Detecting Investment Potential In Medical Diagnostics Companies

by: Chemistfrog

Investments in pharmaceuticals pursuing treatments for cancer, infectious diseases, heart disease and diabetes garner a great deal of attention from investors looking for substantial gains in the event clinical trials are promising and the regulatory paths are navigated successfully. However, I believe solid gains can also be made from another sector fighting these diseases via early detection and close monitoring. Medical diagnostics companies present investors with a variety of choices for consideration with a host of targeted indications via a wide range of technologies. With less risk than typically posed by therapeutics, diagnostics clinical trials are typically shorter in nature, less expensive and more likely to experience regulatory approval due to the more straightforward correlation between proof of concept and actual application in clinical settings. Although I am an avid investor in small pharmaceuticals developing cures for multiple indications, I am also interested in the hopes that early detection can help prevent many of these diseases from advancing to later stages in which the patients would require radical and more risky treatments to fight off their respective diseases. Below, I wish to present three candidates for investment consideration with 2013 being a critical year for each of these. This article should only be considered an introduction and summary of the presented candidates for investment consideration. I recommend much additional due diligence in each of these candidates before opening any positions.

MELA Sciences (MELA) has a simple yet seemingly revolutionary diagnostic tool the company has termed its MelaFind technology. The diagnostic tool is a non-invasive instrument that is used to detect melanoma, a skin cancer that is expected to affect 76,690 patients in the U.S. in 2013. Although often successfully treated if caught in its early stages, the prognosis dramatically worsens once the cancer has metastasized beyond the patient's skin to distant locations. According to the National Cancer Institute (NCI), patients diagnosed with melanoma in the earliest stages before metastasis have a 5-year survival rate of 98.3%, those diagnosed when it has spread to regional lymph nodes have a 5-year survival rate of 62.4% and those with distant metastases have a 5-year survival rate of 16%.

After a successful pivotal study of MelaFind in 1,383 patients in which data indicated 98% sensitivity to lesions 2-22 millimeters in diameter, the FDA approved the device on November 2, 2011 with labeling in place for "clinically atypical cutaneous pigmented lesions with one or more clinical or historical characteristics of melanoma, excluding those with a clinical diagnosis of melanoma or likely melanoma." The FDA's approval came just two months after EU approval for the device, on September 6, 2011. With two major markets approving MelaFind in 2011 for the huge indication of melanoma, one would assume that sales should be skyrocketing by now with the company having a billion dollar market capitalization. However, sales of the novel device have not taken off as anticipated since it was launched in March of 2012, and the company is currently trading with a valuation of just over $47 million.

On April 30th, MELA reported Q1 2013 earnings. Revenues for the quarter came in at $144,100 with deferred revenue of $392,250. The company operated at a loss for the quarter of $6.5 million, or ($0.17) per diluted share, and ended March 31st with cash and equivalents of $21.6 million. If sales remain constant, MELA has enough cash on hand to enter 2014, minimizing the need for financing at least until 2H 2013 at the Q1 cash burn rate. With only slight improvements over Q4 2012's $122,327 in revenue, shares sold off, opening May 1st with a plummet to $1.05 from the previous day's close of $1.23. With cash sufficient to fund the company into early 2014, I believe the sell-off was a bit overdone and gives investors a decent entry for a possible price run up into Q2 and Q3 earnings. I anticipate a gradual improvement in sales is coming, and its current cash position gives the company a couple more quarters to improve sales to at least slow the cash burn rate, if not attain profitability. In its Q1 update, MELA noted several key points that could indicate sustained growth and an active management. The more significant points mentioned are as follows:

  • "Ended the first twelve months of the MelaFind commercial launch with significant national distribution by having placements in 28 states in the US and 21 cities in Germany
  • 63% of US population within 75 miles of a MelaFind practice
  • Ended the first quarter with signed user agreements for 138 MelaFind systems in the US and Germany
  • In discussions with over 140 additional dermatologist practices that either have a user agreement currently under evaluation, or have been classified as "highly interested" by the Company
  • We have now begun phase two of our launch - with increased focus on patient awareness and engagement, as well as system usage, and we believe that our efforts are starting to yield results- usage represented 36% of our recognized revenue in the first quarter, up from 25% in the fourth quarter of 2012," said Dr. Joseph V. Gulfo, President and CEO of MELA Sciences"

MELA's shares closed Monday at $1.10, just above solid support at $1.0, with a market capitalization of $47.3 million. Although more downside is always possible, I believe this support should hold with many of the disappointed shareholders selling last week, and new hopeful ones now a part of the shareholder base. With many catalysts possible heading into the next quarterly earnings release, I believe those earnings will be the key to share price growth throughout the year. In the interim, indications from management on partnerships or large orders could be revealing as to how Q2 sales could accelerate. Now a marketing phase rather than a development phase company for over a year, anxious investors will be watching closely to ascertain what type of sales could ultimately be coming from MelaFind. While the company has cash reserves, it needs to show solid growth in order to keep shareholders impressed and holding on for the longer term while preserving its cash base and minimizing the need for unfavorable financing.

Trovagene (NASDAQ:TROV) has already experienced a phenomenal year, but has still managed to remain largely under the radar for many investors. The $105 million market capitalization diagnostics company is beginning to turn heads with its urine-based diagnostics platform that utilizes nucleic acid (DNA and RNA) fragments to diagnose and monitor infectious diseases, cancer and hereditary disease. While spending much of 2012 validating and improving its diagnostic tests, the company continues to validate its product line in clinicals in 2013 with one product launch to its credit already. On March 27th, Trovagene announced that it was launching its urine-based human papilloma virus (HPV) test. The test is designed to screen for 15 known high-risk strains of HPV using DNA sequences. Shares were remarkably unchanged on the day, closing up just 6% despite the large targeted indication with about 14 million Americans contracting the disease in the U.S. annually.

Trovagene's diagnostic tests are targeting a wide range of large indication markets. As each test is validated and then subsequently marketed, potential revenue should begin to be realized by investors, driving up share price in anticipation of partnerships and earnings. In an April corporate presentation, Trovagene gave some insight into catalysts ahead for 2013. Planned commercialization this year includes the already-launched HPV carrier test in Q1, a Q2 launch of a KRAS mutation test -- applicable in 90% of all pancreatic cancers and 23% of all solid tumors according to an April 2012 test validation announcement, a Q3 launch of a BRAF mutation test -- applicable to more than 20% of all cancers and over 40% of all thyroid and skin cancers according to a January 2012 test validation announcement, a Q4 launch of a PIK3CA test -- applicable to breast, colon and endometrial cancers, and a Q4 launch of a specific double mutation in the hepatitis B virus (HBV) and a p53 test -- applicable to hepatocellular carcinoma (HCC) detection. Awaiting each of these tests to be validated and launched, Trovagene plans on ramping up its sales force in Q4, closing out a possible successful 2013 and readying for increased commercialization in 2014.

In a possible sign of things to come for Trovagene in 2013 and beyond, on April 26th the company filed an 8K noting an "Entry into a Material Definitive Agreement" with $3.5 billion market capitalization PerkinElmer (NYSE:PKI) to jointly develop a test to determine a patient's risk for developing HCC. The collaboration will combine Trovagene's TrNA technology with PerkinElmer's technology for automation of nucleic acid isolation. Although monetary terms were not disclosed in the filing, it did state that Trovagene would receive milestone payments from PerkinElmer and that PerkinElmer would have an exclusive option to garner an exclusive royalty-bearing license to use Trovagene's technology for the HCC indication. I believe this collaboration and possible licensing could be the beginning of many such arrangements, with each one reducing research and marketing costs while providing for revenue and more of the platform's exposure to the investment and large pharmaceutical arenas.

Validation and marketing of each of these diagnostic tests will further legitimize Trovagene's urine-based diagnostic tests and help to garner addition investor and large pharmaceutical interests. As the platform is validated and marketed, share price will likely increase as well, making entry after each announcement more and more expensive for investors and possible suitors. With shares now at the $7.0 resistance region but in breakout mode, interested investors are advised to research the company and determine if the investment is right for them. Friday's closing price of $6.19 after an eye-opening closing minutes volume and share price surge and Monday's 8.9% additional gain to close at $6.74 give the company a market capitalization of $105 million, a low valuation for a company targeting such large markets. Technical support for Trovagene's common shares is at about $6.50 and then $6.00, with entry there advised if the $6.5 support level is compromised. Depending on the behavior of the broader markets, I don't anticipate the $6.00 support fails in the near future and would advise investors strongly consider a position at those levels if not current levels. As of December 31st, Trovagene had about $10.8 million in cash according to the company's 2012 10K, enough to fund its operations into 2014. Depending on partnerships and early stage launch results, the company may need to come up with some funding by the end of the year. However, if financing is required, terms could be more favorable if the company's product line is diverse with large markets targeted and if the product launches appear to be going well.

Vermillion (NASDAQ:VRML) is a diagnostics company focusing on gynecologic cancers and women's health. The $21.6 million market capitalization company has had somewhat of a slow development, but it appears that it is turning the corner and starting to establish its business model with increasing revenue coming from its diagnostics platform. Its flagship product, OVA1®, is designed to help distinguish benign from malignant ovarian masses. A qualitative serum test, it utilizes five well-established biomarkers (each with patent protection pertaining to OVA1®); Transthyretin, Apolipoprotein A-1, beta 2-Microglobulin, Transferrin and Cancer Antigen 125, and a proprietary FDA-cleared software device to render the test's results. Vermillion's OVA1® diagnostic test received regulatory approval on September 17, 2009 which made it the first FDA-approved blood test that could indicate the likelihood of ovarian cancer with high sensitivity prior to biopsy or exploratory surgery, even if radiological test results failed to indicate malignancy. Not a stand-alone diagnostic, the FDA noted that the test should be used by primary care physicians or gynecologists as an adjunctive test to complement, not replace, other diagnostic and clinical evaluations.

OVA1® was developed by Vermillion and is marketed through a licensing agreement with medical diagnostics sector leader Quest Diagnostics (NYSE:DGX). The late 2009 approval was significant for Vermillion as it had financial troubles that could have gotten much worse if not for the approval and milestone payments from Quest, which helped the company pull out of bankruptcy in January of 2010 with creditors receiving 100 percent of allowed claims and the company's common stock being fully restated. Later in September of 2010, the company made another significant step by obtaining the CE mark, allowing marketing in the EU. In July of 2012, Vermillion reported topline results from a new prospective, multi-center clinical study of OVA1®, termed the OVA500 trial. Data were positive and helped to validate the earlier registration trial from 2009. With solid statistics behind it, the company noted that it would "utilize important findings like these as a tool to continue driving adoption and reimbursement of OVA1." Vermillion continues to use this and earlier data to tout its product to clinicians and gynecologists, showing confidence in its flagship product and keeping investors aware of its progression. In 2013, Vermillion continues its work on OVA1® via a collaboration with the U.S. Army Medical Research and Materiel Command (USAMRMC) announced on April 17th. In a project entitled "Cost Reduction Using OVA1 in a Treatment Algorithm for Adnexal Masses in Women," the two entities will perform a cost-benefit analysis of OVA1® testing as a presurgical standard of care in women with pelvic masses, and assess its clinical utility in a managed care setting. A two-part study, the entities will first retrospectively review clinical outcomes and cost of care to establish baseline values and estimate potential monetary benefits of OVA1® utilization. They will then conduct a multi-center prospective clinical study within the Western Regional Command to assess the diagnostic as a standard of care across a large sector of the U.S. military in order to ascertain savings with regard to reduction of out-of-network medical costs, avoidable travel costs and time away from family (and most likely work). The end goal of the collaboration is to measure "real-world impact of OVA1 on medical and health economic outcomes, compared with accurate and holistic benchmarks," according to Thomas McLain, president and CEO of Vermillion at that time. The most important outcome of the study in my view is that of the patients' wellbeing. Also in the USAMRMC collaboration announcement, Mr. McLain noted, "sensitive detection of stage I ovarian cancer has always been difficult. But when appropriately detected and treated, greater than 90% complete cure rates have been reported. This is just one example of benefits we expect to see with a sensitive test like OVA1 when implemented as a standard of care across our managed care network."

With solid data behind it from more than 1,000 patients, an active marketing campaign and the U.S. leader in medical diagnostics helping to market and distribute OVA1®, Vermillion has been steadily growing revenue due to OVA1® sales and licensing payments. Since its Q1 2010 launch, OVA1® has had steady sales increase. In its debut year of 2010, product sales netted $308,000 with an additional $867,000 in licensing fees, giving Vermillion $1,175,000 in revenue for 2010 while operating at a net loss of $19.0 million for the year. In 2011, growth increased dramatically with a full year of sales behind it and the product's marketing campaign well underway. For the year, OVA1® sales garnered $1,469,000 with an additional $454,000 in licensing fees from Quest Diagnostics giving the company $1,923,000 total revenue for the year while operating at a net loss of $17,790,000. On March 1st, Vermillion released its earnings for 2012. Product sales for 2012 increased to $1,640,000 on the year with an additional $454,000, giving total revenue for the year of $2,094,000. More significantly was the overall improvement in the company's financials, a loss of $7,146,000, an improvement of more than $10.6 million over 2012. Cash and equivalents as of December 31st totaled $8 million, while the company anticipates cash-based expenses of $9.5-$10.0 million for 2013, indicating possible financing coming depending on sales growth and/or any changes to the Quest Diagnostics' licensing agreement or other possible partnerships.

Vermillion will release its Q1 2013 earnings on May 15, with a conference call later in the day at 4:30 p.m. EST. Interested investors are advised to perform additional research on Vermillion by first reviewing its last three 10K filings to more closely scrutinize the company's revenue, costs and overall margins. In the upcoming conference call, investors should review product sales growth and in the U.S., the EU, India (India's launch was in 2011) and any other targeted areas. Vermillion's common shares closed Monday at $1.42, with a market capitalization of $21.6 million. The stock's 52-week range is $1.03-$2.79, with recent share activity bulling bullish since its 2013 lows on April 9 of $1.06. While there is a risk of sales decrease in Q1 for any number of unforeseeable reasons, I believe sales will continue to grow in its current approved markets. I would like to see some indication of additional markets being targeted throughout the world in order to continue its solid revenue growth thus far. In its 2012 earnings conference call, interim CEO Bruce Huebner addressed this additional marketing expansion when referring to an upcoming conference in July in stating "... we are also evaluating international partners for OVA1 in the global market. We plan to meet with potential partners during the AACC, American Association for Clinical Chemistry meeting in July, with the goal to discuss partnering opportunities."

Presented above are three medical diagnostics companies addressing different indications while utilizing dramatically different technologies. Each of these companies is in the early stages of marketing with potential growth being indicated. While none has yet indicated blockbuster sales with the potential for hundreds of millions in revenue, each is showing improvement with a solid future ahead. 2013 will be a telling year for these promising companies, with interested investors advised to consider the companies' current cash positions, cash burn rates, partnerships and targeted market groups.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in TROV, MELA, VRML over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.