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Cepheid Reports 19 Percent Uptick in Q2 Revenues; Battles 'Hangover' Effect from Manufacturing Woes

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Cepheid last week reported a 19 percent spike in second-quarter revenues, and said that every one of its Xpert molecular diagnostic tests except influenza demonstrated sequential and year-over-year growth in the quarter.

In addition, executives said they were confident that the manufacturing snafu that plagued the company in the latter half of 2012 has been addressed, although the problem caused a "hangover effect" that negatively impacted Q2 commercial operations and will continue to impact bottom-line performance for the rest of 2013.

Separately this week, Cepheid said that it is partnering with the American Lung Association to promote tuberculosis awareness in the US and the need for improved TB diagnostics. The company currently sells its Xpert MTB/RIF test for detecting Mycobacterium tuberculosis and rifampin resistance exclusively through its high-burden developing country, or HBDC, program, but expects to launch the test in the US before the end of this year.

During a conference call last week recapping Cepheid's Q2 financial results, President and CEO John Bishop said that record revenue of $96 million reflected a record volume of shipments of both GeneXpert systems and Xpert test cartridges.

Bishop noted that the company set a number of operational records during the quarter, including new highs for HBDC system and test placements, commercial clinical revenue, with nearly $21 million outside of North America; and quarterly production volumes, with more than 1 million more Xpert tests manufactured in Q2 than Q1.

Despite the productive quarter, commercial operations were not completely up to snuff at the Sunnyvale, Calif.-based diagnostics firm.

For instance, although revenue from methicillin-resistant Staphylococcus aureus surveillance has grown about 11 percent year-to-date, that performance is "below our internal target," Bishop said during the call.

Bishop dispelled the notion that a May New England Journal of Medicine paper suggesting MRSA screening may not be needed in intensive care units contributed to this underperformance; and he also said that Cepheid doesn't believe it is losing business to competitors.

Rather, Bishop said, "we continue to believe that considerable opportunity remains in North America for MRSA surveillance. Ultimately, the less-than-targeted growth in MRSA is due to our own execution rather than any external factors. We believe we'll see higher growth as customer confidence in Cepheid returns, continues to rebuild, as the sales force focuses fully on selling."

This perceived lack of customer confidence stems primarily from manufacturing issues that plagued Cepheid in the latter half of 2012, when it unexpectedly could not meet the demand for many of its Xpert test cartridges.

In response to the manufacturing woes, Cepheid shook up its management, in January terminating the employment of its former executive vice president of worldwide commercial operations and hiring a new head of international commercial operations, vice president of manufacturing (PCR Insider, 1/31/2013); and in April bringing on board a new vice president of global operations, Warren Kocmond (PCR Insider, 4/25/2013). In addition, during last week's call Bishop said that the company's vice president of technical manufacturing operations and executive director of global supply chain had recently "transitioned out of the company."

Kocmond "hit the ground running during his first two months," Bishop said during the call.

"What we have learned since Warren joined us is that our test volumes grew more rapidly than the capabilities of our manufacturing team," Bishop said. "This resulted in a manufacturing operation that lacked the skills and sophistication necessary to manage rapidly scaling production volumes, which have been unprecedented in the molecular diagnostics business. This, of course, has impacted our ability to drive consistent improvement in yields and margins. Fortunately, we are located in the heart of Silicon Valley, the home of the ultra high-volume semiconductor industry, and we were able to add a skill set in Warren that immediately addresses our need to manage a high-volume and rapidly growing product demand that is routinely seen in the semiconductor world, but is unique to the diagnostics world."

Bishop said that Kocmond and his new leadership team have already driven a 39 percent increase in cartridge volume in Q2, but that it will take several quarters to fully address and improve operational efficiency.

"While we've resolved the primary product supply issue, the level of unexpected challenges we are addressing is significant," Bishop said. "And we do expect our gross margin in the second half of 2013 to be substantially lower than we had previously targeted, and this is our area of focus going forward."

Further addressing this issue during the call's Q&A session, Bishop said that uptake of the company's Xpert MRSA/SA test and recently FDA-approved Xpert CT/NG test are examples of assays that could be affected by this lingering lack of confidence.

"The CT/NG introduction came [after] the majority of the impact on the inability to deliver," Bishop said. "We haven't really seen a big negative impact so far as actually delivering cartridges. The bigger issue is the hangover effects — just customers having confidence that as they consolidate onto our platform, effectively putting more eggs on our basket … that we're going to be able to continuously deliver the product. There we did see … some specific examples of some accounts that we now have the business, but they delayed in bringing that business on."

Nevertheless, Bishop said that Cepheid is "very confident that we have the right person with the right plan in place to get things back on track, and we'll update you routinely on our progress in the quarters ahead."

Financial Results

For the quarter ended June 30, Cepheid reported total revenues of $96 million compared to $81 million in Q2 2012, beating Wall Street expectations of $92.2 million.

The company's clinical systems sales were $16.7 million, up from $13.9 million, while its clinical reagents sales were $70.8 million versus $55.8 million. Its non-clinical revenues were $8.5 million, down from $11.3 million.

"Placing 53 systems in North America was a solid performance and very comfortably within our historical range," Bishop said during the call. "Every one of the 53 placements was driven by multiple tests, showing the importance of the breadth of our menu in driving system placements."

Bishop noted that year-over-year revenue growth of about $10.5 million was driven by HAIs, CT/NG, and commercial TB, in that order. MRSA surveillance was the single largest contributor during the quarter, although every Xpert test experienced growth.

Cepheid installed a total of 156 GeneXpert systems in its commercial clinical business during the second quarter. It also placed a total of 279 GeneXpert systems and 880,000 Xpert MTB/RIF cartridges as part of its HBDC program. Including HBDC systems, a cumulative total of 4,552 GeneXpert systems have been placed worldwide as of the end of the quarter, said Cepheid.

Regarding the HBDC program, Bishop said that the company shipped more Xpert cartridges in the first half of 2013 than it did in all of 2012; and nearly as many GeneXpert systems in the first half of 2013 than it did in all of the prior years combined of the HBDC program.

"Clearly, this program continues to gain momentum, with South Africa leading the way and China, India, [and] Brazil at varying earlier stages of adoption," Bishop said.

Regarding Xpert CT/NG, which won FDA approval in January and received a "moderate complexity" CLIA categorization in January, Bishop said that the company was pleased with the continuing traction of the product.

"At the end of the quarter, we had well over 200 customers in North America," he said. "CT/NG contributed more than $2 million in revenue to the quarter so it's already more than an $8 million annualized business for us. Please bear in mind that it can take upwards of three months for customers to transition to Xpert CT/NG. At this time, we believe that just over half of our 200-plus North American customers are fully ramped up."

Finally, Bishop provided an update on the Xpert test menu expansion, noting that nearly all previously established commercialization timelines were still intact.

"In summary, HPV, targeted for CE-IVD in late 2013, is progressing through trials and the data looks quite strong," he said. "Norovirus, trichomonas, and our [multi-drug-resistant organism] test are progressing well with targeted commercial release outside the US in the first half of 2014. HIV viral load … HIV qualitative and HCV quantitative are also moving forward with targeted commercial release outside the US in the second half of 2014."

Meantime, the company's combined flu/respiratory syncytial virus test and CLIA-waived flu test are on track for release in time for the 2014-15 flu season; its bladder cancer monitor test is progressing with a targeted release outside the US in 2014; and its Xpert MTB/RIF assay will be available commercially in the US in the second half of 2013.

In preparation for the latter of those launches, the company said this week that it was partnering with the American Lung Association to promote tuberculosis awareness in the US and the need for improved TB diagnostics. Cepheid said it will reveal additional details of this partnership at the American Association of Clinical Chemistry annual meeting to be held next week in Houston.

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