revenues in the third quarter of 2008. However, given the recent strengthening of the dollar, we are currently estimating that foreign exchange will become a headwind as we move into 2009, potentially dampening blood screening sales growth by a few million dollars over the course of the next year. Getting back to the third quarter, sales of our West Nile Virus assay were essentially flat compared to the prior year period, as expected. As we said in our last call, we are facing tougher comps now that we have annualized the pricing benefit associated with the early 2007 approval of that assay to run on the TIGRIS system. In addition, you may have read that this year's West Nile Virus season was not as severe as many experts predicted in some parts of the country. As a result, we believe blood banks did less individual donor testing than expected this summer and therefore consumed fewer tests, despite the more stringent trigger mechanisms that many customers adopted in response to draft FDA and AABB guidelines. As we mentioned earlier this year, we think our partner at Novartis, appropriately stocked up on their West Nile Virus orders in anticipation of these new guidelines. But since the amount of IDT testing was ultimately less than had been expected, we estimate Novartis is now holding more inventory than needed over the near term. We believe they will gradually draw down this inventory to normal levels over the next several quarters, reducing overall West Nile Virus sales by an aggregate of a few million dollars in the process. As a final note, TIGRIS related sales to Novartis were 2.8 million in the third quarter, down slightly compared to the prior year period, as anticipated. Going forward, we maintain our previous guidance that quarterly instrument sales will continue to decline based mainly on the larger number of TIGRIS systems that Novartis has already been successful placing worldwide. So in summary, our blood screening business performed well in the third quarter, with sales increasing 16% as we built on our leading market position around the world. Now I would like to turn to a future potential growth driver, our PROCLEIX ULTRIO assay in the United States. We're aware that this is a hot topic among our investors and analysts. Let me begin by saying that Novartis' negotiations with US customers are active and ongoing as we speak. Our current understanding, however, is that no formal contracts have yet been signed with customers. As a reminder, Novartis is responsible for marketing in our blood screening collaboration, so they handle the commercial discussions, not us. We do understand that customers are pushing back on the incremental price premium for ULTRIO. This is typical and to be expected. And we think it is occurring for two main reasons. First, blood banks across the country are struggling financially, compounded by the fact that many have recently increased their testing costs by implementing new serology testing for Chagas disease. And second, molecular testing for HPV is not currently mandated by the FDA. We believe, however, that a mandate should eventually be, based in part on the excellent results we saw on our post-marketing yield studies. Our study results send a very clear message; if you use molecular tests to screen the US blood supply for HPV, you will find contaminated donations that other tests miss. More importantly, the converse is also true. If you're not using a NAT test, you may be allowing HPV infected blood donations to be transfused. Given the history of blood banking, we do not believe that this is something that regulators or the public will be willing to countenance, especially if it means having a dual standard of blood safety, with some customers doing molecular HPV testing, and others relying on less sensitive, serology screening alone. But at this point, we do not know what the final commercial pricing for the ULTRIO assay will be, or what the rate of adoption will be, and I don't want to compromise sensitive commercial negotiations with anything I say today. We'll keep you informed as we learn the results of the negotiations. One thing I can speak to today, is the clinical value of molecular blood testing for HPV, which was clearly demonstrated through our post-marketing studies, the key results of which were presented recently at the American Association of Blood Banks meeting in Montreal. Let me give you some highlights of two of the largest and most complex and most successful clinical trials ever conducted in the blood banking industry. Our ULTRIO assay was used to screen 3.7 million blood donations in the two studies combined. Approximately 54% of the donations were tested in pools of 16 donations, 30% were tested in pools of eight donations, and 16% were tested individually. Our test intercepted eight confirmed cases of Hepatitis B yield, meaning these HBV infected donations were missed by all serology screening. Five yields were detected in pools of 16, two in pools of eight, and only one in IDT, indicating the value of ULTRIO, regardless of pool size. Seven of these eight confirmed yields were missed by Abbott's third generation PRISM assays. Our studies indicate that without molecular testing, as many as 90 individual transfusion recipients could receive infected blood products each year. Many of these people may be immunocompromised, and they could therefore suffer severe clinical consequences. Not only did the ULTRIO assay pick up HBV infected donations, that otherwise would have been transfused, it did so while generating virtually no false positive results. As many of you know, in the blood banking industry, throwing away a scarce unit of blood unnecessarily and losing a future donor through deferral is almost as big a concern as missing an infected donation. With a specificity of greater than 99.9% in both studies, we think our ULTRIO assay performed admirably in this regard as well. Before I turn the call over to Herm, let me mention that over eight yield cases, we now know that four had previously been fully vaccinated for Hepatitis B. This is important for a couple of reasons. First, since the first recombinant HBV vaccine was approved in 1986, more than 30 million adults and 40 million infants and children have been inoculated in the US, and with each passing day, these vaccinees comprise a larger portion of the blood donor pool. The second reason is scientifically complex, but very important to understand. The purpose of the HBV [ph] vaccine, like any vaccination, is to stimulate an immune response that protects against future infection. Given the size of our post-marketing studies, however, we have seen for the first time, evidence that HBV vaccination can have unintended consequences, that could reduce the safety of the blood supply from previously assumed levels. Specifically, in some people the vaccine stimulated immune response fights HBV only partially, so that a very low rate of viral replication occurs, and the traditional serological markers of infection, such as Hepatitis B surface antigen, take longer to reach detectable levels. In other words, when a vaccinated person becomes infected with HBV, the virus remains in his or her bloodstream at low levels and stays there for longer periods than in an unvaccinated person. So in the absence of molecular testing for HBV, a donation from this person could still be transfused, since traditional tests would come back negative. And if this blood were transfused into an immunocompromised person, say someone undergoing chemotherapy, serious clinical problems could result. In scientific terms, this means that HBV infected blood donors who have been previously vaccinated may have longer seroconversion windows. If so, direct detection through molecular testing becomes that much more valuable since its main purpose is to shorten the window period, by detecting HBV directly rather than waiting for normal disease progression and the body's immune response. I should mention that this is a new area of scientific discovery and is therefore controversial in some respects. For example, it's unclear what portion of HBV vaccines, who later get infected, show a long seroconversion window. And some scientists have questioned whether acute Hepatitis B infections in these vaccinated donors would be infectious enough to be transmissible through a blood transfusion. More studies need to be done in this regard. In fact, an important long term study was coincidentally published just days ago in the Pediatric Infectious Disease Journal. The paper showed that as many as half of people who are vaccinated against Hepatitis B, at birth, showed waning immunity 15 years later. This finding dovetails logically with what we saw in our post-marketing studies. Clearly, the scientific data will emerge and broaden with time. But in the meantime and from a practical perspective, we doubt that many intuitions would be willing to assume the risk associated with knowing a blood donation is HBV positive, yet allowing it to be transfused anyway. So in summary, our ULTRIO post-marketing studies were extremely successful. They confirmed that ULTRIO does exactly what it was designed to do, and maybe even more. In addition, they opened up in treating new issues in transfusion medicine. Based on this, we expect that over time and especially with the benefit of potential regulatory guidelines, ULTRIO will be widely used to protect the blood supply in the United States, as it is overseas today. After all, we wouldn't want our blood supply to be screened less stringently than it is in many European, Asian and African countries. Now I'll turn the call over to Herm for our financials.

Thank you, Carl, and good afternoon, everyone. As described in our press release, Gen-Probe had a very strong third quarter. Product sales grew 11% compared to the same period in 2007, despite a tough comp created by onetime instrument sales last year. Total revenues rose 19%, while earnings per share increased by 71%. Carl already covered the dynamics of product sales, so let me begin by discussing collaborative research revenues, which were $11.3 million for the third quarter of 2008, up significantly from $3.1 million a year ago. As most of you know, this increase resulted from the $10 million milestone we earned from Novartis related to the full US approval of ULTRIO on TIGRIS. As we said in our last call, we expect collaborative research revenues to average around $1 million a quarter going forward into 2009, given the reduced need for shared development projects in blood screening. Royalty and license revenues were $1.6 million in the third quarter of 2008, up 33% compared to the prior year period. Royalties from Chiron related to the use of our assays in the plasma screening market continued to be the largest component of this revenue line and increases in this area drove most of the year-over-year change. Now I'll turn to the expense items. As highlighted in our press release, we were very pleased with our gross margin performance in the third quarter. Gross margin on product sales was 71.7%, a very healthy increase compared to 67.3% in the prior year period. This improvement resulted primarily from a favorable product sales mix, namely increased sales of our blood screening products and APTIMA COMBO 2 assay, and reduced sales of lower margin instrumentation. Gross margins also benefited from favorable manufacturing variances that resulted from cost controls and volume leverage and obviously from the foreign exchange benefit that Carl discussed. Research and development expenses for the third quarter of 2008 were $24.5 million, down 11% compared to last year. As a reminder, R&D expenses were unusually high in the prior year period due to the bulk purchase of HPV oligonucleotides from Roche. Nonetheless, R&D expenses were lower than expected in the third quarter, due mainly to the timing of certain expenses such as a slightly earlier completion of our ULTRIO post-marketing studies and better than expected specificity, as well as ongoing efforts to maximize the efficiency of our spending. Marketing and sales expenses were $10.7 million in the third quarter of 2008, up 10% compared to the prior year. This increase resulted primarily from European market development efforts related to our APTIMA COMBO 2, PROGENSA PCA3 and APTIMA HPV assays. As we said in our last call, we believe these efforts are beginning to pay off and we therefore intend to increase our European commercial investments going forward. As a reminder, we continue to expect 2009 marketing and sales expenses to be between 100 and 150 basis points higher as a percentage of revenue than in 2008. General and administrative expenses were $12.9 million in the third quarter of 2008, up 13% compared to last year. This increase resulted mainly from higher compensation and legal costs. Total other income in the third quarter of 2008 was $2.2 million, a 33% decrease versus last year, which resulted primarily from a $1.6 million impairment charge associated with our equity investment in Qualigen. We review our investments regularly and record impairment charges when we believe an investment has experienced a decline that is other than temporary. Our effective income tax rate in the third quarter of 2008 was 34.8%, in line with our expectations, but higher than the 30% rate we posted in the prior year period. As a reminder, last year our third quarter tax rate benefited from a onetime credit of approximately $900,000, or roughly $0.02 per share, associated with the completion of our 2006 federal tax return. All this nets out to a very strong quarter of net income and third quarter earnings per share of $0.53, an increase of 71% compared to last year, which we are very pleased with. Based on this performance, we are again raising our financial guidance for the year. Since three quarters are already on the books, we're giving fairly tight and specific guidance for the balance of the year. We now expect total revenues of $470 million to $472 million in 2008, as we are bringing up the low end of our previous guidance by $3 million. This guidance incorporates some conservatism in blood screening product sales based on the strengthening dollar and in the clinical diagnostics based solely on how the Christmas and New Years holidays fall on the calendar this year. As you might recall, in last year's fourth quarter we had significantly lower sales around the long holiday weekends and we don't want to be surprised by this phenomenon again. In addition, based on this year's holiday calendar, we expect customers ordering to fall off significantly in the last couple of weeks of December. I want to emphasize that this does not imply any weakening of underlying demand for our diagnostics products. As evidence of this, I will reiterate that we are on track to have an outstanding month of clinical diagnostic sales in October. Now let me turn to our updated expense guidance. Based on our healthy gross margin performance in the third quarter, we are increasing our full year guidance to approximately 70% of the year. This implies some sequential moderation in the fourth quarter based in large part on diminishing foreign exchange benefits. In terms of R&D, we now expect expenses for the full year to be around 22% of total revenues, due primarily to our continued healthy revenue performance. Obviously, this implies a significant sequential increase in R&D expenses in the fourth quarter driven primarily by the continued progress and expansion of our HPV and PANTHER development programs. With nine months of actuals on our books, we now estimate that marketing and sales expenses will be around 120% and general and administrative expenses approximately 11% of total revenues. To round out our updated guidance, we now forecast a tax rate of 34% or a little less for the full year and fully diluted share count slightly above 5 million. This leads to our increased 2008 earnings per share guidance of between $1.91 and $1.93 per share, which at the midpoint of the range passes through our third quarter [inaudible] versus consensus. This midpoint implies nearly 22% earnings per share growth compared to last year, which we think is a very healthy bottom line growth rate and faster than our expected revenue growth. So to summarize the financial section of our call, in the third quarter we saw good top line growth combined with operational leverage to drive excellent bottom line growth. And we achieved these results in a difficult economic environment. As a result, we are once again raising our total revenue and earnings per share guidance for the year. Business is good. Now I'd like to turn the call back over to Mike.

Thanks Herm. We're happy to take your questions now. For the Q&A, we're joined by Steve Kondor, our Senior Vice President of Sales and Marketing, as well as Kevin Herde, who's our Corporate Controller. In order to ensure broad participation in the Q&A session, please be courteous and limit your questions to one plus a follow-up, then jump back into the queue. Mary, we're ready to take the first questions. Question and Answer

Thank you. We'll now begin the question and answer session. [Operator Instructions]. And our first question comes from Quintin Lai with Robert W. Baird Co. Sir, your line is open.

Hi. Good afternoon. Congratulations on a nice quarter.

Thank you, Quintin.

A couple of questions, first on the share buyback. You bought back $10 million in the quarter. The guidance for the full year, I guess, doesn't seem to me, assuming any major share buybacks in the fourth quarter. Given the market conditions over the last little bit, why not relook at share buybacks I guess along with M&A, a little more aggressively?

Yes, hi. It's Herm, Quint. I think that we did say that we were going to be a little more aggressive as soon as the window opened. That window opens I believe on Tuesday morning. We'll take a look at it. Our share price was a lot lower just a few maybe hours, a few days ago. But we definitely are going to take a look at that. In addition, we do have in place a 10b5-1 plan, which we'll acquire if we don't in the open market at certain levels. But yes, I think you're absolutely right and that's what we're looking at seriously.

And then with respect to the Chlamydia, gonorrhea market, you kind of made some mention that the overall market is a little bigger than you expected. What does that say about volume versus price or are prices stable? Are you seeing any kind of… any changes there? And then with respect to just general volume growth and then how do you kind of forecast the overall market, especially in the US here, for the next couple of years?

Quintin, this is Steve Kondor I'll answer that question. As you know, we commission a market research company to… on a quarterly basis do channel checks not only in the United States but overseas as well. And so they've characterized the market. It is growing a little bit more rapidly than they had anticipated in previous surveys and previous research, number one. Number two, despite the economic difficulties that we're having here in the United States across our customer segments and even outside the United States across all of our customer segments, we continue to see more CT/GC testing. ASP, your comment about ASP, we've seen… again, we've expected more declines in ASP with the result of competition coming in. We haven't seen that as aggressively as yet. So those are all factors that played into our performance.

Okay. Thank you very much. Congratulations again.

Thank you, Quintin.

And our next question comes from Bruce Cranna with Leerink Swann. Sir, your line is open.

Thanks. Good afternoon, everyone.

Hi Bruce.

I have to ask one guidance question, because I know someone else will if I don't. But if I do the math on the top of the range for EPS, I get kind of $0.37 for Q4. And I have to ask you, it just seems a little bit curious, so that would be really flat year-over-year, Q4 to Q4. And I guess I'm a little bit maybe skeptical that that's in fact a reasonable piece of guidance. Can you comment a little bit about if I look at marketing sales and G&A again on a year-over-year basis, it seems like there should be a little more leverage there in Q4.

Well, there's a couple of things going on there, Bruce. One, we did mention that the shipments in the fourth quarter around the holiday season were likely to be similar to last year, so we probably see a little bit of revenue contraction there. We did mention of course relative to next year that FX would probably cost us a couple million bucks in blood screening, but it's probably going to cost us a little bit too, depending what happens with foreign exchange in the fourth quarter. We see so far that it's headed in the wrong direction. Also, our collaborative research revenue of course is going to be down considerably because we had the $10 million milestone, don't forget, in the third quarter.

Yes, Bruce, it's Mike. I think in the fourth quarter of last year we did close to $5.5 million in collaborative research revenue versus guidance that we're giving this year, obviously at a much lower level. So I think that's a big part of what you're seeing.

And just looking at G&A sequentially from 2Q, what is it that causes that to peel back so much? Can you quickly comment on that? Is that headcount reduction or something else we should be thinking of?

No, from Q2 we had pretty heavy acquisition expenses on Innogenetics, and we had a little bit in Q3 as well. But Q2 was the heaviest quarter.

Okay. And then just last for me on Millipore. I know you didn't talk a lot about it or if you talked about it at all, and I'm sure I can't pry a dollar amount out of you. But can you guys comment on the trend there, if there is a trend to comment on, and if not what seems to be the roadblock with that part of the business.

There really is no trend, Bruce. I wouldn't call it a roadblock. It's just taking a little bit longer than we had thought. It still is a priority both for ourselves and for our partners at… Bruce, you satisfied?

Yes. I'm sorry, you cut out there. I lost you.

At what point did you lose me?

Just when you started to talk. I'm sorry.

Before or after the 20 minute note? I will see if I remember what I said.

I don't think that was…

There really is no trend that's apparent. It's just taking a little bit longer than both parties had anticipated. But it remains a priority item for both companies.

All right, thanks.

So stay with us.

Thank you.

Thank you, sir.

And your next question comes from Bill Quirk with Piper Jaffray. Sir, your line is open.

Thanks. Good afternoon.

Hi Bill.

First up, Carl, understanding the sensitivity around the ULTRIO blood banking discussions. There obviously appears to be strong interest in the channel. Is price really the only roadblock to adoption here? I guess that's kind of what I heard. I just wanted to clarify.

Yes. As we look at it, Bill, we think that the ultimate pricing discussions are the pacing factors right now. I think from the data that we just summarized, you can see the utility. I think that's pretty well established and shouldn't be the issue. So got to get through the price hurdles and then that leads ultimately I think to the adoption curve.

Okay. Understood. And then secondly, just considering your comment about continuing to look at deals and structure them either as potential geographic expansion or tuck-in deals, given the investment that you guys are making and obviously have planned, particularly in '09 to build out the EU team, should we be thinking about tuck-in more so than geographic expansion? And if so, should we be looking at this from an intellectual property perspective or reagent or assay perspective or would you actually look at instrument companies as well?

Well, I'm not really sure what a tuck-in is comparing to one for geographic expansion. I think if we were to prioritize, Bill, our objectives, it would be to get some more activity, some more growth on the top line. And the two products that we're currently selling in Europe, HPV and PCA3 are doing well. And we are investing in people and getting a company with a nice infrastructure, it would be very good. If at the same time we can acquire some technology and some of the skill sets, I think that would be terrific, too. Would we consider an instrumentation company? We have looked at some in the past. And we see some utility from time-to-time. But I don't think we're close to moving that far afield from assays.

Understood. So essentially, if I'm hearing you correctly, it's on the US side to be more focused on the menu and outside of the US, distribution plus potential menu?

Yeah, I think that's true. And I think our focus would be outside the US rather than in the US right now because of the opportunities we have in Western Europe.

Understood. Thanks very much for the color.

You're welcome, Bill.

And your next question comes from Imron Zafar from Deutsche Bank. Sir, your line is open.

Thanks and good afternoon.

Good afternoon.

Could you please talk about PCA3 sequential trends in Europe and also maybe give us a progress report on HPV, both commercially in Europe and then the clinical trial….

Steve, can you comment?

Be happy to, Imron. First, PCA3. We're very pleased with the performance and the adoption of PCA3 in Europe, the CE product. We're able to market the product, as you know. Our business has increased fourfold since this time last year in terms of revenues, in terms of numbers of men that are being screened with PCA3 or tested for PCA3. But remember that's on a very small basis. But we're very, very pleased. In order of magnitude, the number of testing centers we had at this time last year in Europe was three. We now have 30 testing centers. So everything is moving very, very well in Europe and we're very pleased with that. With regard to the United States, you may know that… or may recall that we indicated that we'd be having a meeting with the FDA. We did that a couple of weeks ago and that meeting was very positive, very productive. No decisions have been made yet with regard to the current PCA3 ASR test in the United States in terms of moving to a clinical trial on that in the United States. But we'll continue to have discussions with the FDA, and of course you know we've announced before that we absolutely will have a US clinical trial for the PANTHER PCA3 product down the road. HPV, back to Europe, we have launched the product. We have a number of studies underway. We had the HPV conference, which is called Eurogen, in Nice, France in two weeks where we will show preliminary data of a very significant study that's going to be a multiyear study and that data will be presented. Thank you.

Okay, great. And then for Herm, does updated guidance include any impact from the renewal of the R&D tax credit and, if so, can you quantify the contribution for that in the new guidance?

Yes, it does. And that will bring down probably less than a percentage point.

Great. All right, thank you very much.

Thank you.

And our next question comes from David Lewis with Morgan Stanley. Sir, your line is open.

Good afternoon.

Hi David.

Herm, just starting with you on gross margins, they've been up sequentially on product sales throughout the year, which is nice to see. But given commentary that APTIMA is now 88% of the mix, I'm kind of wondering what factors can be positive or accretive to gross margin on a go-forward basis, either in the fourth quarter or heading into next year.

Well, it's primarily mix. We've talked about somewhat lower instrumentation. Part of that goes out at no profit at all. Our highest margin products continue to be our blood screening products and APTIMA COMBO 2 so additional growth there will give us higher margins because the same kinds of leverage we… operational leverage that we see by manufacturing more tests using the same capacity will continue to improve. That said, of course, we're kind of watching FX which has had… we've had pretty good results from that over the past three or four quarters and it appears that that might be going the other way. But to answer your question, it would be those factors.

Okay. And then, Carl, obviously we're engaged in a high stakes game of Chicken here on ULTRIO, or at least it sounds. The one thing that is in your control besides price obviously would be the FDA mandate. So maybe give us some timing in terms of when do you think a range of FDA mandating ULTRIO was possible and then what can you do or what can Chiron do to help push the envelope there with the agency?

Well, David, I mean obviously that's us speculating about what the government will do. And given the events of the last couple of months, I'm pretty hesitant to do that. I think in practice it's a pretty straightforward process, as we understand it. The Blood Products Advisory Committee to the FDA is the organization that's responsible for evaluating both new technologies and/or threats to the blood supply and making recommendations as to how the industry should cope with that. Our view is that the FDA staff will, and is, frankly, evaluating what the role of HBV NAT screening should be in the US blood supply. They then make a recommendation to BPAC. BPAC in turn considers that and makes recommendations. The result of that recommendation process would be either a decision to do nothing or a guidance document that would recommend screening. We think that that could occur at any point in upcoming BPAC meetings practicality, I believe the only one that I know for sure that's scheduled is December, might be unlikely that it makes the agenda with a full scientific consideration by that time. But they tend to meet either three or four times a year. So I would expect that you could see some discussion of that formally by the regulatory bodies in the first half of next year.

Okay, that's helpful. And then, Hank, one last question for you. Two comments on this call I think are somewhat interesting. One is we have ULTRIO approval so we're sort of T minus the five-year clock with our friends at Novartis. The second comment was one Hank made… I'm sorry, Herm made about falling collaborative research revenue, which is sort of a signal that maybe we don't have as many things to work on with our friends overseas. So those two data points say to me maybe it's time to fly across the Atlantic and talk to Novartis about a potential renegotiation of the contract. So can you kind of update us on that and do you share a similar opinion?

You've given me a lot of options there, David. We have been engaged with Novartis in trying to come up with a mutually beneficial way to extend the agreement. And I think those tests or discussions are proceeding apace. I think that they will end up positively for both companies. But as our discussions and negotiations with Chiron on ULTRIO, I'd be really reluctant to say anything more specific than that tat this point, David.

Okay. Thank you very much.

Thank you.

And our next question comes from Jon Wood with Banc of America Securities. Sir, your line is open.

Hey, thanks. So, back on Novartis…

Hi Jon.

Hey. Back on Novartis for a second, they recently created it looks like a standalone molecular diagnostics business within their oncology therapeutics business. I mean is there an opportunity to work with Gen-Probe, work with them. I'm not sure if they're just screening biomarkers or what, but is there an opportunity to potentially expand the collaboration to the cancer side there?

I think there's always that opportunity. We've talked about personalized medicine and biomarkers over the years we've had our discussions. I wouldn't say it's a certainty, Jon, but it's certainly something that we would be interested in.

Okay. Thanks. And then, Herm, why would product gross margin decline sequentially? Is it just a lower volume… the holiday related lower volume? Can you give us some insight into that?

Are you talking about the fourth quarter?

Right, yes.

So in the fourth quarter we're going to see probably, my guess is the opposite effect from FX for one thing. Talked about shipment patterns as well. I think those two in combination will get you to that lower fourth quarter gross margin that's implied by the guidance.

Okay. And then the DSOs, I mean down eight days sequentially, is that sustainable at this level or is there the potential for that to tick back up sequentially in the fourth quarter?

Kevin?

Hey Jon. Kevin Herde. We had a… we had an excellent question [ph] period. We had a little bit of timing. We had some customers of ours pay a little early. Certainly 33 days is not a diagnostics question period so we're anticipating going forward we think certainly something around 40 is our target. And that still is much better than the industry average and probably where it will be sustainably going forward.

We're going to try to reign in Kevin a little bit, try to soften him up a little bit with his tactics.

And then one last one. Hank, on the M&A situation, has there been a change in the pipeline over the last 60 days or is it too early, just from the dislocation in the equity markets, is it too early to tell perhaps if there's a few more opportunities to look at?

I think there's a noticeable change in startup pharmaceutical companies. I think that the VCs have lost their appetite. I don't think they see an IPO as an exit strategy anymore and I think they're recognizing the risk of these long, long development timelines. But then the companies that we have been identifying and looking at, I haven't seen any change there.

Okay, thanks a lot.

Thank you, sir.

And your next question comes from Patrick Donnelley with Thomas Weisel Partners [ph]. Sir, your line is open.

Thanks. Just filling in for Peter Lawson tonight. How are you guys?

Good, Patrick. How are you?

Good, thank you. Just to build on Bill's question from earlier, can you go over the ability to grow internationally with and without acquisitions and how that has changed in these times now?

I think about the only change, Patrick, has been our pricing with the ascension of the dollar. Whether that's going to be able to be sustained or not, I don't know. I think the metrics are still basically the same. We are investing in putting people in Europe and we're still looking at companies who can assist us in our marketing and sales effort. Carl, you want to add something?

Sure. I think, Patrick, the other thing we could highlight is that the growth rates for the European market when it comes to STD and the related testing of interest to us continue to be robust. They appear stronger than those in the US market, which, as we already covered, is going quite well as well. So we think it's a little bit under-penetrated in terms of the technology and the screening that's been done historically and that represents a good opportunity for us on a go-forward basis.

All right, great. And I know you guys touched on it a few times, is there any way you can quantify the FX effects for next quarter you're expecting?

If you could tell us what the exchange rate's going to be?

That would be great.

But just with the guidance you gave, are you anticipating…

Are we anticipating?

We're always pretty conservative, Patrick.

Okay. All right, great. Thanks, guys.

Thank you.

And our next question comes from Zarak Khurshid with Caris & Co. Sir, your line is open.

Good afternoon, guys. Thanks for taking my questions.

Welcome.

All right. Just curious what happened with Qualigen to make you take that write-down?

Yes, it has to do with their business. Remember we made an investment of about $7 million in their business. That business is an immunoassay box, so to speak, and they sell all the consumables for PSA and testosterone. And they have continually, at least to this point, lost money and are burning cash at a rate where we had to do another valuation and that valuation turned up what we think is another temporary loss on the investment of about $1.6 million.

Understood. And then as a follow-up, just curious if you could break out a little more color on the European clinical diagnostics business versus US, what you're seeing in terms of those different growth rates and so forth? Thank you.

Well, Zarak, this is Steve. Carl touched on it just a moment ago, but we do see an opportunity in terms of STDs. Our penetration in Europe or our market share in Europe is about 30%, 35% as opposed to 60% plus in the United States. So we had an opportunity there. And clearly in the future, with PANTHER coming out, we're very excited about the opportunity to penetrate on a more decentralized basis STD testing as compared to United States. Having said that, our growth is very good international, particularly Western Europe with regard to TIGRIS. We've added some more salespeople at the end of last year, beginning of this year and we're picking up a substantial amount of STD business in TIGRIS in Europe. So we're very pleased with that. Did that answer your question, sir?

Yes, thank you.

Thank you.

Mary, I think we might have time for one more, then we've got some brief closing remarks.

Okay, thank you. Our last question comes from Tycho Peterson with JPMorgan. Sir, your line is open.

Hey, good afternoon.

Hi Tycho.

I'm wondering if you can comment a little bit more on some of the other pipeline initiatives. I appreciate the color you provided on the Millipore collaboration. But I guess maybe coming out of AABB there's a little bit of talk about dengue and ULTRIO Plus. If you can comment on maybe adding some of the other high risk subtypes there? And then also just a quick comment on MRSA in flu testing and whether there's any light at the end of the tunnel there?

Sure, Tycho, I'll take a shot at that. The activities we have underway include, I would say, a considerable amount of work where we look at emerging infectious diseases on our own and in collaboration with some of the customers that Novartis serves. And dengue clearly is high up on that list. Currently, as you may have seen at the AABB as well, there's great concern, particularly in Western Europe, about Chikungunya. So there is a couple of targets that are out there. It is something that we're pretty good at prototyping assays for and doing collaborations with people to establish the efficacy of not only the assays but the prevalence of the disease. And I think you should assume that that's an ongoing effort for us and we'll continue in the future.

I think as we think about other aspects of the blood bank business, right now we're in a pretty solid position having the automation and the fully approved screening products for the major infectious diseases that are routinely screened by molecular technology. So we feel pretty comfortable with that. As we think about MRSA, I would just tell you that we're at a stage now where we're completing a reexamination of both the markets and the technologies post the termination of our relationship with 3M. We did a lot of work there to adapt our assays and our technologies to their instrument base. We're examining the performance of those technologies now on our own platforms and assessing the market and we'll probably complete that assessment over the course of the year.

Okay. And then any… is food kind of off the table now or any hope there?

Oh, it is. Food is still on the table, Tycho. See really a terrific opportunity. We're just not quite sure how to approach it. So we're still investigating it.

Okay. And then to just kind of get a little bit more granular on the guidance you've given in terms of the work-down of West Nile from Novartis, did you imply that that was mostly going to be in the fourth quarter or is that going to trickle out over a couple of quarters?

That'll probably trickle out over several quarters and then we put a couple of million bucks potentially on that.

Okay. And then just to thinking about the infrastructure build-out in Europe, I mean appreciate the color you've given for the year, for next year. But should we assume that that's going to be front-end loaded or is that going to be a pretty smooth build-out throughout the year?

Tycho, this is Steve. No, it's not going to be front-end loaded. It's going to be paced throughout the year.

Okay.

So it'll be strap [ph] operation really, almost a pay as you go.

Okay. And then just to clarify your comment on M&A, are you still seeing a pretty big valuation disconnect? Was that what you were implying in terms of what the sellers are looking for, looking for a premium to the price at the beginning of this year?

We don't see any great buys out there right now, if that's what you mean. No great discounts. We're looking at quality companies and you have to pay for quality.

Okay, great. Thank you very much.

Thanks Tycho, and thank you all for all your questions. To wrap up, Gen-Probe had a very good third quarter. We showed solid revenue growth in a difficult macroeconomic environment and demonstrated good bottom line leverage as well. As a result, we are again raising our annual financial guidance. Before we sign off, I'd like to make two administrative announcements. First, our prepared remarks will be posted on our website momentarily and we encourage you to refer to them if you missed a fact or number during the call. And second, we hope to see many of you at our annual analyst day next Friday morning, November 7th, here at our headquarters in San Diego. And if you need any encouragement to make the trip, it is currently 78 degrees under a cloudless sky. Thank you for your time and attention today and please contact us if you have any follow-up questions. And thanks Mary.

Thank you, sir. Have a good evening.

Bye-bye.

Bye. .