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Foundation Medicine Inc (NASDAQ:FMI)

Q1 2014 Earnings Conference Call

May 07, 2014 04:30 PM ET

Executives

Khaled Habayeb – Director of Investor Relations

Michael J. Pellini – President and Chief Executive Officer

Jason Ryan – Vice President of Finance

Steven J. Kafka – Chief Operating Officer

Analysts

Dan Leonard – Leerink Swann

Tejas Savant – JPMorgan Securities LLC

Isaac Ro – Goldman Sachs

Zarak Khurshid – Wedbush Securities, Inc.

Jose Haresco – JMP Securities LLC

J. P. McKim – William Blair & Co. LLC

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the Foundation Medicine 2014 First Quarter Results Conference Call. At this time, all participants are in a listen-only mode. As a reminder, this conference is being recorded, Wednesday, May 7, 2014.

I’d now like to turn the call over to Khaled Habayeb, Foundation Medicine’s Director of Investor Relations. Mr. Habayeb, please go ahead.

Khaled Habayeb

Thank you, operator, and good afternoon, everyone. Thank you for joining us for Foundation Medicine’s 2014 first quarter call. Here on the call this afternoon to discuss results for the first quarter ended March 31, 2014, are President and CEO, Michael Pellini; Senior Vice President of Finance, Jason Ryan; Chief Operating Officer, Steven Kafka; and Chief Medical Officer, Vincent Miller. Members of the management team will read some prepared remarks, followed by a question-and-answer period.

Before we begin the prepared remarks, I would like to remind everyone that comments made by management in responses to questions on this call will include forward-looking statements and information. Forward-looking statements include among others, statements about our expected financial results, our markets and the implementation of our business strategy.

All forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from those expressed or implied in such statements, including the risks and uncertainties that are described in our filings with the SEC, including the section entitled risk factors in our most recent Annual Report on Form 10-K, as well as other risks and uncertainties detailed in our subsequent SEC filings. Except as required by law, we have no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

Before I turn the call over to Mike, I’d like to let you know that we will participate in the Bank of America Merrill Lynch Healthcare Conference in Las Vegas, the week of May 12, as well as the Goldman Sachs Healthcare Conference in Los Angeles the week of June 9. For those of you unable to attend, we encourage you to listen to webcast presentation, which will be available through the Investor Relations section of our website.

With that, I’d like to turn the call over to President and CEO, Mike Pellini, for his opening comments. Good afternoon, Mike.

Michael J. Pellini

Thanks, Khaled. Good afternoon, everyone. And as Khaled said, thank you for taking the time to joining us for our call today.

For those of you that may be new to the Foundation Medicine story, we are a molecular information company that is the first to put the comprehensive genomic profiling of cancer into the hands of practicing oncologists, both in academic medical centers and community practices, as well as pharmaceutical companies.

We bring a pan-cancer orientation to the treatment of both solid tumors and blood-based cancers and believe that single-test philosophy and comprehensive information-based approach is enabling precision medicine for patients with virtually all types of cancer today. The molecular information generated by our testing, whether in the clinic or in the research setting contributes to a growing knowledge base of information about human cancers that today is being used to inform both drug development and clinical practice and is enabling a paradigm shift in the treatment of human cancers.

Foundation Medicine’s commercial momentum continued through the first quarter, resulting in strong sales and volume increases in a range of positive operational successes. The team executed well against our goal and our financial results speak to that fact. Externally, we continue to feel encouraged by the sustained enthusiasm around our products in the oncology community as evidenced by continued growth in tests reported, overall revenue, and continued expansion into academic and community practices.

We again expanded our commercial infrastructure with the addition of talented and experienced sales professionals who continue to rapidly gain meaningful traction with oncologists and pathologists. We are extremely pleased with the initial rollout of FoundationOne Heme, which as you recall, was launched in December of last year. The strong uptick underscores the tremendous and growing validation of foundation medicine and our market leading platform.

Now for some commercial and financial highlights from the quarter. We reported 4,702 clinical tests in the first quarter, which is a 25% increase over Q4 2013 and a 312% increase over Q1 2013. We reported our first full quarter of test from FoundationOne Heme, a total of 715 tests in the quarter, which represents a great start for the recent launch. Total revenue was $11.5 million in Q1, a 19% increase over Q4 2013 and 120% increase over Q1 2013.

Of the $11.5 million in total revenue, $7.1 million was clinical, which represents a 34% increase over clinical based revenue in Q4 2013. And on the business development front, we announced the expansion of our ongoing collaboration with Clovis Oncology to incorporate a coordinated regulatory strategy for the development of a novel premarket approval or P&A companion diagnostic test, an important step in the evolution of cancer care from a static single gene companion diagnostic approach towards a universal companion diagnostic.

I’d also like to call out a few other important updates. One such item relates to the accelerating pace of new study supporting the use of FoundationOne. In the first quarter, another eight manuscripts were published and nine manuscripts were under review in many of the top scientific and medical journals. We will continue to build a broad array of clinical data to support our commercial efforts and payer dialogue, including 18 abstracts, which we authored or co-authored, and which will be presented at ASCO in June.

In addition, we are also on track to release an updated and expanded version of FoundationOne in the second quarter. The new content continues to be informed by our internal team, our key opinion leaders, our pharmaceutical partners, and by a vigorous review of the evolving scientific literature for solid tumors. These are all positive results for the quarter with each category on or ahead of plan and we are very pleased with the progress on rapid growth our company has achieved in a relatively short period of time.

I will now turn it over Jason and Steve, who will walk through the financial, operational, and commercial highlights of the quarter. And will then return to provide an update on the evolving commercial landscape before opening it up to Q&A. Jason?

Jason Ryan

Thanks, Mike. As Mike indicated, we had a strong first quarter in terms of our commercial ramp and revenue growth. We reported 4,702 clinical tests, 25% increase from the 3,752 tests reported in the prior quarter and over four times the volume reported in the same quarter last year. This number includes the 715 FoundationOne Heme tests. And as Mike mentioned, we’re very encouraged by the initial traction of the Heme offering. We also reported 851 tests to our biopharma partners during the first quarter.

Total revenue for the first quarter was $11.5 million, up 19% from the $9.7 million reported in Q4 of 2013 and up from the $5.2 million reported in the same quarter last year. Revenue from tests reported by ordering physicians was $7.1 million, a significant increase from the $2.3 million recorded in the same quarter last year, and a meaningful increase from the $5.3 million recorded in the previous quarter.

The average reimbursement for clinical tests that was recognized in revenue during the first quarter is approximately $3,400, which is consistent with our experience in the prior quarter. As we’ve mentioned previously, we do expect this average payment to vary between periods, as we work to attain broad coverage decisions in the future. Regarding Medicare, we disclosed on our call that we had started the process of submitting claims at the end of 2013 using miscellaneous code. Consistent with our expectations, we’ve not received payment on those claims, given that we’re not yet covered by Medicare.

We’re appealing those claims through the normal channels and we’re also continuing our broader dialog with our local Medicare administrative contractor and with other regional contractors. We continue to believe that this process will play out overtime, and we do think we’re headed in the right direction with our overall approach to reimbursement.

In addition, since our last call, we have received unique Z-Code identifiers from the McKesson Diagnostic Exchange, for both FoundationOne and FoundationOne Heme. We believe that obtaining the Z-Code is another step towards adequately differentiating our assets and providing greater transparency in reimbursement billing practices. Revenue from our pharma partners during the first quarter was $4.3 million, a fully 7% increase over the same period last year and similar to that recorded in the prior quarter.

Moving down to P&L, gross margin for the first quarter was 54%, down from the 56% recorded in the fourth quarter. Change from the prior quarter was driven by the significant number of FoundationOne Heme tests reported, for which costs were recorded during the period, but for which much of the revenue will be recorded on a cash basis in future periods.

Operating expenses in the fourth quarter were $18.3 million, including stock-based compensation expense of $0.7 million. This compares to total operating expense of $18.9 million in the prior quarter, which included $2.3 million in the stock-based comp. Excluding that stock-based compensation, the increase of $1.0 million in OpEx was primarily driven by expanded commercial activities, including the hiring of 17 new account executives within the U.S. Our ending cash balance at March 31 was approximately $110 million, as compared to $124 million at the end of 2013.

In closing, we continue to be encouraged by our test volume and revenue growth and we believe the company is well positioned to leverage its current investments as volumes continue to expand. As we cautioned last quarter, we are still early in the commercial ramp for FoundationOne and even more so for FoundationOne Heme. Volumes and revenues are not yet fully predictable and there will likely be some variability going forward. The same is true of our biopharma business. While we’re proud of the progress we have made with our pharma partners, clinical trials start and stop sometimes unexpectedly, which can cause variability in that pharma revenue from quarter-to-quarter.

And with that, I will turn it over to Steve.

Steven J. Kafka

Great. Thank you, Jason. This afternoon, I’d like to highlight three areas related to our commercialization and operations efforts. First, our ongoing commercial expansion in and outside the U.S.; second, our recent first of its kind companion diagnostic collaboration announcement with Clovis Oncology; and third, the planned introduction of a new version of our flagship FoundationOne product.

I’ll begin on the commercial front. We have continued to strategically add experienced members to the sales force. Our U.S. sales team grew to 43 as of March 31, well on our way to the approximately 45 to 50 account executives and sales managers that we expect to have onboard in U.S. by the end of the year. Outside the U.S., we have now received test orders from over 40 countries and continue to expand our efforts through both direct sales and distributor relationships. We now have three professionals dedicated to international sales and expect that number to at least double by the end of the year.

Also notable this quarter for the European market, we have obtained a DE Mark for FoundationOne, which allows FoundationOne to be placed on the market in the European economic area. We believe this is a unique step for lab developed test, which could be an important differentiator in the region.

As part of our commitment to innovation and commercial expansion, in December, we launched our second commercial product FoundationOne Heme. While we are still in the very early days for this product, we’re encouraged by the results so far. As mentioned, Q1 volume of 715 reported tests were ahead of plan.

As a point of reference, these volumes are nearly double the number of tests reported from the soft launch version of FoundationOne Heme, which was a DNA only version that we made available for customers in the fourth quarter of last year. We expect to share additional insights with you about the total addressable market for this product as we learn from our market experience with the test. Today, we’re approaching the market much as we have with FoundationOne, focused on later stage patients who either lack systemic treatment options or who have exhausted their existing options.

Turning next to our pharmaceutical partners, we recently announced a groundbreaking deal with Clovis Oncology that expands our ongoing collaboration to now include development of a novel FDA-approved companion diagnostic for Clovis’ PARP inhibitor, Rucaparib. We believe this collaboration represents the first of its kind using MGS based approach to comprehensively assess a multi-gene signature as the companion diagnostic, and that our product will uniquely support the clinical development and eventual commercialization of Clovis’ molecule.

Development and regulatory milestones will fund the construction and related regulatory expenses of establishing a new lab that meets FDA quality system regulation or QSR and will also fund the cost of seeking pre-market approval. The lab can also be used for other future PMA approvals, an important step in our work to enable the development, approval and clinical use of novel targeted therapeutics.

It’s important to acknowledge that there is not yet an established approach to FDA regulation of a complex comprehensive test like ours. And this effort among others were involved with such as the lung cancer master protocol, has engaged us in the dialog with the FDA regarding how to approach this process. We view this expanded agreement with Clovis as an important step away from the traditional single marker CDx test towards a universal companion diagnostic that can address the increasing number of targeted therapies and development for complex genomic signatures.

Finally, on behalf of the whole FMI team, who’s worked so hard to deliver it, I’m pleased to share that we are on track to introduce an updated version of FoundationOne for solid tumors in the second quarter. This new version introduces a number of improvements designed to ensure we’re delivering the highest quality, comprehensive molecular diagnostic test for cancer patients that’s available today. This new version of the test further improves our already excellent success rate with small low tumor content tissues and multiple tissue types including fine needle aspirate. It further improves the efficiency of our variant calling through a proprietary computational biology algorithm, and it expands the content of the test to assess the more than 300 genes and more than 30 genes involved in fusion that are believed to be somatic drivers of human cancer.

In addition, with now more than 15,000 cases part of our knowledge base, we also expect in parallel with this product update to have completely internalized our medical reporting capabilities by the end of the current quarter, a function that we have been systematically shipping in-house over the past year. With such a significant volume of data in our knowledge base, we believe we’ve built the unique asset at Foundation Medicine that helps us drive a higher degree of automation to our reporting process and which we’re leveraging to both improve the quality of our reporting and also to streamline costs which we continue to scale.

These efforts all speak the Foundation Medicine’s commitment to maintaining our leading position through our commercial expansion as well as through our commitment to innovation. And before we move to Q&A, I’d like to now turn it back to Mike for some additional comments on how we think about this new market space. Mike?

Michael J. Pellini

Thanks, Steve. As it relates to the evolving landscape in this important new market, I would like to reiterate, as I discussed on our last earnings call that we do not yet see any validated comprehensive approach that is competing with us in the market today.

There has been a good deal of discussion among investors and others in the Oncology community about the commercial environment in cancer diagnostics. And it can be confusing. To help give clarity to the market, earlier this year we mapped out three categories of molecular tests.

Category one test are the routine molecular tests such as IC, PCR and FISH, that have been used for decades and are still the most common type of molecular testing performed. These tests play an important role in oncology, allowing pathologists, especially in a community setting and others to deliver information that often help the oncologist make important decisions about surgical options and/or chemotherapy in early stage disease.

Category two tests are the targeted Next Gen sequencing panel, which may represent an advancement over category one type test in certain clinical indications. Category two tests typically employ hotspot analysis and seek to identify pre-specified mutations occurring in limited areas of oncogenes of interest. They focus on a narrow subset of genes and tend not to analyze the entire coding regions or detect all known alterations or classes of alterations.

And then, there is the category three testing, the comprehensive genomic profile that represents Foundation Medicine segment today, as well as that of several leading academic medical centers. Collectively, we believe this category represents an important approach in identifying potentially important treatment options for patients with many types of cancer.

We are convinced that we’ve gained early and growing traction in the marketplace due to our unique approach of testing all the known relevant cancer genes for all classes of alterations in DNA, in a way that makes it easy for the oncologist or pathologist to utilize this information in everyday patient care. Indeed, the most fundamental differentiator of our laboratory platform is that we sequence across the entire coding region of all genes known to be altered in human cancer, not just high probability hotspot regions, and detect all classes of genomic alterations in a single assay with great accuracy. Something that is extremely complex to do let alone scale.

We have set an extremely high standard in this segment and continued to support that standard through peer-reviewed publication highlighted by our analytic validation study published in Nature Biotechnology last fall. We believe the pathway to providing true precession medicine in cancer is to perform this type of analysis, associate that information with potentially relevant therapies, clinical trials and peer-reviewed literature, and then work to seamlessly integrate that information into daily practice. Of course, building the tools to network our clients, which would allow them to share data in a HIPAA combined fashion and learn from one another is an important next step in a current focus for our team.

In closing, I want to reiterate that this was a great quarter for Foundation Medicine. And we look forward to continuing to execute during the rest of the year ahead. And with that, I will turn it over to the operator for questions. Operator?

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) And our first question comes from the line of Dan Leonard from Leerink. Your line is open.

Dan Leonard – Leerink Swann

Great. Thank you. I was hoping can you give us an update on your conversation, your reimbursement conversations with private payers in terms of are they getting their margin down the field to getting coverage decisions for your product, that sort of thing.

Jason Ryan

Hey, Dan, Jason here. I think what I would tell you is that what we continue to feel is that we’re headed down the right path. And so we’re continuing to work with really all of the national payers as well as some of the regional payers, continuing to educate working with them on sort of the clinical validity as well as utility data that continues to come out and we feel good about the direction we’re headed in. As you know, in the near-term we continue to be paid well on the third party payer front, but really since the last call, we still feel like we’re headed in the right direction with the payers and we do think this is a process that will play out over time.

Dan Leonard – Leerink Swann

Okay. My second question, what’s been your experience in that category three of molecular touching? What’s been your experience when an academic medical center has internalize broad molecular profiling? Do you still do business with the providers in that center or do they keep all the business in-house?

Michael J. Pellini

Yeah, Dan. It’s Mike. That’s a great question. And we’ve been watching this market unfold over the course of the past couple of years, and I think we’ve learned a tremendous amount over this, especially over the course of the past 12 months.

First of all, and we described this before. We think there are about maybe a half dozen academic medical centers that will ultimately come to market with testing, that falls into this category three bucket. And as they bring the test up, we’re really seeing two things unfold. Number one, they tend to really just produce the results from the test and not necessarily the additional components that Foundation Medicine reports out on our report information that comes from the knowledgebase, and so it’s still not exactly the Foundation Medicine offering, but again they are doing – I think they are doing a nice job with it.

I think the second thing to consider is that these institutions will run these tests for their inpatient – for their own patients. This is definitely they tend not to be an approach that they would scale and so there’s still great opportunity for Foundation Medicine to work with these organization as they have any overflow testing. And I think the third piece that I had mentioned is that, again these are important partners to us even though they do have their own testing for two additional reasons; one is that as we innovate and bring new products to the market such as FoundationOne Heme, there is a great opportunity for us to work with their oncologists and their pathologists perhaps before they bring up the Heme based test a couple of years from now.

And the second reason to continue to partner is as we all tend to work together on the reimbursement side, I think that’s important to understand and maybe goes back to your first question, a little bit as well. Even though FoundationOne and FoundationOne Heme, or Foundation Medicine test and we’re working for coverage decision, this approach is something that’s supported by a significant number of academic medical centers in particular, whether they are bringing up their own test in a handful of cases or whether they are simply working through Foundation Medicine. And collectively, we can make an even stronger argument to the payers as we generate the data and I think have a voice to ultimately obtain those coverage policy decisions. So we’re not in this alone and I think that’s again another important piece to realize.

Dan Leonard – Leerink Swann

That’s helpful. And my final question. Could you address the sequential growth in solid tumor volume? It seem like growth was a couple of hundred tests sequentially, which is lower than you’ve reported in the prior few quarters and isn’t all that seasonality or through our other drivers?

Michael J. Pellini

Yeah. I think it’s the really important question, and let me start with the overall volumes and I’ll turn it over to Steve, who will really drill down a bit more on the Heme and Parcell, the solid tumor testing. So overall as I said, we’ve been really pleased with the execution and the demand for our test. Our total volumes grew 25% over Q4 and that is robust growth. In the bigger picture, volumes grew more than three-fold over Q1 of last year. We did in fact had a strong launch for Heme, which further bolsters the confidence in the growth of our volumes quarter-over-quarter. And we saw growth in both the academic medical centers as well as community oncologist areas, which is very positive.

So before I turn it over to Steve, I guess the last point that I’ll make is that, it is important to remember that majority of our sales team has been hired in the last two quarters. So I think at our public offering, we had 17 or 18 salespeople and as you can see that number is growing significantly over the course of the past six or seven months. Let me turn it over to Steve to add some additional color on that.

Steven J. Kafka

Yeah. I think what I’d like to just point out is that, first of all, even prior to the launch of the FoundationOne Heme test, we have been getting volumes of orders that now are over FoundationOne Heme. As I mentioned on the call, we had 751 cases on the Heme side that we reported in Q1. But if you look at the comparable number in Q4, when we have launched what we call our soft launch version of the test, which was the DNA-only version, we had about half of that volume directed towards that soft launch version in Q4. So, the relevant sort of quarter-over-quarter comparison on the solid tumor side is actually a bigger step than what you’re calling out on the surface of it.

The other thing I would just mention is that of the 750 tests reported in Q1, remember the heme test is applicable to not only hematologic malignancies, but also to sarcomas and to pediatric cancers. And so, what we saw, the 750 test was roughly half of those came in the sarcoma in the peds category and so you would expect that there was some switching over to the heme test in those patient cases.

Jason Ryan

And also said, Dan, this is Ryan. How are you?

Dan Leonard – Leerink Swann

Good.

Jason Ryan

There are – there is also a real subset of other cases that migrated to FoundationOne Heme from the solid tumor universe because the doctor ordered that. So, certain, let’s say, salivary gland tumors, adenoid cystic carcinoma whether they’re passing them on to fusion or diseases that are commonly planned genomically the doctor would not uncommonly take a shot and order FoundationOne Heme.

Dan Leonard – Leerink Swann

Got it. That’s helpful clarification. Thank you.

Operator

Thank you. Our next question comes from the line of Geoffrey Porges from Sanford Bernstein. Your line is open.

Unidentified Analyst

Hi. This is (indiscernible) for Geoff. Congratulations on the progress, especially the strong launch on the heme side. I have two questions, one is could you clarify on the Clovis field? Obviously as you said, a multi-gene companion diagnostic is almost unprecedented. So what are you envisioning here? Is this test going to be like anything like FoundationOne or it’s going to be a subset? And also I think you previously mentioned that maybe the companion diagnostic is not necessarily a business you want to go into. So, has that thinking changed? And finally on the same topic, I think Myriad has also got a collaboration on the PARP test for this asset if I remember correctly. So, how does that relate to what you’re doing?

Vince Miller

Hey, it’s Vince. I think I’ll take the first part and maybe Steve will take it on how we think about the TDX when it’s a good opportunity and not. So, of course the – I wouldn’t say knee-jerk but the reflective place to go when one looks at PARP inhibitors of course is identifying patients who have germline BRCA mutation and I think Clovis and other pharma are now beginning to look at the opportunity how the addressable market might expand if one took a look through a broader lens. And specifically, as you know last year, at ASCO, Astrazenica presented data on a laparate and ovarian cancer showing that it has ratio for patients who’s tumors harbored somatic BRCA mutations was basically identical to that or those who had germ line BRCA mutations.

Going a step beyond that, I think our colleagues at Clovis took an even broader view that while there are so many genes involved in (indiscernible) or a combination repair and efficiency that isn’t it plausible and suggested perhaps by TCGA and other data sets that some of these could play into a molecular signature, predicted biomarker for benefit from Rucaparib. And so, we worked carefully with our pharma partners in addressing the content of our test and we have a very rich content to ram candidate genes in that area.

I think the way we think about the CDX is that it may, it will probably prove to be a subset, but perhaps a significant subset of FoundationOne. In addition, one thing that’s important to consider is that almost all the genes that we talked about in that area were are tumor suppressor genes. So unlike tests that might identify hotspot mutations in an oncogene that activates the kinase. These alterations could occur anywhere in the gene and therefore one need to sequence the entire coding sequence of that gene to maximize the bang for the buck, so to speak, and get that drug to every patient who needs it. And Steve, do you want to do the business end?

Steven J. Kafka

Yeah, sure. Hi, Evan, thanks for the question. I think what we’ve said is that, we’re not as keen to be in the traditional companion diagnostic business. And I think as Vince just described, this is not a traditional kind of relationship, and really we get over a couple of key hurdles here that we believe makes this really exciting transaction for us. First of all that it makes good economic sense for Foundation Medicine, and we can’t get into a lot of the details about it. As I mentioned, there is milestone based funding that’s going to help us construct this laboratory and register the test with the FDA.

I think the other thing is that, we want to work with molecules where our approach is really very well uniquely suited to the molecule and to the development paradigm. So that will be the case through not only the clinical development process, but also into the commercialization of the drug.

And then the last thing I would just say is that, as I mentioned too in the prepared remarks, this is an important component of our overall regulatory strategy as well as we believe the field moves towards these comprehensive complex tests. And so, it continues our engaged dialogue with FDA. So there’s a number of reasons why we think this is a really exciting and important deal for us.

Unidentified Analyst

Thank you. And then just briefly, can you give us some color on all of the clinical utility study, the decision impact study, there’s quite a list in one of your prior presentations, right. Are we seeing any of these at ASCO, right? Presumably, I think the US Oncology business impact is going to be there and what else are you planning to present. Thank you.

Vincent Miller

Thanks. It’s Vince. So, as mentioned previously and as you alluded to, we do anticipate top line results from the US Oncology decision impact a study to be present at next month. As you know, the work other companies have done and have been successful, this is a necessary and helpful requisite for both commercial adoption and traction with payers although it’s certainly not sufficient. And some of you may have reviewed the titles of abstract and which authors or co-authors and you know the embargo has looked at, I believe May 14, you can actually start to dig in the content and as I such I thought, I would highlight sort of a few bins or scenes that emerge as you look across those approximately 18 abstracts.

The first is, we continue to identify genomic alterations that provide rational treatment approaches for rare, uncommon or the most treatment refractory cancers, things like angiosarcoma and adenocarcinoma of the gallbladder come to mind as you bring you the titles a bit earlier. Some of these diseases are now starting to report meaningful activity of targeted therapy instituted on the basis of our tests.

Secondly, we continue to demonstrate utility of our approach in other more common cancers, things like carcinoma of unknown primary, non-small cell lung cancer, and triple negative breast cancer as you look through the abstract list. In each of these, the win can be slightly different. In some, it obviates the need for additional biopsies, in some it identifies, anticipate or appreciated treatment options in the light of the breadth of our test or the fact that we have such sensitivity.

I would say a third theme is we’re starting to look at and see data on new populations and that’s a natural process as one becomes comfortable with the testing. In two areas, you’ll see at ASCO are data on the pediatric population and data on the so-called AYA or adolescent and young adults, and some you may have seen the attention that gotten the recent Wall Street general article.

And I think what you hear as we talk and review these things, is they really emblematic of the approach was taken and how we think about the population, the addressable population for our test currently and how we’ll migrate over time. We haven’t said order to test in every solid tumor patient, we try to be possible and try to work with key opinion leaders and the available data, developed data and were collaboratively with payers and others to develop a very rational approach that people are comfortable with as FoundationOne becomes more and more well known.

Unidentified Analyst

Thank you s very much.

Vincent Miller

Thanks.

Operator

Thank you. Our next question comes from the line of Tycho Peterson from JPMorgan. Your line is open.

Tejas Savant – JPMorgan Securities LLC

Hey, guys. It’s Tejas on for Tycho. Just had a quick one on your solid tumor panel expansion in the back half of the year. Is the expectation still that pricing remains where it is and will there be any impact on COGS at all.

Michael J. Pellini

Hey, it’s Mike. And so one of the things that we have focused on, I think with the broader communities, especially the payers since the early days is that our aim is to continue to deliver more information at a consistent price, And so one of the things that the payers (indiscernible) in the diagnostic industry are used to getting beat up with as every time, there was new marker, every time there was a new gene, every time there’s an expansion or an evolution of a test, there is a greater charge. And our focus has always been to set a price and deliver the necessary clinical information to our clients for that price. And so to answer your question, we do not expect to – we do not anticipate any change in the price of the test.

As we talk about, and I’ll turn it over to Jason for any additional color as well. As we talk about expanding the G&A content, whether we add 30 genes, 50 genes or 100 genes, there is a not a meaningful difference in our cost of goods sold. Jason, do you want to add any other color on that at this point?

Jason Ryan

No, I think that sums up well.

Michael J. Pellini

Okay.

Tejas Savant – JPMorgan Securities LLC

Okay. And then, nice ramp on the Heme side. I just wanted to get some color if possible on the kinds of therapies that are being enabled by the Heme test? And then, as the Heme test kind of ramps, it’s little bit steeper than at least what we had expected which is great. So then, will that be sort of a slightly steeper ramp in terms of your OpEx as well to support that ramp through the rest of the year and into 2015?

Vincent Miller

It’s Vince. I’ll start and then we’ll give it to Jason for the back half of your question. So I do have to caution it’s early in our Heme ramp. And so, the trends we’re starting to see certainly may not be what we see 3, 6, 9, 12 months from now. Today, we’ve seen I think certainly a significant volume of test across the major bins of the liquid tumors. We’ve seen a relatively high proportion of multiple myeloma, but a good representation of the acute leukemia’s, lymphomas and myeloproliferative neoplasms.

As we’ve mentioned previously, with our proceeds from the IPO and around trials, we will – I think we’ll be discussing on future calls, anticipate discussing some of the prospective trials we’ll be launching. But I think in each of these bins will be slightly different wins. Certainly data and myeloma suggest that targeted therapies around oncogenes, with which we’re familiar from the solid tumor, things like (indiscernible) may be amenable to therapy and occur real in leukemias, these both a prognostic component and also the ability to identify some predicted biomarkers for targeted therapies. And then in subsets of lymphomas, the wins may vary including potentially both predictive and prognostic components.

Michael J. Pellini

And, Tejas, you had asked about OpEx as well. I think with the Heme rollout, I wouldn’t think of it as a significant increase to our core OpEx and couple of reasons for that. One is that again this comes part of the platform that we built for solid as well. So it’s an infrastructure. It’s already here. And then on the commercial side, the team that we’re building and amassing in terms of sales structure is going to be – can be selling both solid test as well as the Heme test. So from sort of an operating leverage standpoint, the new test is pretty advantageous in those ways.

Tejas Savant – JPMorgan Securities LLC

Okay and then just one quick one to wrap up on interactive cancer explorer and then you mentioned initializing those informatics capabilities. Is that related to the team based out of Silicon Valley that you had mentioned on the last call?

Steven J. Kafka

Hey, Tejas, it’s Steve. So couple aspects here to your question in terms of the medical reporting capabilities that we are on track to fully internalize by the end of the quarter. Those are resources that we built here in Cambridge both in terms of the knowledge base that’s underlying, the intelligence that we put into the test, but also the expertise in terms of the scientists who are doing the curation.

We are on track also with Interactive Cancer Explorer to add those additional features that we’ve talked about in the second half of this year. And we do have a team – a growing team in place now in Silicon Valley, who is leading the charge on that, but again also that is connected very much to the infrastructure and expertise that we built here in Cambridge. So, it’s really working out of the company as a whole.

Tejas Savant – JPMorgan Securities LLC

Great. Thank you.

Steven J. Kafka

You bet.

Operator

Thank you. Our next question comes from the line of Isaac Ro from Goldman Sachs. Your line is open.

Isaac Ro – Goldman Sachs

Good afternoon, guys. Thanks. I just want to ask, first off a numbers-related question. Looks like, we overshot the gross margin this quarter and then undershot the R&D and I realize that there is a lot of volatility quarter-to-quarter – this staging into business development. But that’s – I just want to confirm, number one that you guys are so comfortable with the gross margin guidance that you guys have previously given us. And then secondly, just as we think about R&D spend for the balance of the year in the context of some of the product stuff that you’re working on, just help us get a sense of what the sequential trend should look like on the R&D line?

Jason Ryan

Hey, Isaac, Jason. Thanks for the questions. On the gross margin, I would reaffirm the guidance FDA report. On the last call, the annual guidance of the 55% to 65% and what we saw in the first quarter was an artifact of actually very strong team launch where as I mentioned simply that costs were recorded in the quarter and a lot of that revenue cash base as you know, and that will land in future quarters.

And then on the overall operating expense guidance we gave for the year, we are reiterating that OpEx guidance. We haven’t broken it down necessarily. So I think that while we can’t give quarterly guidance around R&D, we do see continued investment in the year likely picking up around some of the technology investments, as well as the trial, as well as our technology infrastructure that Steve had alluded to. So I think it’s not unreasonable to think that those will grow through the rest of the year.

Isaac Ro – Goldman Sachs

Okay. And then just a follow up maybe about the quarterly cadence on sales and marketing, I mean, you mentioned earlier, you’re adding reps. So is it fair to say the sequential trend there will be upwards as the year progresses and anything notable, up or down in the next quarters there that you can point to?

Jason Ryan

I think the sequential trend, I think that’s correct. We did guide to the year of course to 45 to 50 – sales team of 45 to 50. And as Steve mentioned, we’re already over 40 and in the 40s. And so I think there is an upward cadence and Q1 represented a lot of new reps. So there’ll be that upward cadence for another quarter, if you think about full quarter of that full team, but then you wouldn’t expect to see that necessarily for Q3 and Q4.

Isaac Ro – Goldman Sachs

Got it. And last one if I could real quickly would be on just the channel out there. You’re seeing a lot of hospitals trying to develop their own tumor profiling services and tests. So can you comment at all as to whether or not you guys have seen any account bleed to in-house volume and things of that nature? Any anecdotal evidence there one way or the other would be helpful. Thank you.

Michael J. Pellini

Yeah. Hey, Issac, it’s Mike. And just to comment on what we’re seeing in the field, it’s again very consistent both not only in the academic medical center arena, but also with some of the larger laboratory. They tend to be bringing up the targeted panel and it’s one of the reasons that we carved out these different categories of testing. What we’re seeing are a number of laboratories bringing up targeted panels. Some are more limited than others.

And as they bring them up, what they’re going to have to work on is ultimately, what is the indication for those targeted panels? As you know, what we’ve done with FoundationOne in particular, but also FoundationOne Heme is we’ve curved out our clinical indications in four, five different areas that number somewhere in the neighborhood of 800,000 to a million patients per year who we believe would benefit from this approach. That’s the core focus of our clinical studies and that’s really the core focus for the commercial team as well and as we interact with the payers.

Overall, we believe that represents about a $3.5 billion to $4 billion market segment. As you jump into the targeted panel, that really kind of extends back into category two, and while there is some overlap, I would argue that there might be 10% or 15% overlap is what we do. We do see that as a different category. We do see that being very differentiated from Foundation Medicine’s marketplace.

Isaac Ro – Goldman Sachs

Got it. Thanks a lot, guys.

Michael J. Pellini

Sure.

Operator

Thank you. Our next question comes from the line of Zarak Khurshid from Wedbush Securities. Your line is open.

Zarak Khurshid – Wedbush Securities, Inc.

Yeah, Zarak Khurshid in Wedbush. Hey, guys. Good afternoon. Thanks for taking the questions. So based on your limited experience so far with Heme, would that be a drag or do you think that may help with the average reimbursement levels this year?

Jason Ryan

I think it’s a great question, and the answer will be really that it’s very early in the game, because we started billing these cases in the first quarter. So we can’t be sure yet. We don’t have enough experience in full to be able to answer. I think we’ll have, we certainly have more information in the second quarter, but the average revenue per test that was recorded in revenue that I mentioned that was $3,400 which is consistent with Q4. The lion share of that of course those solid test, and because – timing of launch.

Michael J. Pellini

Zarak, as you know it’s Mike. We did price FoundationOne Heme 25% higher than FoundationOne. But again as Jason said, we have to wait and see how we’re being reimbursed on that, but it is too early to tell.

Zarak Khurshid – Wedbush Securities, Inc.

Got it. Thanks for that. And then can you give us any color in terms of the growth with your – the growth of the customer base versus growth within the prior customers during the quarter?

Michael J. Pellini

Again, it’s Mike, Zarak. What we saw in Q1 continues to be very consistent with what we have seen in previous quarters. And in many ways, what we’ve seen over the course of the past year and a half. Out of the gates, we saw the majority of the adoption of the early adoption was when the major academic medical centers, the key opinion leaders, they still represent a really important customer base for us. And again, that’s the way you want to kick off a product launch is by having that pull into the KOL community.

As the testing became a little bit more well known, it started to leak out into the community, often in a regional way around some of the – academic medical centers, where you have the initial uptake in testing. Now, as we build the sales force, they continue to reach out into the community, and they’re giving additional cover to the communities doing a lot of the education. And as you know, the second half of last year is where we first saw the transition from the majority of tests coming from academic centers through the majority of tests coming from the community practices. And for Q1, our number was virtually consistent, 54% community – tests were from community practices versus 46% from academic medical centers. So we really have seen tremendous consistency over the past several quarters with growth in both areas. And I think again, what we’re seeing is the early impact of the sales team in our opinion.

Zarak Khurshid – Wedbush Securities, Inc.

Got it. Thanks for that, Mike. And then just a last one from me in terms of the cost effectiveness argument, should we expect any studies this year on that topic and how might that help with the pair discussions? Thanks.

Jason Ryan

So it is an important question and one of the things that we laid out earlier in the year as we mapped out the clinical trial, and Vince touched on this indirectly in his comments. It’s really the evolution of the clinical study and this is where we are still a reasonably young organization, but we did jump on these studies early. The first study that we focused on really related to can we do this, can we demonstrate to the world that there is a way to appropriately validate this approach and show that the sensitivity and specificity of this approach can be greater than anything the marketplace has seen before. So that was the first series of studies that emerge and I think the biggest piece that came out of that was a major biotechnology.

The second phase really had a little more to do with the clinical utility, but of course it takes time to get that type of data. So we saw the next wave of studies emerge and we’re starting to get little bit of color on this study that Vince mentioned, and the first one that you’ll hear about is really U.S. oncology at ASCO. And then really the third wave is getting our arms around the economic or studies that really relate a little bit more to the economic modeling of this approach and that is going to take a little bit of time. So, we’re not giving any specificity whether it’s 2014, 2015. But it’s something that we are working on, but I think it’s something that where we just have to show a little bit of patience that we go through the natural evolution of these studies.

Zarak Khurshid – Wedbush Securities, Inc.

Understood. Thank you.

Operator

Thank you. Our next question comes from the line of Jose Haresco from JMP Securities. Your line is open.

Jose Haresco – JMP Securities LLC

Good afternoon.

Jason Ryan

Hi, Jose.

Jose Haresco – JMP Securities LLC

Congratulations on a good quarter again. Just a couple of follow-up questions. One of the questions is, one thing that I think everyone appreciate the kind of importance of the (indiscernible) trial that you are involved in? Could you layout some of the milestones that you’re thinking about or the guards of the umbrella trial. And should we expect you to be involved in more of those types of endeavors now that – that there is such a broad interest in both basket and umbrella designs?

Vincent Miller

Well I think – Jose, this is Vince. So, I think your last comment was the critical one. What we’re seeing really in front of our eyes is an evolution of the clinical trial system to become what others have described as a Nextgen clinical trial system, meaning that the way we did clinical trials just was not suited at all for highly sensitive tests that looked wholely at the cancer genome and identify unpredictable, but key mutations or other classes of DNA alternations in patients with advanced cancer where you need to make decisions quickly.

So, the long math or master protocol, it is a prototype, I think it will be followed closely. The successive individual drug there in, while of course desirable is not the win per se. This is putting a system in place that should really change the clinical trial universe. And so, I’ve already been approached about, can we look at the master protocol in this disease – master protocol in that disease, can we look at it in a Heme disease, and similarly, for the so called Basket Trials.

So I think that you’ll hear that across the industry. We would like to think that we will continue to be and I anticipate we will be part of the solution, because the long master protocol couldn’t have happened without a test that didn’t have rigorous analytic and clinical validation and that wasn’t able to detect all classes of DNA alterations, one stop-shop and so to speak, from a single specimen. Meaning that there are such diverse drugs in there, an FGFR inhibitor, PI3-kinase inhibitors, CDK 4/6 inhibitor, a net inhibitor that one needs to be able to package those in a test. There is not time with critically ill patients to be parsing tissue to six different labs to get the answer and then throw your hands up in the air at the end of the day and say, ah, crap, we couldn’t do these two tests without patients.

So I think this a theme that will resonate across what we work on, but also across our most pleasant pharma partners. I don’t see us being positioned to give any milestones on our own per se around this study. This is a collaborative effort that requires input from the multiple pharmas, from FNIH, from CDRH, from the intergroup mechanism, great support from the FDA et cetera. So it’s more likely you’ll hear them from a border consortium, which hopefully will be a voice as well.

Jason Ryan

And I would say overall what we believe, we’re going to see across clinical trials and across the industry is this gradual migration to this concept of the universal diagnostic or universal companion diagnostic and we just believe that’s going, it makes we believe that’s going to play out over the coming years.

Jose Haresco – JMP Securities LLC

Okay. I guess as follow-up to one of the questions that you often hear about some of these new trial designs is tissue acquisition. So first of all on (indiscernible) tests, you don’t need a lot of it, but is there a need to keep pushing the threshold down in terms of the amount of DNA or tissue that you need to run FoundationOne in other words, if there is a FoundationOne version 2.0, is it possible to push out threshold lower. Or do you think you guys have achieved what you need to meet the tissue constraints that sometimes happens when you get these really complicated trial designs?

Jason Ryan

That’s a really important clinical question as well as a business question. I think one of the – a paper that came out last year that was a bit – that’s little bit under the radar for some, but I actually always point to it as one of the most important papers that we published last year outside of the nature biotech piece, is a paper that relates to our ability to run FoundationOne on fine needle aspirates and run it with the same level of consistency that we run FoundationOne on even as we use PARP and embedded tissue.

And so we, I’ll point to that paper as an indication that we want to continue to drive the substrate to a smaller and smaller amount, greater heterogeneity. We have to be able to run our approach on less and less tissue.

Going forward, we talked about the investments that we will continue to make in terms of utilizing our approach on liquid biopsy, circulating tumor cells, cell-free DNA. Those are all important parts of our R&D initiative and there is only one way that we’re going to get there and that is to continue to push the tissue requirements lower and lower.

Jose Haresco – JMP Securities LLC

Okay. I guess on a related note, and we talk a lot about our marker identification, but are you guys starting to get interested, are you working on products that are more focused on marker identification with the object of therapeutic monitoring versus fine therapeutics that works.

Jason Ryan

So, in the solid tumor arena, we tend to work with specialty biopharmaceutical companies. We work with their translational and their clinical development department not – we tend not to work with the research group that are discovering markers, and so I think with solid tumors, it tends to be very much therapeutically driven. I’m going to ask Vince to comment on the inside because there is as he mentioned earlier, the idea of identifying the markers that relate to prognostic results, that’s something that may impact emerge with FoundationOne Heme and it’s use.

So, regardless of the path that we give down here, I think your question also touches on something else, but we have been building a foundation that has been for a long time and that is the database, the knowledge base of information. At this point in time, we have one foundation on 15,000 clinical cases, if you include our guidance of 22,000 to 25,000 cases this year, we will be pushing 40,000, 35,000 or so clinical cases by the end of the year and we keep all that data here. We certainly make it available to our collaborators, but it is rich – there’s a rich opportunity for new discovery in that database.

Vincent Miller

And I understand, there’s a lot of ways to sort of approach these different spaces and opportunities and we’re always being driven by where there’s a true oncologic need working with our Biopharma partners, working with KOL to define that one could envision saying the Heme space, really sort of the ultimate and precision medicine where one does FoundationOne Heme upon diagnosis with some early point in the natural history of the patient’s disease identifies the several alterations particularly in that patient and then monitors that patient longitudinally either for recurrence or for status of disease in the phase of treatment with the use of those alterations.

Jose Haresco – JMP Securities LLC

Thank you for that answer. Last question from me. You mentioned a lot of your sales force had only been hired in the last six months. So, what proportion of the 41 would you consider 100% active and at what point are you expecting those 41 to be fully active?

Jason Ryan

What we’ve said in the past and again we’re still learning here, but we do believe it will take close to 18 months for salesperson to really be fully effective and I think one could argue that even thinking about it in 18 month to 24 month timeframe is probably appropriate. There is an important learning curve that even the top sales professionals that we’re bringing onboard have to go through. And so again, as we mentioned earlier, we had 17 or 18 sales people as of the time of the IPO in September. And so roughly two-thirds of our team has come onboard since the end of September and so we’re still in the early phase. There is an 18 months or so ramp and as we have a better sense of this of what one should expect from a newly hired sales professional, that’s information that we would like to be in a position to be able to disclose as well, I think to help everyone get a better understanding of what the ramp could look like. We’re still going through a learning process ourselves.

Jose Haresco – JMP Securities LLC

Okay. Great. Thank you for all the answers and congratulations on a good quarter.

Jason Ryan

Thank you.

Michael J. Pellini

Thanks a lot.

Operator

Thank you. Our next question comes from the line of Amanda Murphy from William Blair. Your line is open.

J. P. McKim – William Blair & Co. LLC

Hi, good afternoon everyone. It’s actually J.P. in for Amanda. Can we go back to the competitive dynamics a little bit? I mean the most physicians and peers understand this difference between category 2 and category 3 or is that kind of a hindrance to adoption for some physicians?

Michael J. Pellini

JP, it’s Mike, I’ll start and other members of the team might jump in. The most I think important competitive dynamic relates to education and what we could drive in the path again one of the reasons we have the early and significant uptake in the academic medical centers is that I think intuitively many of the key opinion leaders had a sense that this was an important tool and we made that relatively easy for them.

The next phase was then to migrate this into the community setting and also to educate not only to payers but also work with the FDA as far as the education process. And so those are ongoing activities and there are couple of academic medical centers that are out there that are either working with Foundation Medicine where they pioneer to run approaches and frankly it’s helpful to have those academic medical centers talking about their approach, talking about their relationship with Foundation Medicine and publishing data in parallel with Foundation Medicine. So again, I would say the most important thing that we are – one of the most important things that we are focused on in 2014 is educating the oncology community on really how to think about FoundationOne and FoundationOne Heme within the context of these preclinical indications.

J. P. McKim – William Blair & Co. LLC

Got it. That’s very helpful. Can I just ask one more quickly, I know we’re running over, but what’s your thoughts on the recent kind of pharma consolidation, especially with Novartis getting oncology unit from GSK, I mean how do you think that in the long run affects that side of the business for you guys?

Vince Miller

So this is Vince Miller. So as you’re aware, we’ve not disclosed a relationship with GSK. They certainly have a lot of interesting approved and molecules and also molecules under development. We think that this is positive for FMI to help diversify the trials and work streams in which we’re involved, potentially introduces us to some new partners through GSK’s pre-existent collaboration, because as you know, we work very closely with Novartis. That being said, we have 18 pharma industry partners and expect that to continue to grow and we’re not dependent on any given one of these for our pharma, majority of our pharma revenues.

J. P. McKim – William Blair & Co. LLC

Got it.

Operator

Thank you. At this time, we don’t have any additional questions. I will now turn the call back over to Khaled Habayeb.

Khaled Habayeb

Thank you, and thank you all for joining us this afternoon. Before we sign off, on behalf of the entire management team and board of directors, I’d like to thank all of our employees, collaborators and shareholders for their continued support of Foundation Medicine.

As a reminder, replay of the webcast will be available shortly after the conclusion of this call through the Investor Relations section on our website. Operator?

Operator

Ladies and gentlemen, that does conclude today’s presentation. Thank you, and have a great day.

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Source: Foundation Medicine's (FMI) CEO Michael Pellini on Q1 2014 Results - Earnings Call Transcript
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