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Response Genetics, Inc. (NASDAQ:RGDX)

Q4 2013 Results Earnings Conference Call

March 20, 2014, 10:00 am ET

Executives

Thomas Bologna - Chairman of the Board, Chief Executive Officer

Kevin Harris - Chief Financial Officer, Vice President

Analysts

Kevin DeGeeter - Ladenburg

Operator

Good day, everyone and welcome to the Response Genetics Incorporated fourth quarter and full-year 2013 financial results conference call. This call is being recorded. With us today from the company are the Chairman and Chief Executive Officer, Mr. Thomas Bologna and Chief Financial Officer, Mr. Kevin Harris.

At this time, I would like to turn the call over to Mr. Bologna. Please go ahead, sir.

Thomas Bologna

Thank you. Welcome to our fourth quarter and year-end 2013 conference call. Before delving into our financial and operational results, Kevin Harris, our CFO, will read our forward-looking statements. I would then highlight our financials, discuss our fourth quarter and full-year 2013 results, summarize where we are, discuss our expectations for 2014 and then open the call for questions.

Kevin Harris

In addition to the historical information, our fourth quarter and year-end 2013 conference call today contains or may contain among other things, certain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements include, but are not limited to, statements concerning our expectations, strategy, future operations, future recruitment, future financial position, future revenues, projected costs, prospects and plans and objectives of management.

When used in this call the words expect, anticipate, intend, estimate, plan, may, will, believe and similar expressions are intended to identify forward-looking statements, although not all forward-looking statements contain these identifying words. Forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from those expected.

These forward-looking statements speak only as of the date hereof. We expressly disclaim any obligation or undertaking to update any forward-looking statements in this conference call to reflect any change with regard thereto, or any change in events, conditions or circumstances on which any such statement is based. Tom?

Thomas Bologna

Thanks, Kevin. Let me start by saying, we are pleased with the increase in our fourth quarter 2013 DX sales relative to both the fourth quarter of 2012 and the third quarter of 2013. Relative to the third quarter of 2013, our fourth quarter DX 2013 sales increased by more than 25% to approximately $3.2 million and by 3% relative to the fourth quarter of 2012. Our Pharma business was steady compared to the third quarter of 2013 and increased 3% to approximately $1.6 million. With stronger DX sales and steady Pharma results, our gross margin increased nicely as well to approximately 48% or 15 percentage points over that of our Q3 2013 gross margin.

That said, we are optimistic about our Q1 and full-year 2014 DX accessions or number of samples that we process increasing as result of the many initiatives that we took in 2013 which begin to materialize in the fourth quarter of last year and which we believe will gain momentum quarter-over-quarter in 2014. I will highlight the specifics and reasons for that optimism later in my comments.

Our fourth quarter 2013 losses increased relative to the third quarter of 2013, primarily as a result of our decision to increase the reserve for accounts receivable related to the many changes in Medicare reimbursement associated with the implementation of the new molecular codes of 2013. We made this decision based on our appreciation that the Office of Medicare Hearings and Appeals is processing a record number of Medicare appeals and as such the average processing time for appeals has been extended significantly.

That said, I would like to stress that right now we are less concerned about our short-term losses as we invest to grow the top line. Our primary objective is to show consistent increases in our DX business since we believe that is the best way to create short and long-term shareholder value.

Now with that in mind, let's look at where we were and where we are. No question, 2012 was the year of the turnaround and 2013 was the year of building the infrastructure and investments to build first our DX business aggressively and then our Pharma business selectively. We did have a challenging third quarter of 2013 as we completed the acquisition of the Pathwork Diagnostics assets while we were also well into the throes of several sales initiatives, all of which came together at the same time. But again, I will let our fourth quarter 2013 DX results speak for themselves.

I believe we are back on track which begs the question, how did total 2013 compared to 2012 when we transitioned from a turnaround to appear to building an infrastructure for growth? I believe, relatively well.

Even with the numerous changes and investments we made 2013, our Pharma business increased by 14% over 2012 and with all the marketing, sales and operational changes that we made in our DX business last year, DX sales were steady with an increase of 1%. However, the steady results do not tell the whole story. What you cannot see in the absolute numbers is the year-over-year account mix, namely 2013 was an important year because late in 2013, we began to realize a result of our efforts to shift our account mix to larger accounts thereby leveraging our sales efforts and that trend continues in the first couple of months of 2014.

I also believe our operational changes clearly produced results we expected during this period of infrastructure investment as proven by our gross margin. Our full year 2013 gross margin increased to 47% from 44% in 2012 and our operating losses increased by about $300,000, all while we were investing for growth and making significant changes.

And with that, let me now comment on the changes we made in 2013 and what we believe they mean going forward, especially for 2014. First, in January 2013, we had nine DX sales people and no one dedicated to selling for our Pharma business. Today we have 17 account executives in the field, three regional sales directors and an experienced Vice President of Sales. Also in the fourth quarter of 2013, we brought in a Director of Biopharma Sales to begin selectively growing our Pharma business.

We also capitalized on many changes in 2013 that we initiated in 2012. In February 2013, we went live with our state-of-the-art laboratory information management system, the information backbone of our company, to help us better understand and manage our business. We also completely reconfigured our lab and added capacity to accommodate the launch of the Tissue of Origin Test that we acquired when we purchased the Pathwork Diagnostics assets in the second half of 2013. More on that later.

We also strengthened our infrastructure from a human resources perspective as well. Several new positions were added to both attain the growth we are seeking as well as servicing it. In addition to significantly building the sales force, as I just noted. We now have regional sales directors in place to drive and manage that growth. We also added a Vice President of Business Development and we strengthened our billing department and back-office operations in general.

In mid-2013, after committing and focusing significant resources and time, we completed the submissions for our license to market our services in New York State. We met with the regulators in Albany earlier this year and we believe our submissions were well received. We hope to receive our license in 2014. I previously stated that we anticipate a license to be granted in early 2014. As early 2014 is quickly coming and going, we sincerely believe all indications point towards receiving our license in 2014, but at this time we cannot provide any more expected guidance on the timing, except we are very optimistic that we will be receiving the license shortly based on our interactions with the regulators.

Subsequent to completing the work for New York State license, we began reallocating additional resources to new product development. We introduced several new tests late in the second half of 2013 and expect more to be introduced in 2014. In 2013, we also expanded our test offering beyond our lung, colon, gastric and melanoma panels and begin testing for thyroid. Additionally in 2014, we expect to introduce testing for yet another [buying] (ph) site.

A key priority for 2013 was to aggressively pursue new tests based on many factors including, but not limited to our strength to rapidly identify and develop actionable tests, reimbursement considerations, applying the appropriate technology based on oncologists and pathology needs, cost and pricing implications and of course turnaround time. A good example is our newly expanded KRAS test that we recently introduced for colon cancer.

Our tests, which we believe is the first of its kind, is a mutation detection test that provides broader coverage of KRAS mutations, including those in the regions of the gene not previously examined. We believe this is important because KRAS mutation status is used to predict whether or not a patient will respond to anti-EGFR therapy, and assessing KRAS status is recommended in the NCCN guidelines for colorectal cancer. This test is particularly interesting because recently, additional mutations in the KRAS gene were discovered in global, multicenter, randomized phase 3 studies and these studies show that in addition to the well studied mutations in exon 2 that predict for the lack of response to anti-EGFR therapy, mutations in exon 3 and exon 4 may be important for anti-EGFR therapy selection.

The most significant point about this test is that in addition to its importance to patients with colorectal cancer, it is consistent with our goal of being a differentiated company that is first to market a new test that provides actionable information for oncologists and pathologists. Today the development and introduction of this test is consistent with our mission, namely that of being a content driven, solid tumor molecular diagnostics company and not just another lab.

In late 2013, we introduced what we believe is the best in class Tech-Only FISH service for TP system, TC/PC system for solid tumor specimens. Simply put, this development was a major and expensive undertaking for a company which enables us to partner with pathologists in a way that until late 2013 we were not able to do. This system allows us to prepare the samples for the pathologist who are our customers, who then remotely read and determine patient results firsthand rather than our doing both the preparation and reading of samples.

With this system, we are now realizing sizable business from larger accounts that we would not otherwise have been able to serve. I am pleased to note that since its introduction of late September 2013, our daily TC/PC volume has increased at an average monthly rate of' approximately 32% through February of this year.

I also believe one of the most significant accomplishments achieved in 2013 was the acquisition of the Pathwork Diagnostics assets. We believe our acquired Tissue of Origin Test will contribute significantly to our 2014 DX sales growth. In 2012, Pathwork Diagnostics realized Tissue of Origin Test of nearly $6 million and since its introduction in 2010, has achieved an annual compounded growth rate of 45%. The more we learn about this test, the more excited we become.

Based on recent publications and our understanding of the market, we believe the market opportunity for this test could be in the $300 million range, as it is used for tumors that are likely to have difficult diagnosis, namely tumors that are metastatic, undifferentiated or poorly differentiated or have an unexpected location. We acquired the assets in August, expanded and further build out the footprint in our LA facility and then moved and set up to test that what we believe was a relatively short period of time, only six months.

With that, we introduced the test early last month after bringing in our sales people for an intense and long week of training, primarily in our new Tissue of Origin Test but also on our other key new product introductions. We sincerely believe our February National Sales Meeting was the best sales meeting we have ever had.

Our people left well informed motivated and ready to hit the street selling, which they did. I am pleased to note that accessions or samples for our Tissue of Origin Test are off to a good start and our overall DX related accessions are growing.

Now one of the lessons learned in 2013 was yes, we were going at full speed and then some in acquiring differentiated products that is the Pathwork Diagnostics assets, initiating and building our relatively complex tools like our TC/PC system and introducing new tests while also building our sales team and infrastructure for expected growth. But perhaps we needed to take two steps back and focus more on enhancing our sales training process. Well, we did that in our National Sales Meeting in February in a concentrated and focused manner and while it is too early to know for sure, we expect that effort to pay off nicely.

Let me now switch gears a bit and briefly highlight what is going on in our Pharma business. We continue to support our GSK relationship with intensity and priority. We value their relationship very much and are pleased that GSK is our second largest shareholder. Regarding that relationship, I am also very pleased to highlight that in the fourth quarter 2013, we received another $500,000 milestone payment, our third such payment from GSK. That payment was related to our U.S. patent entitled Methods, Primers, Probes and Kits Useful for the Detection of BRAF Mutations which was recently allowed by the United States Patent and Trademark Office.

Part of our overall strategy is to selectively grow our Pharma business and in that regard I am also pleased to note that we continue to gain more work from a second large Pharma account and we also expect to be awarded a multimillion dollar contract related to some exciting NCI work. That said, we also appreciate that our Pharma business is lumpy and expect that it could vary significantly from quarter-to-quarter, but at the same time, as I noted today and I believe in previous quarterly reports, we are selectively building our Pharma business and adding resources accordingly, with the latest edition being the addition of our Director of Biopharma Sales.

Before making some concluding remarks and opening the call to questions, let me also highlight a few other activities that we expect to happen in 2014. First, we expect to introduce a next-gen sequencing service shortly and we are well along in accomplishing that objective. We, at Response, fully appreciate that next-gen sequencing is part of the future and today we believe we are seeing its introduction in the marketplace for expected routine clinical use, along with all the questions regarding when and how to use this technology.

Quite sincerely, we believe Foundation Medicine has done a very nice job in introducing the long-term promise of next-gen sequencing to the marketplace and we further believe there is room in the market for other players, including Response Genetics, especially since we expect to take a somewhat different approach in its utilization. We believe next-gen sequencing is a powerful tool when used appropriately and when one appreciates its strengths while also appreciation what we believe is required for its full potential to be realized. That is all I am prepared to say at this time.

Secondly, we are pursuing several opportunities to grow our business aggressively and we look forward to sharing them with you, assuming we bring them to fruition. In that regard, we will let our track record speaks for itself.

Before opening the call to questions, let me make a few concluding remarks, First, 2013 was a dynamic year for us. Yes, we stumbled in the third quarter for all the reasons that I noted in our third quarter conference call, but we believe our Q4 2013 results suggest that we are back on track and we believe we are stronger than ever with new DX products, the Pathwork Diagnostics asset acquisition, a well trained and highly motivated cancer sales force with solid leadership, enhanced operational capabilities and we believe a track record of ever-increasing operational efficiencies, just to name a few reasons for our optimism.

Secondly, we view our mission as building a very special company. Quite frankly, we do not believe the world needs another LabCorp, Quest or similar type lab much less one that is a fraction of the size of LabCorp or Quest. We believe our aim could not be more different. We are pushing to build a content driven solid tumor molecular diagnostics company with differentiated content that makes a difference in the lives of oncology patients, is a major player in making personalized medicine a reality and in doing so, drive shareholder value.

That is why we acquired Pathwork's diagnostics assets. That is why we introduced our new KRAS test. That is why we believe we were the first with both commercially available ALK and ROS1 test. That is why we interrogate and process samples in a unique way and we believe like no one else. That said, from time to time we realize that we need to do something differently based on our experience in the marketplace as we did in introducing what we believe is the best in class TC/PC system late last year.

Finally, we also view ourselves as a patient centric company that utilizes the appropriate technology, tests, processes and tools to provide oncologists and pathologists with cost effective and appropriate cutting-edge information, thereby enabling them to provide the highest level of care for their patients. The bottom line is we view ourselves not as a lab but again rather as a content driven solid tumor molecular diagnostics company.

Last but certainly not least, I want to thank our customers, our investors, both old and new, our employees and our board for the support that they have given to the company over the last year.

And with that operator, please open the call for questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions). Our first question comes from the line of Kevin DeGeeter with Ladenburg. Your line is open.

Kevin DeGeeter - Ladenburg

Hi, good morning, Tom. Congratulations on a nice quarter.

Thomas Bologna

Thanks, Kevin.

Kevin DeGeeter - Ladenburg

Few questions here. Can you talk in a little more granularity on the sales and marketing message for the Tissue of Unknown Origin test? Is that test is being sold by all of your reps or is there a subset of reps that are kind of carved out to specialty reps for that product?

Thomas Bologna

Now that's a good question. It's sold by all of our reps, and we also were fortunate enough to bring someone that was formerly with Pathworks who is helping direct all of those efforts, and I would say the key advantage we have is clearly it is a great test relative to anything else that is out there in the marketplace. And more importantly, quite honestly, we were able to capitalize on all of the great science and work that was done at Pathwork's prior to our acquiring those assets. And as I say that we feel really good about it, we bought our people in for an intensive week of training. They came out here on Super Bowl Sunday and they left late that Friday and it was pretty intense and they left really pumped up and jazzed up and ready to go, and we are seeing this coming, and we are pleased with the way results are coming in thus far.

Kevin DeGeeter - Ladenburg

And can you talk a little bit more about realistic expectations for the TC/PC introduction? Those are typically large accounts with long selling cycles, but you mentioned there is some pretty strong growth, but often what I suspect for pretty low activity levels previously. Do you anticipate you that being a meaningful contributor to revenue in 2014? Meaningful being, more than 10%?

Thomas Bologna

Yes. There is no question. We see that being quite meaningful, and we see it for a number of reasons. Historically, at Response, we have a lot of small accounts and those accounts are relatively challenging to handle. The 80/20 rule didn't really apply for some reason to our company. But now with the TC/PC were able to really focus on those bigger accounts. We get the business. And I think what we learned, however, in 2013 is once we get the business, it probably took a little bit longer for them to ramp up to speed than we anticipated because we do an intensive amount of training, whether it's on-site training, web-based training before we can get it really up and running. But once we get those accounts up and running, meaning the orders come in very, very nicely and like I say, we are able to really manage it like we weren't otherwise able to do.

Kevin DeGeeter - Ladenburg

And just a bit of structural questions. When you think about, particularly gross margin for 2014, a lot of moving parts, to say the least. New products coming in with a little bit different margin profile. What's your realistic gross margin, backing out one time things like a $500,000 milestone from GSK in the current quarter, what's a reasonable gross margin target for the business with the product mix?

Thomas Bologna

That's a good question. I would say when everything is hitting with full strides, I would expect us to be in probably the low 50%, but it fluctuates so much that I would say we could get it into the 40%, even into the high 30s from time to time depending on the variability with our Pharma business and other matters.

Kevin DeGeeter - Ladenburg

And then just lastly, and I will get back into queue. I appreciate that you aren't talking in specifics at this point with regard to your strategy on going to market with the next-gen service, but can you at least talk a little bit with regard to timeline and in what context, we may see that service rollout?

Thomas Bologna

The timeline is, we are talking I would say maybe weeks. It's clearly not several months. And our approach is going to be a bit different. And that's because we really, quite honestly, I believe we have a very, very unique understanding of this marketplace and what's needed to introduce something as powerful as this. Quite honestly, we are taking the approach of being patient centric, in the sense that when is the appropriate time to use next-gen sequencing, when is the appropriate time to use other tests. Now we like to think of ourselves, again, as patient centric as opposed to being a hammer and everything looks like a nail, so to speak. So we are pretty excited about it. We have been working on it for quite some time. We have put a lot of thought and effort into it and we are pretty jazzed up about what we are about to do.

Kevin DeGeeter - Ladenburg

Great. I appreciate the feedback. Thanks, Tom.

Thomas Bologna

Thank you.

Operator

(Operator Instructions).

Thomas Bologna

Okay, well, listen I want to thank everyone for following us and the continued support of the company and we really look forward to moving forward in building is company quarter-over-quarter and the number of accessions that we are bringing in to processing. Thanks, again. Bye, bye.

Operator

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program and you may all disconnect. Everyone have a good day.

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