On August 14, Trovagene (NASDAQ:TROV) released its 10-Q for its most recent fiscal quarter ending June 30. After reading it, I thought that a follow-on piece from my July 20 article would be informative to potential investors.
Top line revenue for the quarter was $41,500 and $75,653 for the first half. Comparatively, these results were down 48% and 63%, respectively. The decrease was principally due to the cancellation of the royalty contract with Sequenom. Q2 results were up 22% sequentially from Q1's $34,153.
Revenues are tiny. They will remain tiny through 2012. There should be a modest increase in 2013 if TROV achieves the two milestones by the end of this year that I listed in my previous article.
One of the milestones is the launch of a urine-based KRAS testing service by their CLIA laboratory. In TROV's prospectus, it stated that it purchased the laboratory assets from MultiGEN Diagnostics on February 1 of this year. These assets could have been both non-physical (e.g., certifications, patents, contracts) and physical (e.g., equipment, supplies, facility). I believe that it is fair and reasonable to assume that TROV's purchase included some physical assets. It is a viable business, right? Well, apparently not. It looks like all they purchased was the CLIA certification. The "laboratory" is a shell.
On page 18 on the 10-Q under "Asset Purchase Agreement" TROV states (bold type mine):
On February 1, 2012 the Company entered into an asset purchase agreement with MultiGen Diagnostics, Inc. The Company determined that the acquired asset does not meet the definition of a business, as defined in ASC 805, Business Combinations and will be accounted for under ASC 350, Intangibles- Goodwill and Other. In connection with the acquisition, the Company issued 125,000 shares of restricted common stock to MultiGEN. In addition, up to an additional $3.7 million may be paid in a combination of common stock and cash to MultiGEN upon the achievement of specific sales and earnings targets. In addition, in connection with the acquisition, the Company entered into a Reagent Supply Agreement dated as of February 1, 2012 pursuant to which MultiGEN will supply and deliver reagents to be used in connection with a Clinical Laboratory Improvement Amendment (CLIA) laboratory. The total purchase consideration was determined to be $187,500 which was paid in the Company's common stock.
Under ASC Topic 805, Business Combinations, the Company was required to assess the fair value of the assets acquired and the contingent consideration at the date of acquisition. Therefore, the Company assessed the fair value of the assets purchased and concluded that the purchase price would be allocated entirely to one intangible asset, a CLIA license. The contingent consideration of the $3.7 million milestone was determined to have a fair value of $0 by applying a weighted average probability on the achievement of the milestones developed during the valuation process. The Company will assess the fair value of the contingent consideration at each quarter and make adjustments as necessary until the milestone dates have expired.
After reading this, I went back to the prospectus and found this on page 1 under "Business Overview":
In order to facilitate early availability and use of our products and technologies, on February 1, 2012, we acquired the CLIA laboratory assets of MultiGEN Diagnostics, Inc., or MultiGEN, which included CLIA (Clinical Laboratory Improvement Amendments of 1998) certification and licensing documentation, laboratory procedures, customer lists and marketing materials.
This statement implies that there were other assets, presumably physical, that constituted the transaction. This was also the clear message in its January 6, 2012, press release announcing the fact that it had acquired a reference laboratory business. In actuality, though, all they bought was the CLIA certificate, a few files and a stack of promotional brochures.
The problem with this issue is not the physical versus non-physical argument. It pertains to the lack of adequate accounting for and disclosure of the transaction by management. The CEO was on board by late 2011 and the CFO by early 2012 so they are accountable for the accurate reporting of what transpired. Obfuscation, lack of disclosure and a reversal of accounting treatment seriously undermine management's credibility. There is nothing untoward with reporting that it purchased MultiGEN's CLIA certification and that it intends to ramp up the lab services business. Sounds like a prudent strategy to me. Puffing up what actually happened to make it appear that it purchased a fully functioning diagnostic reference laboratory when it did not, is.
Another issue that is a bit disconcerting is TROV's disclosure processes. Again from the 10-Q, page 27 under "Controls and Procedures":
At the end of the period covered by this Quarterly Report on Form 10-Q, our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to the issuer's management, including its principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure. Based on that evaluation, as of June 30, 2012, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures are not effective, due to weaknesses in our financial closing process. We intend to implement remedial measures designed to address the ineffectiveness of our disclosure controls and procedures.
This paragraph implies that the CEO and CFO are somehow removed from the reporting process to such a degree that there is a high risk of material omissions occurring in their SEC-mandated reporting. This sounds bureaucratic. TROV's revenue run rate is only $150,000 and they only have ~eight employees, half of which are scientists. How in the world are the CEO and CFO out of the reporting or quarterly closing loop? This strains credulity.
Considering Trovagene's situation, management's top priority should be to build trust and credibility with the investing community. If it truly believes that it has a valid value proposition and that the current executive team can turn the company's prospects around and deliver results, then its behavior must be beyond reproach or suspicion (see Xenomics 6/14/06 prospectus for background). All communications to the outside world should be squeaky clean. There should be nothing to hide. I perceive that TROV fails to achieve this standard.
On a final note, if you hold any TROVU or TROVW, be aware that the 90-day lock up period ends August 27. For punters who hold TROV, be aware that Panetta Partners' current stake is 36,477,079 shares. This represents 24% of the 150M authorized shares and 157% of the 14,175,060 shares that are currently issued and outstanding. In subsequent quarters, you should see the number of issued and outstanding shares go up as the company routinely sells treasury stock. If you see Panetta's stake go down, then it has begun taking money off the table. This will be your signal to do likewise.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.