OraSure Technologies Inc (OSUR) 2005 Q4 法說會逐字稿

Good day, everyone, and welcome to OraSure Technologies 2005 fourth-quarter and full-year financial results conference call and simultaneous webcast. As a reminder, today's conference is being recorded. (OPERATOR INSTRUCTIONS). For opening remarks and introductions, I will now turn the call over to Shannon Morin at OraSure Technologies. Please go ahead.

Good afternoon, everyone, and thank you for joining us today. I would like to begin by telling you that OraSure Technologies issued a press release at approximately 4:00 PM Eastern time today regarding our 2005 fourth-quarter and full-year financial results and certain other matters. The press release is available to you on our website at www.orasure.com or by calling 610-882-1820. This call is also available real-time on our website and will be archived after seven days. Alternatively you to listen to an archive of this call until midnight February 16, 2006 by calling 800-642-1687 for domestic or 706-645-9291 for international. The access code is 4670366.

With us today are Doug Michels, President and Chief Executive Officer and Ron Spair, Chief Financial Officer. Doug and Ron will begin with opening statements and then follow with a question-and-answer session.

Before I turn the call over to Doug, you should know that today's conference call will include a discussion of certain non-GAAP financial measures. Additional information regarding the most comparable financial measures prepared in accordance with GAAP and a reconciliation between the non-GAAP and GAAP financial measures is contained in the press release issued today. The press release is available to you on our website at www.orasure.com or by calling 610-882-1820. If you go to our website, the press release can be accessed by opening the Investor Relations page and clicking on the link for News Releases.

I must also remind you that this call may contain certain forward-looking statements including statements with respect to revenues, profitability, earnings per share and other financial performance, product development, performance, shipments in markets and regulatory filings and approvals. Actual results could be significantly different. Factors that could affect results are discussed more fully in the SEC filings of OraSure Technologies, including its registration statement, its annual report on Form 10-K for the year ended December 31, 2004, its quarterly reports on Form 10-Q and its other SEC filings. Although forward-looking statements help to provide complete information about future prospects, listeners should keep in mind that forward-looking statements may not be reliable. The Company undertakes no obligation to update any forward-looking statements to reflect events or circumstances after this call.

With that, I would like to turn the call over to Doug Michels.

Thanks and good afternoon, everyone, and welcome to our fourth-quarter and full-year earnings conference call for 2005. We are very happy that you have joined us, and we look forward to updating you on our results from another great quarter and year.

Specifically for this afternoon's call, I will first provide a brief review of our record year, focusing on our strong financial performance and some of the more noteworthy developments involving our major product lines. In particular, I will provide an update on the field performance of our OraQuick ADVANCE test, and I will also spend some time discussing the initiative recently announced by President Bush to expand the deployment of rapid HIV testing in the United States and what it might mean for OraSure. Ron Spair, our Chief Financial Officer, will then provide a more detailed review of our financial results for the fourth quarter and our expectations for both the first-quarter and full-year 2006, including the impact of stock option expensing. I will conclude with a brief overview of the progress we are making on our long-term strategy and then open the floor up for questions.

2005 was a truly excellent year for OraSure. The Company realized record revenues of $69.4 million, a 28% increase over 2004. Our infectious disease, substance abuse and cryosurgical businesses all performed very well and continued as our main growth drivers in 2005.

We also delivered our first full-year of profitability in 2005. Net income for the year was $27.4 million, which includes an $18.2 million income tax benefit which Ron will discuss shortly. These results represent $0.59 per share on a fully diluted basis, which is outstanding. Without the tax benefit, our net income would have been $9.3 million, which is an extraordinary improvement over the net loss of $560,000 experienced in 2004.

We have also continued to strengthen our cash and liquidity position. We had more than $77 million in cash and short-term investments and about $91 million in working capital at the end of 2005.

Before turning to a review of our business, I would like to update our investigation into the reports received late last year from specific testing sites that were experiencing unexpectedly high levels of false positive results using our OraQuick ADVANCE test with oral fluid. As previously disclosed, immediately after learning of these reports we embarked upon a multi-pronged investigation. First, we went directly to the specific sites that reported these results in order to understand the reported problems. We have been collecting data and continue our efforts to identify any specific causes that could have affected the test results at those sites, including specimen collection and testing procedures.

I think it is important to note that all of the affected sites continue to use the OraQuick tests, and all have been extremely cooperative with our review. We have identified some possible site-specific factors that may have contributed to this issue, and we are investigating these in the experimental studies that I will describe in just a minute.

Second, we have performed a thorough review of our manufacturing processes, including all related matters that could affect product performance and quality. This review is substantially complete, and I can report that we have not uncovered any significant process or raw materials issues or nonconformances that correlate with the reports of higher levels of false positive results. We have no evidence that the false positives were caused by a raw material used in the test or the way in which the test is manufactured.

Third, we embarked upon an extensive effort to contact our customers around the country to collect actual performance data for our tests and to determine if these customers have experienced any problems with false positives or otherwise.

Last month we publicly reported some of this data, which at that point had been collected from various state and city health departments, HIV/AIDS service organizations and other public health agencies in eight states. Since that time, we have contacted all of our oral fluid customers and have been collecting additional performance data on a site by site. We now have data from numerous sites across 27 states that represents approximately 150,000 oral fluid tests with an overall specificity of 99.8%. This performance is entirely consistent with our FDA approved label claims for this product. The additional data we collected is also consistent with what we reported previously about the overall performance of our test.

Fourth, we conducted an experimental study examining any possible relationship between the reported false positive results and particular loss of our product. This study examined specificity with oral fluid of nine lots of products each at various ages throughout the product's shelflife. The study is complete and shows no correlation between the higher levels of false positive results reported at the specific sites and any particular lot or lots of our OraQuick ADVANCE test. Moreover, we observe no deterioration in specificity throughout the shelflife of the product.

These findings support the conclusion that the unusual rates of false positives observed at a few sites were not related to lot or age of product. In fact, as previously reported, the same lots of product which generated these unusual results at these particular sites were also used by other sites in that same region and in other parts of the country without issue.

We are also conducting an experimental evaluation of the impact of specimen collection methods on observed rates of false positive results with oral fluid. These studies are underway, and we look forward to obtaining results in the near future. We will also be continuing our postmarket testing to examine clinical performance in various potentially interfering patient conditions as part of our routine postlaunch studies of product performance.

All of this data, as well as other information, has been shared with both the FDA and the CDC as we have been working closely with both agencies throughout the investigation. Our relationship with both has been collaborative and corporative, and we appreciate the effort extended by both the FDA and the CDC in helping us progress our investigation.

This past Monday, February 6, 2006 the CDC provided an update on their own investigation into the reported false positives at the 13th conference on retroviruses and opportunistic infections. What is most significant is that the CDC's analysis is in line with our investigation. The CDC found that the overall specificity of OraQuick ADVANCE is consistent with our labeling claims and that the excess false positives reported by these specific sites experiencing problems appear to be related to unidentified site or host specific factors. The CDC concluded that there is no evidence that false positives were generated due to a lot related or device problem.

As you can see, we have taken the reports of these false positive results very seriously, and we have been conducting a careful and thorough investigation. Based upon all of this information, including that provided by the CDC, we believe the higher rates of reported false positives were likely caused by one or more site dependent factors. Based on the extremely large volume of actual performance data collected to date, we continue to believe that our test is performing very well and in accordance with its label claims in the field throughout the country. We, therefore, remain extremely confident in the quality and performance of OraQuick ADVANCE in testing oral fluid specimens for the presence of antibodies to HIV-1 and HIV-2, and we will continue to work with those customers who for whatever reason are not realizing the high quality performance seen throughout the country.

Now let me turn to some highlights for each of the product lines, starting first with our infectious disease business. The primary growth driver for 2005 revenues was our infectious disease testing business, which experienced a 67% revenue increase over 2004. The primary reason for this growth was the continued strong demand for OraQuick ADVANCE. Increasing numbers of public health entities, hospitals and many other customers are turning to rapid HIV testing and in many cases to our OraQuick ADVANCE test in their battle against HIV/AIDS. A number of recent events strongly suggests that this trend will continue.

The most significant development occurred during the January 31, 2006 State of the Union speech. President Bush called for a nationwide effort working closely with African-American churches and faith-based groups to deliver rapid HIV tests to millions in order to help end the stigma of AIDS and come closer to the day when there are no new affections in America. We share the President's vision and are fully supportive of this new initiative, calling for a nationwide effort to deliver rapid HIV tests to as many people as possible.

In a statement issued after the speech, the administration indicated that the President is proposing to direct more than $90 million to the purchase and distribution of rapid HIV test kits in order to facilitate testing more than 3 million people. This program would focus on areas with the highest rates of new HIV infection and the highest rates of undetected cases. Examples include the testing of inmates in jails and prisons and intravenous drug users. We believe this is a very positive development both with regard to the country's fight against HIV/AIDS and more specifically for our Company. The President's proposal is a clear signal of the administration's intent to further expand the deployment of rapid HIV testing.

As previously reported, we have been working with the CDC and other government agencies to obtain additional bulk orders for OraQuick. While that has not happened yet, we're encouraged by this latest development and believe that our OraQuick ADVANCE test due to its versatility and ease-of-use with oral fluid can and will play a significant role in the President's initiative. I hope to be able to report more on this in the near future.

Turning now to some recent highlights, sales of OraQuick ADVANCE to Abbott for hospital distribution remains strong throughout 2005, increasing 149% over 2004. This increase reflects the continued strong cooperation between our companies and the hard work of our hospital sales team and their support of the Abbott Diagnostics hospital representatives in targeting key hospital accounts for conversion to OraQuick ADVANCE. Our OraQuick test is now being used in over 1300 hospitals across the United States and, according to the CDC, is now the most used rapid HIV test in hospitals. Our relationship with Abbott remains strong.

On November 17, 2005, the CDC hosted a satellite broadcast entitled "Revised Recommendations for HIV Screening of Adults, Adolescents and Pregnant Women in Health Care Settings." This broadcast focused on the needs of expanding HIV testing into emergency department settings, as well as labor and delivery units. Specifically physicians spoke about rapid HIV testing and how it was an important tool in facilitating successful outpatient testing. Additional guidance for this initiative is expected to come from the CDC later this year and could have an immediate impact on how rapid HIV testing is routinely used in health care settings.

One such example as previously announced is Johns Hopkins Hospital where oral fluid testing with OraQuick ADVANCE is now offered to patients entering the hospital's emergency room for evaluation or treat. Funded by the CDC and the Maryland Department of Health and Mental Hygiene, this is one of the first programs of this type to be offered in the United States.

During 2005 direct sales of our OraQuick test in the public health market grew 103% over 2004. This increase reflects a further expansion of public health testing programs. We believe a significant portion of this growth was fueled by the availability of oral fluid testing. As testament to this belief, we currently estimate that approximately half of OraQuick customers in the public health market are now using the test with oral fluid, and that percentage continues to grow.

Also, the CDC recently stated that testing in New York City has increased 30% since the conversion to oral fluid. In 2005 we began shipments under a $4 million bulk purchase order from the Substance Abuse and Mental Health Services Administration, or SAMHSA, for the delivery of OraQuick ADVANCE to substance abuse treatment and prevention sites throughout the United States. Deployment of this order is over 95% complete. Under this program, devices have been sent to 30 states.

In international, sales of OraQuick have also been strong during 2005, growing 30% over 2004. The international market remains a priority, and we have continued discussions with leaders of both the President's Emergency Plan for AIDS Relief or PEPFAR, the global fund, and global business coalition members to access available funding for the purchase of our OraQuick tests for use in developing countries.

Moving onto our second main growth driver, substance abuse and specifically Intercept, our Intercept lab-based oral fluid drug tests performed very well throughout 2005. Total Intercept revenues were up 61% over 2004, reflecting an 87% increase in workplace testing revenues, a 62% increase in criminal justice, and a 14% increase in international. The continued growth of Intercept is attributable to the steady increase in acceptance of oral fluid drug testing.

During 2005 we added over 100 new Intercept customers to our already strong list of satisfied users ,which includes Lowes, Kroger, ShopRite, Georgia-Pacific and Fruit of the Loom. Recent significant new accounts include Capital Returns, the leader in pharmaceutical returns management solutions, and Allied Barton Security Services, the premier provider of office security services. Another new customer, [Body Knoll Enterprises] which owns the [Hardee's and Texas Steakhouse & Salon] restaurants, is using Intercept in a pilot program and is extremely pleased with the performance of our tests. All of this indicates that we are making great progress converting customers from traditional urine drug testing to oral fluid testing.

Finally, in past calls, we have talked about the oral fluid testing guidelines under consideration by SAMHSA. Draft guidelines have been issued and are under review by government agencies. In its December meeting, SAMHSA's drug testing advisory board, or DTAB, said, "The process is ongoing." We expect to hear more information at the upcoming DTAB meeting scheduled for March 7 and 8.

On to Histofreezer and Freeze Off. During 2005 our cryosurgical systems business grew 13% over 2004, which was largely in line with our expectations. The main driver of this increase was the launch of our over-the-counter cryosurgical product by SSL International in Europe. This product called [Freeze Spray] is being sold under SSL's Dr. Scholl trade name. The launch was started during the fourth quarter of last year in a few select countries and is expected to expand to other countries during 2006.

Sales of the Freeze Off product to MedTech also contributed to the increase in cryosurgical systems revenues, primarily because of the launch of this product in Canada which started during the third quarter. Domestic Freeze Off sales were down 21% for the year as our distributor worked through an inventory issue in its retail distribution channel. We believe that issue is near its resolution.

Sales of our professional Cryosurgery product, Histofreezer, grew nicely during 2005 in both the U.S. and international markets. This growth reflects enhanced sales and marketing efforts and our close work with existing distributors to increase sales. For example, we have now been granted placement in the Cardinal Health Physician Plus Program as a preferred Cryosurgery products provider.

Finally, our patent infringement litigation against Schering-Plough continues. On November 2, we had a pre-trial conference in this matter during which the court heard oral argument on the motions for summary judgment filed by both parties. The court has not yet reached any decisions, but we expect that to happen in the relatively near future and a trial date to then be scheduled. We remain confident in our position and look forward to a successful completion of this litigation.

And lastly, sales to the insurance risk assessment market continued their downward -- their recent downward trend with revenues declining 12% from 2004. The primary reason for this we believe was a decline in the number of applications for life insurance. In an effort to boost sales in this market, we have implemented a program to refocus our marketing efforts on increasing the number and types of life insurance policies where oral fluid testing is used by life insurance companies. We expect our 2006 revenues in this market to be lower than 2005 levels.

In the area of manufacturing and operations, sales growth in 2005 provided an opportunity to decrease costs through increased utilization of our manufacturing facilities. Increased volume production across our product lines was the main driver of unit cost reduction and will continue to be so in the future.

In anticipation of the need for significant capacity expansion, the automation system for OraQuick was installed in the fourth quarter. The validation of the system and submission for FDA approval are key initiatives for 2006. U.S. manufacturing of our over-the-counter cryosurgical product for distribution in Europe increased dramatically in the second half of 2005. Initial shipments took place in the third quarter with an increase of 470% occurring in the fourth quarter.

With that, I will turn the call over to Ron Spair. Ron?

Thanks, Doug, and good afternoon, everyone. Given the color that Doug has given to our full-year results, I will focus primarily on our fourth-quarter performance.

Total revenues for Q4 were 18 million or 27% higher than the same period in 2004. This revenue increase came primarily from increased sales of the Company's OraQuick ADVANCE test Intercept oral fluid drug test and the international over-the-counter cryosurgical products.

In the infectious disease market, sales increased 40%, primarily as a result of the increased strength of our OraQuick ADVANCE test. During Q4 we sold 5.3 million of OraQuick, which included 2.4 million in direct sales to the public health marketplace, 1.3 million in sales to Abbott, 1.2 million in sales to SAMHSA and 430,000 into the international marketplace. Sales of the OraSure device in the infectious disease market decreased to 1 million in the quarter as compared to 1.4 million in Q4 of 2004. This reduction is reflective of some customer transition from oral fluid lab-based testing to our Rapid Testing platform. We expect our infectious disease revenues in the first quarter of 2006 to be approximately the same as Q4 as we shift the remaining product under our SAMHSA contract and accelerate our direct sales to public health.

In the substance abuse testing market, sales were 3.5 million, up 24% over Q4 of '04. Total Intercept sales were up 57% over the fourth quarter of 2004 and reflect increases in all markets. Sales of Intercept devices, which are predictive of future demand, totaled 1.6 million, up 53% in Q4 versus 2004 with workplace up 52%, criminal justice up 59%, international up 17% and direct sales to our website up 119%.

Sales of Intercept oral fluid drug assays are indicative of the number of oral fluid specimens being processed. Assays sales grew into Q4 by 45% over last year to 1.2 million with workplace up 55%, criminal justice up 71% and international up 17%. We expect our substance abuse revenues to be up modestly in Q1, which traditionally is a slow workplace testing period.

Sales to the cryosurgical systems market in Q4 were up 34% compared to last year. While U.S. OTC sales were down 62% from Q4 of last year to 1.2 million as a result of higher inventory levels at our distributor, MedTech, we saw new sources of revenue contribution during the quarter from the launch of our Freeze Off cryosurgical product into Canada and the launch of our newest OTC product surgical product in Europe. Sales of our international OTC product cryosurgical products totaled 3.3 million during Q4.

Sales of Histofreezer into the U.S. and international professional markets also increased 7% and 35% respectively as compared to 2004. We expect total cryosurgical revenues to exceed 5 million in the first quarter of 2006.

Insurance risk assessment sales of 1.5 million in the quarter were 18% lower than the comparable quarter in 2004. This decrease reflects an overall reduction in domestic life insurance application activity during 2005. We expect that 2006 revenues in this market will be lower than 2005. First-quarter revenues are expected to approximate $1 million.

As we look forward to 2006, we expect total revenues in the first quarter to be in the 15.75 to $16 million range. Despite this slow start, we are maintaining our expectations of a full-year revenue increase for 2006 of 25% over 2005 levels. The primary drivers of 2006 revenue growth are expected to be continued increases in sales to the infectious disease market, including a bulk purchase by the government and increased revenues in the cryosurgical systems and substance abuse testing markets.

Turning to gross margin, gross margin for Q4 of 2005 was 60%. This is consistent with Q4 of last year. Gross margin for the quarter reflects more efficient utilization of our manufacturing facilities, offset by higher scrap and warranty expense related to a change in the OraQuick ADVANCE shelflife to six months. We recorded approximately $560,000 in warranty and scrap expense during the quarter related to this latter issue.

Our operating expenses for Q4 decreased by 4% or 355,000 to 8.6 million when compared to last year. This decrease is primarily attributable to a reduction in consulting, advertising and rent expenses, partially offset by higher legal fees and increased travel expenses. Our operating margin for the fourth quarter was 12%.

Turning to net income, as discussed during our third-quarter earnings call, we completed an analysis in the fourth quarter to review the realizability of our deferred tax asset under Section 382 of the Internal Revenue Code. A deferred tax asset allows a company to reduce its cash tax payments to the government.

Based on current year and forecasted taxable earnings and as a result of the completion of this Section 382 analysis, we released a significant portion of the deferred tax asset valuation allowance in the fourth quarter to reflect the realizability of this asset. This increased our net income by $18.2 million and earnings per share by $0.39. Partially offsetting this was a $436,000 income tax provision on 2005 earnings.

Had we not recognized this tax benefit and provision, our fully diluted earnings per share would have been $0.06 per share in the fourth quarter and $0.21 per share for the full year. We now project that our 2006 tax rate for financial statement purposes will be approximately 39%.

Effective January 1, 2006, we adopted new accounting rules requiring the expensing of stock options. After adjusting our prior guidance for this change, we now expect to achieve fully taxed first-quarter 2006 net income of approximately $0.02 per share. Additionally we expect to achieve fully taxed full-year net income for 2006 in the range of $0.13 to $0.15 per share after giving effect to stock option expensing, which we project will reduce generally accepted accounting principle earnings per share by $0.04 to $0.05 in 2006.

Turning our attention briefly to our balance sheet and cash flow, we continue to maintain a very strong liquidity position. The Company's cash and short-term investments were 77.6 million, and working capital was 90.9 million at December 31, 2005. Cash flow from operations was positive at 2.1 million for the fourth quarter and 10.6 million for the full year, an improvement of $900,000 and 7.1 million respectively over the comparable period in 2004. Capital expenditures in the fourth quarter amounted to 653,000. We also receive 1.4 million from the exercise of stock options. Depreciation and amortization amounted to 538,000 for the quarter. Our Accounts Receivable, days sales outstanding increased from 51 days at September 30 to 59 days at December 31, 2005, primarily due to approximately 4.5 million of cryosurgical systems sales in the month of December 2005.

With that I would now like to turn it back over to Doug.

Thanks, Ron. The final area that I will address is the recent progress that we have made against our strategic objectives. These objectives focus on the extension of our base business, further growth in the area of infectious disease point of care testing and the development of new over-the-counter opportunities.

In an effort to expand our base business, we have made significant progress. As previously noted, we launched the Scholl Freeze Spray cryosurgical wart removal product in the over-the-counter footcare market in selective European countries with SSL International in the fourth quarter of last year. We are excited about this launch, and we will be working with SSL to roll out the product in other countries throughout the year. We are also engaged in active discussions with potential distributors to represent our over-the-counter cryosurgical products in Japan and Asia.

We continue to make progress in our efforts to obtain a CE mark for OraQuick ADVANCE, which is required to sell this product in the European Union. All studies have been completed, and all data required by the notifying body have been cemented. Our submission is under review, and we hope to receive the CE mark shortly. Once the CE mark is obtained, we will then move to obtain necessary country-specific registration and would expect to launch OraQuick ADVANCE in Europe.

While this has been going on, we have been actively reviewing the market and potential list of marketing and distribution partners for this opportunity. Selecting and negotiating an agreement with a European distributor is a top priority, and we expect to make significant progress in the coming months.

We also continue to move forward in identifying and signing new distributors for our products in foreign territories. We recently signed a South Korean distributor for both Histofreezer and OraQuick and a distributor in Singapore for OraQuick. We are also close to signing a deal for OraQuick in the Middle East and are actively pursuing new distributors for Histofreezer in Mexico, for OraQuick in Thailand and for Intercept in Europe and other countries. Discussions also continue for both OraQuick and Histofreezer in Japan and for OraQuick in China.

Turning to the expansion of our infectious disease point of care testing business, the development of a rapid test for hepatitis C on our OraQuick platform continues nicely. We are continuing to develop a prototype HPV test on the OraQuick platform, and based on the preliminary data generated so far, we believe we will meet our design goals for this product. With an estimated 170 million people in the world who are chronically infected with HCV and an estimated 3 to 4 million new infections each year, the opportunity for a rapid HCV test remains very attractive.

We also continue to evaluate a number of other opportunities to acquire or otherwise gain access to tests in the infectious disease point of care market.

Another area where progress has been made is in our efforts to build an over-the-counter diagnostics business, the most immediate of these opportunities being the sale of our OraQuick ADVANCE HIV test over-the-counter. As indicated during our last call, there was a discussion of the over-the-counter HIV testing at the FDA's Blood Products Advisory Committee meeting on November 3rd. One purpose of the meeting was to discuss criteria the FDA should consider when evaluating an over-the-counter rapid HIV test. We were able to present at the meeting, and the feedback received has helped clarify a path forward toward our FDA submission.

The FDA and the advisory committee will be meeting again on March 10 to further discuss the process for approving an over-the-counter HIV test. This meeting is expected to focus on clinical trial requirements. We expect the outcome of this meeting will allow us to begin more detailed planning for the initiation of trials later this year. We are certainly pleased that this BPAC meeting is scheduled, and we look forward to working with the FDA as we prepare our submission for approval.

One final piece to update is in the area of operational improvements. Automation and increased utilization of our manufacturing facilities are expected to continue to drive costs down across all our product lines. We have moved to full production with suppliers in the U.S. for our European over-the-counter cryosurgical product line, and we are preparing for the transfer of our U.S. over-the-counter product to a United States vendor in 2007.

During our last conference call, we discussed the efforts of a cross-functional team to identify an enterprise software system for the Company. Recommendations have been accepted by our senior management with an anticipated project start of April 2006. This represents a major commitment and investment to build a solid foundation for growth.

So in conclusion you know 2005 was truly an outstanding year. I remain extremely optimistic and enthusiastic about our growth opportunities across our different product lines in all geographies, as well as our ability to improve efficiencies, reduce our costs and improve our margins. Our strategy is in place. Our team is performing very well, and we are executing as we have promised. We remain committed to and we look forward to delivering a very successful 2006 for our stockholders.

And so with that, I would like to open the floor for questions.

(OPERATOR INSTRUCTIONS). David Lewis, Thomas Weisel Partners.

Could you give us a more kind of detailed layout of the timeline around automated manufacturing and the potential impact on 2006 gross margins? The reality is looking at the percentage across surgical throughout the year, you still kind of had increasing gross margins. In the fourth quarter, you had 37% of sales were cryosurgical. I imagine that mix pressured gross margins. So how should we be thinking about gross margin expansion with automated manufacturing in 2006?

Well, we are working on that. As Doug had indicated, we have actually installed the equipment itself in our facility here in Bethlehem, and all of the equipment is here in place, and we are working on the validation protocols, and then we will be submitting for FDA inspection and approval, and we expect that process to continue during 2006 year with an expectation that towards the middle to latter part of the year that we will have something come online that will actually make a very positive contribution to gross margin appreciation in the OraQuick productline.

Now the first go live piece of that, what percent of total products will be on automated manufacturing?

You know, it is difficult to say right at the moment. We will have a transitional period where we will be going from our existing manufacturing platform over to the automated manufacturing platform. But it is not our expectation that we will flip the switch and turn all of it over to automated manufacturing at one time.

Okay. And then just focusing on guidance for 2006, obviously you're maintaining guidance both top and bottom line, but focusing in on areas that are not necessarily incorporated into guidance here, what assumptions are being made in existing guidance for the advanced product obviously overseas where you have not yet announced your international distributor? What assumptions are made as it relates to the 20 or $30 million of business that is out there given the President's budget assumption, and then what assumptions were made as it relates to the return of the prestige brand's distribution inventory either in the first quarter or second or throughout the year?

Typically, David, we have not commented specifically on individual contributions from revenue sources of that nature. But directionally we have revenues in our operating plan from a European launch of a product for OraQuick ADVANCE in 2006. However, it is not -- I would say the majority of that would be more in the latter part of the year. We also do anticipate that there are some potential upsides to our revenues that we are looking at as far as international business in relation to significant PEPFAR opportunities. We are also looking for recovery in the cryo business as you have indicated with MedTech in the United States there. And, of course, a significant contribution from a successful launch of our cryo product in the European market with our partner SSL.

So MedTech is indicating that their problem is essentially two weeks away from being resolved from an inventory perspective at least off their call, so we would assume that that is essentially appropriate there could be upset on that cryosurgical number just on the U.S. piece?

I think it is a little early to tell, but we are certainly optimistic about them performing at a level equal to or potentially better than what they had done in '05.

Okay. And maybe lastly here, just for Doug in terms of the strategic question. You talked about Hopkins. I'm wondering with all the success you're having in the hospital channel per se and given that there is close to $80 million of cash in the balance and you have a positive operating cash flow, maybe you could update us about your thoughts on hospital acquired infections potentially moving into that marketplace because it seems somewhat adjunctive. We've seen some recent M&A activity in that space with other broader hospital supply players.

Well, you know, I think for right now we're focused on the HIV opportunity and eager to see the CDC issue the revised guidelines later this year. We expect continued strong growth with the HIV product with Abbott in hospitals. And obviously with the announcement of the revised guidelines and the great leadership that places like Hopkins have demonstrated, we would hope we're going to see significant uptick there.

From a business development perspective, we are continuing to look at technologies, as well as other infectious disease products, that might be complementary to our position with OraQuick ADVANCE in the HIV area. I mention we're very pleased with the initial work that we were doing with the HCV assay on the OraQuick platform, and any other infectious diseases that make sense in that marketplace, we are going to try to develop on the platform if it looks right.

And am I assume that any acquired revenue inorganic revenue was not in the existing forecast for 2006?

That is a correct assumption. This is all organic.

Wade King.

A couple of questions if I may. First off, if you look at [Dr. Branson's] data from the retroviral conference, there continues to be a month by month progression as relates to lower specificity in the sites that were highlighted three -- obviously in New York, one in San Francisco. And you mentioned the possibility of some site-specific factors, user specific factors and gave us a very thorough presentation that there were no shelflife issues and manufacturing issues. So could you based on your analysis of the 150,000 oral fluid test results and the progression to scale in November, one, has there been any flattening out or rebound of that progression in any data you have seen in December and January? And number two, can you be more specific in what might contribute to these individuals sites, especially the one in San Francisco where the specificity, the false positive rate, excuse me, you know, was the lowest as to what is going on? (multiple speakers). What are the outstanding theories that you think are out there or likely related to the cross-reactivity or anything else that you would surmise?

You know, we continue to work very closely with these affected sites, and we saw some improvement in December. We are just collecting the December -- excuse me, the January data now, so it is premature to comment on that.

But again within those affected regions, we are seeing specific sites exhibit these unusually high rates of false positive, while the majority of the other sites are seeing really pristine performance. And so that has what has been a bit challenging here, and when we lay that against the backdrop of the national data where you have states and many many other customers where the test is performing directly to the product insert claims or even better, that has been part of our challenge in trying to analyze this.

Now, as I mentioned, we have thoroughly evaluated our manufacturing processes, the raw materials used. We have not seen any relationship between those variables and the false positives -- the report of false positives in these sites. We have this collection study that I mentioned which has just kicked off, which we hope will provide some insight as to the effect or the non-effect of collection differences or variables. And we are also working with the sites to understand any patient specific variables that may have impacted this. The investigation of those specific sites is ongoing, and like I said, they have been very cooperative, and we want to work with them until we understand what may be causing these higher false positives in these few sites so that they can begin performing at the national level.

And once again it sounds like (inaudible) recently approved three sites in New York. The specificity actually rebounded somewhat in December suggesting some reassurance. Is that right?

Somewhat in December, and again I have not reviewed the January data, so we have to do that. But we continue to work with them.

All right. Thank you. Secondly, can you give us your perspective did the issue on the false positives that emerged in these sites I mean in your view restrain OraQuick sales in the fourth quarter? On the one hand, you said -- and what is your view on that in the first quarter given the guidance? On the one hand, you said that all the sites were these false positives had been reported higher than normal still are using OraQuick, but maybe some of them obviously as we have talked the sites are now using it with blood specimens as opposed to oral fluids. Some may now have returned to oral fluid, but obviously your OraQuick sales, though impressive, were less than we expected. So what actually happened real-time in terms of the impact on sales in the fourth quarter?

I think that actually if you dive down and compare it to Q3, the public health direct sales were actually up in the fourth quarter versus the third quarter of '05. Where we saw a little bit of a drop-off would be in the fact that we did not have a CDC contract against which to ship in the fourth quarter. So if you look at the government funded revenues in Q3, we had approximately 1.5 million. That dropped down to government funded revenues of about 1.2 million with the Substance Abuse and Mental Health Services Administration. We also had a sequential decline in our Abbott revenues, but clearly the demand in public health was there, and it is forecasted to actually continue to increase going forward in 2006.

So, in fact, from management's viewpoint, the issue on the false positives select sites really did not restrain OraQuick sales in the quarter?

No, that is correct. We have no indication that customers either reduced or discontinued the use of OraQuick.

And would you say that that trend that you feel the same way as relates to what you have seen so far in the first half of this first quarter, that you would not surmise that your OraQuick sales were restrained by the false positive issue?

We don't expect the false positive issue, and certainly the reassuring reports that we have been able to put out and that we receive from the field to have an impact on customer's confidence in OraQuick. As a matter-of-fact, one of the real benefits that we have realized out of business while we were contacting all these customers, we did a customer satisfaction survey. We thought, what the heck, we are getting them all on the line, so why don't we find out how satisfied they are with the product and with the oral fluid in particular. And greater than 94% of the customers rated their satisfaction with OraQuick as a four or a five out of five being extremely satisfied.

So customers love the product. I mentioned the situation in New York where they are seeing increased testing because of the availability of oral fluid. Customers have not moved away from it in any significant number at all.

It must be that (inaudible) Ron Spair you provided him with.

Yes, that helps.

The last question, please, the inventory issue. Compared to end of September, your inventories actually declined $600,000. You mentioned the large amount of cryo sales shipped in the fourth quarter, which increased DSOs. Did that also put -- have an inordinate impact on your inventories in the fourth quarter? And the reason I ask is obviously trying to sort out the MedTech inventory situation, exactly what is going on there and have you implemented things to try to prevent any large purchaser or distributor from taking on too much inventory of any product going forward?

Well, we have tried to monitor that, those inventory positions at the retail level. But that is very difficult as I think we have discussed previously. Although my understanding from the MedTech conference call, for Steve (inaudible) conference call, they had about a half a month's worth of inventory in excess of what they wanted for the Freeze Off product line. And they have stated that. So that is a relatively de minimus amount of inventory from our perspective.

As far as the drop-off in our inventory levels and whether that is related to MedTech, it is not, because the arrangement that we have for our MedTech sales is that we purchase from a COGS subcontract manufacturer at the same time we ship that product out to MedTech. So, in effect, we never take possession of the product for inventory purposes, or if we do, it's a very very minor amount for a very short period of time.

And once again, having seen this before over the years, are you getting regular reports from your large purchasers on what their inventory levels are?

Well, our sales folks are ever vigilant in monitoring inventory levels throughout the various distribution channels in which we participate. But it is a significant undertaking as we have sales through distribution, direct sales, international sales through distributors who then sell onto additional sub-distributors. So we do the best we can, and we think we have a very good read on where we stand.

Okay. Thanks and good luck at the BPAC meeting.

Sara Michelmore, SG Cowen.

Back to your comment about the issues with the false positives potentially being site-specific and potentially being related to sampling issues, could you just give us a sense in terms of what the oral fluid sample collection process is? I mean is there a certain difficulty associated with it that you think is happening, or is it potentially just the difference between the sampling collection of the OraQuick device and the prior OraSure device? And if you could just put that in perspective in terms, as you think about taking the product over-the-counter, if there's a way that you can improve that or possibly simplify the collection process?

Well, the first, and let's be clear, is we don't have any definitive proof that there is a correlation with the sampling process. So that is why we're doing the study. But what we have observed in some sites is a tendency to over collect, and to your point the collection processes defined in the instructions for use is very simply. You simply take the device, and you do one swipe across the upper gum line and one swipe across the lower. That does not mean two or three or four, and it does that mean that you try to collect as much saliva or oral fluid on the device as you possibly can to just make sure there is enough. It is just once across the top and once across the bottom.

That differs from the OraSure collection device where the device is actually inserted in the mouth between the cheek and gum and left there for I don't recall exactly how long, but I think it is 30 seconds or a couple of minutes to really saturate the pad with oral fluid. So it is different. And some of these sites actually use the OraSure collection device for follow-up testing where they would send it off to a lab, and then they might also use the OraQuick device.

So it is different. We want to first understand if, indeed, there is a causal effect, and if there is, then clearly we will try to understand if, indeed, that is happening in these sites, which we're in discussions with them right now and we will work on. Relative to the over-the-counter application, clearly instructions for use are very important for a consumer product. And that is an area that we're working on in our design trying to make sure that the instructions for use can be understood by all ranges of educational background, and we are designing that into the product right now.

Okay. That is helpful. And then on the guidance, I was just wondering I know you talked a lot about some of the initiatives that you guys are looking at for 2006. Operating expenses in 2005 were reasonably flat with the prior year, and the guidance does infer a significant uptick investment. I am just wondering if you could put that into the context of where the incremental dollars are going primarily in 2006?

Sure. One of the big items, as you may see from the press releases, is the fact that we're going to be expensing stock options this year, and we are looking at somewhere around the $4 million mark for increased expenses that heretofore had not been reported in the P&L, and that falls primarily in the operating expense area.

Additionally we expect our research and development activities to increase and for the development of our HCV test on the OraQuick platform, as well as other activities that are ongoing and clinical work, as well as work related to the OraQuick product for potential OTC application. We also will be expending monies, additional sums in the sales and marketing area as we add some additional staff internationally and continue to grow our businesses here domestically.

Okay. That is helpful. And then I guess my last question was related to the Abbott decrease in the quarter, and I know Doug mentioned that he thought that relationship was going well and that they remain committed to the product. But were there any specific reasons for the decrease in sequentially in Q4 from the Abbott OraQuick deal?

Actually we not only -- this reflects our sales to them. We also track their out sales, and their out sales were actually increased in December. They have been on an increasing trend through the fourth quarter.

Okay. That is extremely helpful. Thank you.

Aaron Lindberg, William Smith & Co.

A couple of quick questions. Number one, would you guys be presenting at the BPAC meeting on March 10?

We have not been requested to make a formal presentation. We will be in attendance, and we will be prepared to make a statement or respond to questions.

Okay. When was the last product funded by the CDC shipped?

That was back in the third quarter.

Okay. What is the status of extending the shelflife of OraQuick ADVANCE?

Well, we are continuing to work on that. One of our key objectives as part of the over-the-counter initiative is to significantly extend shelflife, and we have a number of different studies going on on how we might be able to do that. We have tested a lot of different materials and conditions to extend the shelflife. A number of those different conditions are on stability right now, and we're monitoring them. So we have got a clear plan to do that, and we know that that is important for an over-the-counter product.

Did some of the data collected after the false positive issue contribute to that then as well, as far as you are studying some of the lots and how old those products were?

We have gained a lot of insight into the performance of the test through the exhaustive study that we have been completing, and we use all the information that we get. But really we have found no correlation between the false positive issue and product dating.

Can you help us understand why the shelflife is at its current length in the labeling and not longer?

Well, you know, our current product shelflife is six months. And during routine product monitoring, we test quality control panels, and it is based on those panel members and the performance of those that we set dating. Our specifications are set to be very sensitive, and so even small shifts in product performance that would not be necessarily seen in the field, we adjust product dating according to those. So we have a very sound method for establishing our dating.

So based on when you were doing your initial research for FDA approval, you found deterioration in the performance beyond six months, and so this was -- that was the kind of cleanest date, if you will, is that what you are saying?

That is generally in the right direction, yes.

Okay. And if you had to draw a line in the sand today, what would be the target shelflife that you would like to have on the product?

Well, as we evaluate a different condition at launch or in steady-state, at launch we believe we could launch the product with as little as eight months to 12 months dating, somewhere in the range. But ultimately with an over-the-counter product, we would like to have something in the 15 month to 24 months timeframe.

And do you believe that is feasible without substantial product or material changes?

Yes.

And obviously as it takes some time to do those studies, there is at least 15 to 24 months worth of product sitting out there --?

You don't have to launch with, like I said, 15 to 24 months if you have a good view towards the product stability out that far you can launch with eight months or -- and then you just extend the dating as you generate the stability data from internal testing.

Okay. Last question. How do you guys feel about a blood-based rapid OTC test?

Well, it's not how we feel about it, it is how the consumer feels about it.

What do you think for the likelihood of that? I mean, as I look at your FDA approval and it was obviously a substantial change for people to think about oral fluids in this context, and so the blood-based approval was easier. I just wondered if it is the same kind of thing. Obviously it is slightly more complex, but I guess I am curious as to your thoughts?

Well, we have done a lot of market research in terms of consumer preference for either oral fluid, urine or blood, and clearly consumers prefer by a significant margin oral fluid versus either of those other two matrices. That is point number one.

Number two, there have been a lot of consumer products put into the field that use blood, and consumers have expressed a dissatisfaction with those cholesterol, home cholesterol testing being one example.

Do you want to make another point? I forgot what I was going to say on that.

Oh, the other piece is with oral fluid you don't have any concern in dealing with infectious material or infectious waste disposal where you would with blood or blood products. So oral fluid has a lot of advantages. That is why we are seeing increased uptake on the professional side, and we expect to the same over-the-counter.

How do they deal with diabetes testing and with home cholesterol testing and things like that? How do they deal with that hazardous wastes?

Home cholesterol testing really has not taken off any measurable extent. And on the diabetes side, I cannot comment.

Okay. I mean it seems to me, I understand the difference in the waste, if you will, but I'm having a hard time seeing why it's a significant issue if there's millions of people testing their blood for blood sugar levels?

I think once again, I think it is customer preference, and I think you see all the effort in the diabetes market focused on getting away from finger sticking blood. People want to do something non-invasive. And I'm pretty sure that once somebody comes up with a non-invasive accurate procedure in the diabetes market, the market is going to flock to it. That is my opinion.

[Ed Shankan], Needham & Co.

I hope that was not your dog in the background there.

No, they are at home.

As for expectations for the BPAC meeting, could you tell us what you would expect as far as outcomes of the meeting, what they will have then as goals for the future meetings after this one?

Well, our hope is just to gain further clarity on the scope and requirements of the clinical studies that we are going to need to perform to get over-the-counter approval. And if we can come away with that kind of clarity, our expectation is that we are going to develop those studies and get our submission in as rapidly as possible.

Okay. And as for as Abbott, you mentioned that you had a sequential increase or that Abbott actually sold more product, although you sold less product in the fourth quarter than you did in the third to Abbott. Does that imply that they probably bled down their inventories towards year-end, and is that what you think might have happened there?

I think so.

Perfect. And then lastly, as far as the costs of these studies that you're doing around the false positives, what kind of cost to OraSure is being incurred in the first quarter, and what would you expect in the second quarter, and on what line would we see that in? Is that G&A, or where would we see that?

It would be in research and development, and we have baked those costs into our guidance of $0.02 a share.

Okay. And I guess to throw in one last question and get back in queue. For hepatitis C could you walk us again through your development timeline where you are there with that great product that could come to market?

Yes, we are still in the development phase. We need to continue to refine the prototype, continue to do pre-clinical testing. Once we have a prototype device that we believe can meet our specifications, we will go out to clinical trials in the back half of 2006.

Bill Quirk, RBC Capital Markets.

[Dave Clare] here for Bill. I will not prolong the call any longer here. Most of my questions have been asked. Just kind of one last question about how we should think about the revenue ramp for Freeze Spray outside U.S.? I think you commented that Germany and France were kind of the initial markets and then maybe rolling out to Spain and Italy. Is that still their schedule, and are you guys on track?

I believe that is still correct, and we are on track, yes.

What kind of eventual opportunity do you see there, any color there?

I think it is a lot early to tell and project right now given that we are only about a quarter into it. But I think as the months progress here, we will be able to give a little bit better color as we see out sales data from the local markets in Europe and work with SSL to maximally penetrate that market, which is a significant one.

Okay. Great. Thanks.

[Elop Laye], Jefferies & Co.

This is actually Ryan Rauch in for Elop. I would just like -- the first-quarter revenue guidance I mean looks to be a little bit weaker, about 4 million beneath First Call consensus and flat year-over-year growth. And it looks like the biggest discrepancy is cryo therapy. And if the MedTech inventory issue is behind them or nearly behind them, I guess it leads me to believe of the 3.3 million of outside U.S. international cryo therapy sales in the fourth quarter, what do you assume -- more end-user sales in the quarter or just sort of one-time inventory build at your distributor?

I think the latter is probably an accurate depiction. Of course, just as we had with our Compound W launch a couple of years back, we saw an uptake from SSL to get product into the channel. That is clearly an effect in the fourth quarter, and I think you will see some tapering off of that in the first quarter and then again a ramp we expect going forward.

Okay. And then that is the reason behind the DSO increase? A), I think somebody asked, but I did not hear the answer. And B), what gross margin should we look for for the first quarter and then full 2006? In the 60% range or 62 to 64? Can you just give a little bit more insight there?

Right. I think that we are looking to have our margin increase. Obviously, though, again on an apples-to-apples basis, you have to be a little careful in that stock option expense is finding its way into the gross margin line. And we would currently expect that to have a percentage or a little better of negative effect on an apples-to-apples basis for '06 versus '05, but clearly though trending upward as we move out towards the year with additional volume.

Okay. And then the DSO increase in the quarter, that is just based on the increased cryo therapy sales outside U.S.?

Yes.

Okay. And then finally, can you just -- it just seems a little bit conservative that infectious disease guidance is flat fourth quarter to first quarter. Is that just because you don't have the CDC order yet or another order from SAMHSA?

Yes.

[Caroline Korner], Montgomery & Co.

Congratulations on the good quarter. I have a question about OraQuick ADVANCE used with oral testing. If I heard correctly, you said that 50% of the tests are used with oral fluid. Was there any higher than that prior to the false positives issue? And going forward are you seeing any new customers that are using it primarily for blood testing that you would not have expected to prior to the false positives issue?

No, not at all. As a matter-of-fact, the majority of new customers that we sign on to OraQuick are using it with the oral fluid application.

Okay. So what is the pushback from the customers that are still using that with blood testing?

I don't think we get a lot of pushback. I think it just depends on what their internal standard operating procedures are, if they are also drawing a tube of blood for other tests. It is really a site by site decision. I guess it just goes back to one of the great features of OraQuick in the fact that you have a choice, and you can alter that decision by site. So places like San Francisco Department of Health, New York City Department of Health, they have a mix of some sites that use blood and some sites that use oral fluid depending on what they are most comfortable with.

And does that 50% rate you talked about, does that include some of that being people using a blood test to confirm an oral test after they have had a positive reading?

No, no, when we talk about the percentage, it is really what percentage of oral fluid is used in the initial screening.

Okay, it is all initial. Okay. And then I'm assuming that there is nothing in the first-quarter guidance regarding a CDC contract or some government funding coming in, is that correct?

There's just the remaining amount under the existing Substance Abuse and Mental Health Services Administration, and that approximates $.25 million.

Okay. And then for the PEPFAR and presidential initiative funding, when is the earliest that we could see some of that money coming in, best case do you think?

It is very very difficult to predict on that. We're working on a lot of different initiatives in many different countries to see if we cannot secure some of that funding right now. I would not speculate on that.

Okay. My last question related to the cryo sales, it seems to me that that Canada launch is going well and has been contributing. Can you tell me, break it out how much of that you think in Canada is due to stocking and how much of it is sustainable going forward?

The original order to Canada occurred in the third quarter of 2005 with a follow-on order in the fourth quarter of 2005. And so I think that that channel has sufficient inventory, at least that is what our understanding is at this point, for the foreseeable future. We do obviously expect it to come back online later on this year. But right at the moment, I think that we don't anticipate any revenues to Canada in the first quarter.

Okay. Great. Thank you very much for your time.

The allotted time for the call is up. We apologize to those who are still holding to ask a question. I will now turn the call over to Doug Michels for closing remarks.

I just want to thank everybody for being on the call with us tonight, and thanks for your continued confidence in the Company. We will talk to you soon. Bye-bye.

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