Genoptix, Selling Shareholders Create Opportunity

In the healthcare arena there are many large companies that dominate particular sectors of the industry. But from time to time, new players emerge with attractive unique focuses which help to revitalize the overall arena. Genoptix (GXDX) is an up and coming diagnostic firm which caters exclusively to hematologists and oncologists. The tests that Genoptix offers are often unique and unavailable from any of the larger competitors. Also, the small company culture allows Genoptix to offer exemplary service that would not likely be available from a larger more established competitor.

Despite the stereotype of small cash flow negative healthcare startups, Genoptix is a profitable company with quite an impressive string of consecutive quarters of growing revenue. In the fourth quarter, the company earned 27 cents to lift the 2007 total to $0.78 per share. In addition to executing well on the business side, the company raised $72.5 million through its IPO which gives the company a very attractive balance sheet. The company has no long-term debt and will use the capital for facilities expansion over the next two years.

One of the toughest processes in the medical field is actually collecting on services rendered. Previously, Genoptix had struggled in its collections process with an average Days Sales Outstanding (DSO) of 82 for the fiscal year 2006. Management spent time and energy on developing a remedy and has managed to reduce that average to 58 for 2007 with the statistic at 52 at the close of the year. The improvement is due to advancement in the company’s billing systems and collection processes as well as general experience improvements in the collections staff.

Looking into 2008, the company is guiding for revenues of $90 million and earnings of $15 to $17 million. This equates to roughly 0.85 to 0.95 per share and represents significant growth over last year. The guidance is very likely conservative as aggressive hiring plans in the sales department should beef revenues up substantially. Lehman Brothers estimates an average of $1.8 million in additional revenue for each sales associate hired and with 10 additional sales positions expected for 2008, the revenue guidance is not accounting for any growth with the already installed and active salesforce. Margins are likely to continue to improve as the company leverages its existing overhead over a larger revenue base so the additional sales should equate to large increases in earnings.

Additionally, management guided for capital expenditures of $4 to 6 million. this caused some confusion to analysts who were expecting the company to purchase or begin building a new facility later this year. It now appears the capex guidance will be used exclusively to build out unused warehouse space in their current facility to increase production levels. It is not until next year that the company anticipates actually making the investment in a new facility. But the point is not particularly important when considering the fact that the company has the available capital to spend, and the necessary capacity will be available through the end of the year and then will continue to expand next year.

There has been some speculation that Genoptix would make an attractive target for one of the larger diagnostic firms to acquire. Companies such as Quest Diagnostics (DGX), Labcorp (LH) or Sonic Healthcare could benefit from Genoptix’s niche focus on the hematology market and may find the current stock price an attractive place to make such an offer.

Over the past month, the stock has dropped significantly in part due to a filing by large shareholders who wished to sell a portion of their holdings. It appears that these shareholders are venture capitalists who are now monetizing their long-term investment. This is not unusual with companies that are incubated and then come to market, and it should be encouraging to see that the investors only liquidated about half of their holdings leaving the rest of the capital to benefit from the projected growth. Still the supply of stock on the market has driven the share price lower and likely offers investors a chance to pick up this quality stock at a discount. I would suggest building positions in this name and have begun to increase my own exposure.

GXDX Notes

Disclosure: Author has a long position in GXDX.