The LipoScience Holding Pattern Continues

| About: LipoScience (LPDX)
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LipoScience met expectations, but lower realized prices are leading to revenue contraction.

The company's new CEO needs to sell payers on the importance of LDL particle testing in managing cardiovascular health.

LDL particle testing and a potential diabetes risk assessment panel address large markets, but commercialization is key.

The reimbursement environment for diagnostics company LipoScience (NASDAQ:LPDX) is not going to change in a quarter's time and with that, neither will the commercial/financial situation change all that much. LipoScience remains what it has been for some time - a company with a very interesting cholesterol test, one that measures the actual number of cholesterol particles and not just the overall amount of cholesterol in the blood, but a company that definitely needs to sell payers and clinicians on the importance of this test and its role in health care management.

If LipoScience can accumulate and present the data necessary to sway insurance companies and doctors, $100 million in annual revenue in five years' time and $200 million in 10 years' time should be sufficient to justify a stock price closer to $8 today. Unfortunately, it's quite difficult to get institutions excited about a small-cap med-tech stock reporting contracting revenue and that has seen recent executive turnover. Readers thinking about LipoScience as an investment need to realize that this is both an above-average risk situation and one where patience will be required.

Q4 As Expected, But Not Exciting

Perhaps the best that can be said about LipoScience's fourth quarter is that it wasn't any worse than expected.

Revenue fell 6% this quarter, as revenue tied to the NMR LipoProfile test declined almost 5%. Test volume continues to increase, up about 4% yoy and up slightly from the third quarter. Due to customer mix and the fact that many of LipoScience's largest lab customers have hit volume thresholds that result in price breaks, the average selling price declined almost 9% yoy, to just under $24.

With the lower ASP, gross margins declined three points. Operating expense growth was relatively restrained; R&D spending was up 19% and sales and marketing was up about 16%, but G&A expenses were down slightly. All told, LipoScience reversed a tiny year-ago operating profit to a loss of a little more than $2 million this quarter.

For the full year, LipoScience burned through about $15 million in cash flow (operating cash flow minus investing cash flow), exiting the quarter with about $34 million including restricted cash.

Still A Missionary Sale

There is really no doubt in the commercial market that the NMR LipoProfile test does what it is supposed to do, that is measures the number of LDL cholesterol particles in a blood sample. What is still in doubt is that this measurement is clinically important and that payers like private insurance should reimburse labs for running this test.

LipoScience has been slowly accumulating endorsements. The Association of Clinical Endocrinologists endorses LDL particle measurement, and new AHA and ACC guidelines also call for lipoprotein measurement.

What would help now is more data regarding the benefits of managing patients by their LDL-P scores as opposed to conventional cholesterol measurement. An analysis of the WellPoint Anthem database showed a 25% annual reduction in cardiovascular events when LDL-P management was used as the goal, and other small-scale studies have likewise supported the notion that treating patients on the basis of particle counts leads to better outcomes. Unfortunately, the company is still stuck in that "the plural of anecdote is not 'data'" limbo where payers can argue that there is not a compelling reason to pay for the test yet.

Hopefully new management can lead to greater adoption. New CEO Howard Doran has ample experience in the clinical diagnostic space, having worked at Constitution Medical before it was acquired and having served as the president of global diagnostics for Hologic (NASDAQ:HOLX) and in other prior roles at Cytyc before Hologic acquired them.

I think Mr. Doran has very relevant experience, but the situations are not identical. Constitution Medical and Cytyc were both largely predicated on taking existing testing concepts and developing significant automation to improve accuracy, workflow, and lab profitability. Said differently, Constitution and Cytyc didn't invent new hematology or cytology tests, they invested better ways of running those tests.

Waiting For Growth

LipoScience investors have already had a frustrating wait for growth, as revenue seems stuck in the mid-$50 million range for the foreseeable future. On the post-earnings conference call, management declined to confirm that the first quarter would be the low point for the year. Management also talked about 30% to 40% of revenue coming from out-of-network business, which could be a risk considering how insurance companies are clamping down there.

Still, I see reason for hope. I believe that data support the conclusion that the current standard of cholesterol testing is inadequate and that particle measurement can lead to better outcomes. I also believe that the upcoming launch of new PCSK9 inhibitors for cholesterol will add incentive to payers to find optimal ways to manage and monitor patients who need medical intervention for their cholesterol. In the short term, having two additional labs putting the Vantera analyzer into validation is a modest positive.

I also believe the company can expand its testing menu. Management mentioned that developing a diabetes risk index test is a top priority for the company and that there will be abstracts presented at upcoming ACC and ADA meetings. Considering the epidemic-level of diabetes incidence in this country and the rising costs of managing diabetes, I have to think that payers would be interested in risk assessment tests that could lead to patient care changes that prevent the development of diabetes.

The Bottom Line

With an in-line quarter, not much changes in my valuation analysis. I'm still looking for 15% long-term revenue growth and FCF margins in the mid-teens, but acknowledge that it's hard to argue forcefully for that when revenue is contracting today. Likewise, LipoScience seems undervalued compared to other diagnostics companies when a 2x multiple to 2014 revenue would produce a target of almost $7 (high-growth diagnostics companies often trade at 5x to 8x forward sales), but I am aware that many institutions literally will not consider a med-tech stock that isn't showing double-digit revenue growth.

If you are patient and willing to accept risk, LipoScience is still an interesting growth turnaround story. There are many examples, though, of companies like LipoScience that linger on in disappointment for years before finally making it (or never making it and fading away/accepting a low-ball buyout), so I would not look at LipoScience with an eye toward making a major return in six months.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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