HTG Molecular Diagnostics' (HTGM) CEO TJ Johnson on Q2 2016 Results - Earnings Call Transcript

| About: HTG Molecular (HTGM)
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HTG Molecular Diagnostics, Inc. (NASDAQ:HTGM) Q2 2016 Earnings Conference Call August 9, 2016 4:30 PM ET

Executives

Jamar Ismail - IR, Westwicke Partners

TJ Johnson - President & CEO

Shaun McMeans - CFO

Analysts

Mary Kate Gorman - Canaccord Genuity

Adam Callahan - Rodman Renshaw

Operator

Good day, ladies and gentlemen, and welcome to the HTG Molecular Diagnostics Second Quarter 2016 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions]

I would now like to turn the call over to Mr. Jamar Ismail from Westwicke Partners. Please begin.

Jamar Ismail

Thank you. Earlier today, HTG released financial results for the quarter ended June 30, 2016. Before we begin the call, let me remind you that the Company's remarks include forward-looking statements within the meaning of federal securities laws, including statements regarding HTG's planned clinical diagnostics and IVD strategy and activity, expected growth from pharma collaboration, HTG's strategic initiatives, including planned menu expansion, potential market adoption, anticipated regulatory interactions and submissions, instrument development and installed base progress, and revenue and gross margin and expense expectations.

These forward-looking statements are subject to numerous risks and uncertainties, many of which are beyond HTG's control that may cause HTG's actual circumstances, events, or results to differ materially from those projected on today's call. Factors that could cause events or results to differ materially include those risks and uncertainties described from time-to-time in HTG's SEC filings. HTG cautions listeners not to place undue reliance on any forward-looking statements. HTG is providing this information as of the date of this call and HTG undertakes no obligation to update any forward-looking statements.

With that, I would like to turn the call over to TJ Johnson, President and Chief Executive Officer. TJ?

TJ Johnson

Thank you, Jamar. Good afternoon everybody and thank you for joining us on our second quarter 2016 conference call. On today's call, I will provide an update on our recent highlights and progress toward our long-term goals. I will then turn the call over to our CFO, Shaun McMeans, to cover our Q2 financial results. After that, I will make some closing comments and then open up the call to your questions.

HTG is an emerging molecular diagnostic company who has matched our proprietary extraction prechemistry with next-generation sequencing detection. We are a purpose-built diagnostic company leveraging the key market drivers such as acceleration of precision medicine, the migration of molecular testing to next-generation sequencing workflow, to movement to smaller and less invasive biopsies, the need for greater sensitivity, the need to fit into the healthcare economics and the need to have automation and easy-to-deploy workflow. We also believe we are at the right place at the right time to benefit from the growth of immuno-oncology. To use an analogy, we have been skating to where we believe the oncology molecular diagnostic market is headed, and we'll be taking our first shots on goal very soon with our clinical program.

In the shorter term, our second quarter was very productive as we continued to execute against our long-term strategies. In today's diagnostic market, a key goal is to become a manufacturer of companion diagnostics for new or existing therapeutics, and we believe we are getting closer to this goal. Our pharma biomarker companion diagnostic funnel continues to strengthen and our key programs preparing us for a second launch into clinical diagnostics in 2017 are progressing as expected.

We are incredibly pleased with the growth of our number one priority customer segment, large pharma. Our biomarker and companion diagnostic funnel grew from 30 to 34 programs, with 11 in Phase I and 23 in Phase II. Immuno-oncology programs dominate our pipeline, driven by our goal to profile thousands of genes from the tiny FFPE tissue section. The ability to work from amounts as small as those obtained from a needle biopsy, a method of growing preference, makes our technology better suited for the clinical market than other competing methods.

In June, we announced the VERI/O laboratory to support the expected increase in demand for access to our technology through services. Our VERI/O lab formalizes and expands HTG's traditional service offerings, including retrospective molecular profiling of cohorts to support development of targeted and immuno-oncology therapies, building customer research use only assays to support early-stage programs, developing an investigational use only companion diagnostic assays for use in Phase III registration trials, and ultimately, companion diagnostics for patient use.

While service revenues continue to dominate our recent revenue swings, we now have instruments either sold or engaged in pilot programs at four of the six major immuno-oncology pharma targeted companies. We expect this top priority pharma business segment and it's rapidly growing funnel to plant the seeds for significant future diagnostic revenue streams.

A second aspect of our diagnostic strategy is developing new next-generation sequencing, or NGS-based, assays on our HTG EdgeSEQ DLBCL platform to replace and consolidate existing testing modalities. Our HTG EdgeSEQ DLBCL Cell of Origin assay has recently obtained CE IVD status and we expect to begin commercialization in Europe very soon. This assay was developed in anticipation of updates to the 2016 World Health Organization Guidelines for Diffuse, Large B-Cell Lymphoma, or DLBCL, which are reported to require classification of tumors as ABC or GBC subtype. Unlike traditional neohistochemistry approaches requiring multiple tumor sections and multiple assays to subclassify DLBCL, our HTG EdgeSEQ assay can provide this classification from just a single FFPE tissue section from a needle core biopsy. There are an estimated 79,000 non-Hodgkin's Lymphomas per year in the European Union, with as many as 40% being DLBCL, and we believe we can penetrate this market opportunity quickly.

Turning to our HTG EdgeSEQ out plus assay has begun clinical studies at three sites, and our first two of the required free market approval or PMA modules have been submitted to FDA. Once approved, this assay will be an NGS-based gene expression alternative to the current companion diagnostics on market for evaluating out and status and possible on Corey or Crizadinum therapy in advanced, non-small cell lung cancer. In addition to detecting any out rearrangement, the HTG EdgeSEQ out plus assay will, at the same time, from the same tiny sample, measure in research-use-only mode, the ROS1, RET, and Interact1 rearrangements, HER-2 activating insertion, and c-MET amplification. This is notable, as many of these targets could also be potential biomarkers for future therapies and ROS2 rearrangements were just added to the label for crizadinib [ph].

The design of the out plus assay should give us flexibility to supplement our initial BMA with intended uses for other markers and if they become medically proven, which would expand the applicable market for the assay. Moreover, the initial clinical product is intended to demonstrate the power of the HGT EdgeSEQ system to profile multiple key tumor characteristics with high sensitivity from a single tiny sample. In July, we announced our agreement with Firalis, who will use our technology to produce a custom gene expression assay as a theranostic tool to predict response to anti-TNF alpha therapies for rheumatoid arthritis. Millions of patients are treated with TNF alpha-inhibiting agents; the clinicians are unable to predict who will respond to these expensive biologicals. We are excited that Firalis chose our technology and its precision-led initiative and to assist in providing the tools to meet a major unmet medical need.

Significant requirements for R&D resources associated with high-value assay development for customers and new menu expansion and have led us to realign our resource allocation and suspend development of Project Janus for the remainder of the year. We remain committed to the Janus product, but it is simply critical for us to deploy our R&D resources on more immediate and compelling opportunities. We will evaluate the timing of the Janus program later this year and keep you informed, and we expect no material impact to our long-term plans with this delay.

Generally, I would not discuss publications on an earnings call, as it takes considerable time to produce a peer-reviewed publication. On a new technology, it's been exactly two years after the first panel launch on our NGS-based HTG EdgeSEQ chemistry, our first peer-reviewed publication concerning this technology was issued in the June edition of Clinical Cancer Research. This paper hit at the heart of our value proposition. The ability to reliably test multiple genes in difficult to use and extremely small FFPE samples such as needle biopsy. I would like to thank our collaborators at MD Anderson Cancer Center, University of Texas Southwest, and Memorial Sloane Kettering, and we look forward to supporting you in making these assays as described in the paper available for patient care.

While we continue to focus on value-building milestones, it is notable that our revenue growth has been accelerating. Year-over-year, we grew product and service revenues 33% in 2014, 63% in 2015, and our first six months' revenue this year are 85% higher than the first six months in 2015. With the current mix of revenues, we continue to expect monthly and quarterly inflation, but the trends are all in the right direction.

I'll now turn the call over to Shaun.

Shaun McMeans

Thanks, TJ. As TJ has stated, we are very pleased with our Q2 results. Our total revenue grew to $1.9 million in Q2 from $0.8 million in Q2 2015, a 140% increase. Our Q2 service revenue increased to $1.3 million from $51,000 in Q2 2015. Product revenue was relatively flat at $0.6 million for both years. Product revenues were impacted by three factors: one, pharma's increased preference for access toward technology via services; two, the completion of a study by a major customer which offset new customer consumable order growth; and three, lower than planned capital convergence.

We continue to believe that, while revenues may fluctuate quarterly, our top line trend is very positive. In Q2, we recognized revenue from the largest number of customers of any quarter to date. Pharma continues to be our top priority market and anticipating their current preference for outsource sample profiling, we expect that service revenues will continue to be an increasing percentage of our revenues. We do anticipate improved capital convergence in the second half of the year, but we believe capital will be a modest percentage of our revenue until we begin to launch our diagnostic assay as expected in 2017.

As we discussed in our Q1 and prior calls, with a large component of our cost of sales comprised of fixed operating costs, we anticipate improving our overall gross margins as our business scales. We are extremely pleased with our standard product margins at this stage in our growth. Specifically, our Q2 margin was 50.8% compared to -5.6% in Q2 2015. To further illustrate this improvement, our gross margins for the six months ended June 30, 2016, were 35.7%, compared to 4.7% for the same period in 2015. We believe we have a very leveragable business model which can produce solid gross margins from either product or service revenue. Our operating expenses increased to $7.3 million in Q2 from $4.7 in Q2 2015. Our spending remains focused on strategic initiatives to drive our clinical strategy, including R&D, HTG EdgeSEQ product menu expansion and sales and marketing initiatives to accelerate our market adoption, both domestically and in Europe.

Our selling, general and administrative cost increased 26.5% to $4.7 million, primarily related to a $0.7 million increase in employee salaries and benefits, which include $0.6 million of increased salaries and benefits from the United States and Europe, from expanded commercial activities, and increase non-cash, stock-based compensation expense.

Research and development expenses were $2.6 million in Q2 compared to $1 million in Q2 2015. This increase was driven by Project Janus development costs, scientific bioinformatics and product development staff additions, and direct cost incurred in the effort to obtain FDA approval for our first IBP panel. Project Janus development fees accounted for the largest portion of the increased spend since last year. As TJ mentioned earlier, with the temporary suspension of our development effort on Project Janus, we expect that our research and development comps will decrease in the second half of 2016.

Our primary R&D spending will be directed to our out plus clinical trials, development of our Version 2 Chemistry for Mutation Analysis, and planned menu expansion. Net loss for operations for Q2 was $6.4 million compared to $4.7 million for Q2 2015. Net loss per share was a $0.98 per share for Q2 and $1.73 for Q2 2015.

We ended the quarter with $22.9 million in cash and investments. At this point I would like to turn the call back to TJ for some closing comments.

TJ Johnson

Thank you, Shaun. At the midway point of 2016, we are encouraged with our progress but never satisfied. Our team is continually assessing how we can do better. While we continue to accelerate our revenue growth, our mix has shifted considerably to services. We have redeployed resources into our VERI/O lab to support this shift. Our service margins are strong and enable us to provide this flexibility to our customers, which we expect to be margin neutral. I want to reinforce that we are building a global company. Our full R&D efforts are focused on diagnostic applications and menu, demonstrated by the HTG EdgeSEQ DLBCL Cell of Origin and out plus programs.

Our pharma focus is to provide profiling products that can be utilized in biomarker discovery with the goal of generating new companion diagnostics. Our academic collaborations are focused on diagnostic applications. I believe we became overly driven to expand placements in the research market, which is not the right focus nor measure for us at this time. Our value today is determined by the depth of our pharma companion diagnostic opportunities and achieving our diagnostic development milestones. We want placements with ongoing annuities in the diagnostic market, and our work today with pharma and academic collaborators is a means to that goal, not the goal.

Last quarter, we made a leadership change in our U.S. capitol sales team and now are midstream in an alignment effort. We have bolstered our capitol pharma sales team with new positions to leverage our momentum as we reset roles and skill sets in our academic team to achieve improved account targeting and quality of our capital placements measured by potential annuity.

In the quarter, we had four new evaluation placements, four evaluation returns, and one conversion. We see no trends in our returns and believe that it is an account targeting issue, not adoption. We do expect the install base numbers to grow slowly but consistent with our strategy, as I just discussed. Our instrument placements are expected to accelerate in 2017 as we begin commercialization of our diagnostic assays. At that time, we will refocus our instrument placements as a key measure.

Overall, we are pleased with our progress toward our long-term value-creation goals. Our pharma companion diagnostic pipeline is strengthening and generating a number of potential near-term Phase III opportunities. We achieved our first regulatory milestone with the CE IDV marking of the HTG EdgeSEQ DLBCL Cell of Origin assay and the HTG EdgeSEQ system.

Our business in Europe is shaping up, punctuated by our agreement with Firalis. Our out plus companion diagnostic program is now in the clinical trials phase, and we continue to expect the PMA filing and CE IDV marking for this product this year. We have also begun development of our next-generation pathology product under the project name Mercury. Project Mercury is designed to integrate next-generation sequencing based in gene expression profiling into the anatomical pathology workflow. I will provide more information on Project Mercury in our future earnings releases. While we continue to expect our revenues to fluctuate monthly or quarterly, our first six-month numbers demonstrate accelerated top line growth and leveragable margins.

I'll now open up to your questions.

Question-and-Answer Session

Operator

[Operator Instructions] And our first question will come from Mary Kate Gorman at Canaccord Genuity. Your line is now open.

Mary Kate Gorman

Hi there, and congrats on the quarter. This is Mary Kate Gorman on for Mark Massaro. Thank you for taking my questions. I'd like to start off with a bit more on lung fusion. It's my understanding that you met with the FDA earlier in the year to align your approach to clinical trial work with FDA criteria. How are clinical trials progressing and what is some initial feedback that you've been seeing? And are you still planning on submitting through the FDA via a modular submission process?

TJ Johnson

Yes, we met with FDA, Mary Kate, last December and aligned on the general approach to our clinical trials and submission. We are utilizing the modular PMA approach. As indicated in my comments, we've now submitted two of the four required modules and, yes, we do expect to complete the full PMA submission at this year. To date, we are currently in the IRL version or the intralab reproducibility studies, and upon completion of those, we will then be moving on to the method comparison studies. So, so far so good.

Mary Kate Gorman

So are you still targeting a U.S. launch for the lung fusion panel sometime by year-end 2017?

TJ Johnson

Yes. We'll actually be able to get CE/IVD marking the ALKPlus fusion. After they within a short amount time after our PMA submission. So we would expect to start launching in Europe early 2017. And then we will launch into the U.S. immediately upon approval from the FDA. Because of the modular approach, our expectation is that we hope to have a fairly quick final approval of modular four, but we would say looking at I from a conservative perspective we will start launch in the U.S. in mid-2017.

Mary Kate Gorman

Great thank you, very helpful. Again congrats on securing the CE-mark for your cell origins test [ph] in the quarter, do you expect to add additional sales wrapped in Q3 and Q4 as you make a play for the oncology space, and how should we thinking about your sales spend and provides for that.

TJ Johnson

Yes we will be adding some resources in Europe to support both cell origins and then beginning of next year launch of the ALKPlus along fusion test. Well, we're not expecting to see a material change to our commercial spend here in the U.S. we are in the process of realigning some of those resources focused on what we believe are the higher value of segments, especially pharma. So yes will continue to see some modest increases in our sales and marketing expenses. But it will be just pre-modest.

Mary Kate Gorman

Great. And so the final question this one on insurance placement. You have previously mentioned that you are expecting a slight inflection possibly driven by a former business and then that could possibly happen in the back half of 2016. So how should we be thinking about the pacing of unit placement as we head into Q3 and Q4 and then of the follow up, are you seeing any additional opportunities to convert existing range in rentals, and then the capital placement? What type of activity are you seeing in this pace, thank you?

TJ Johnson

No problem, yes I think as related to capital placements, we've fairly extensive evaluation of what we're doing and made some adjustments to our approach, first of all WRAPS, our reagent annuity programs for the research market make very little sense. So we've eliminated WRAPS or reagent annuity programs as an option, within our current research market, we obviously restart that type of financing programs for our diagnostic products where it makes sense next year. We plan to reduce the size of our valuation pretty considerably. And we believe we've reached the point now where there is less need for us to have the valuation units in market. And I will in essence use our [ph] lab, to assist customers with pilot or proof of concept programs, and then move directly into a capital sale that will either be a full capital or some sort of monthly capital rental fee that we would roll from the financing perspective.

So we expect to see a fairly significant mix ship to our installed base to higher quality installations pronominally capital and rental of a reduction of the size of our ongoing evaluation fleet that are out in customer hands, as they convert. We're fairly comparable - with kind of where you guys have our back half a year on capital sales.

Mary Kate Gorman

Great, thanks. And I guess as a follow up. Is it still appropriate to say that around 70% of your install bases any academic translational market currently?

TJ Johnson

So I would say historically that is accurate, we would expect that potentially to move more to a 50-50 split between that and the pharma market.

Mary Kate Gorman

Wonderful, well, thank you for taking my questions and again congrats on the quarter.

TJ Johnson

Thank you.

Operator

Thank you. And our next question will come from Adam Callahan at Rodman Renshaw. Your line is now open.

Adam Callahan

Thank you for taking my question. I have quite a few. The first it do you expect service for a few to go - to grow in the coming quarters or jump in the one time - I am sorry do you expect service revenue to grow in the coming quarters or the just the one time announced that a second quarter.

TJ Johnson

And we would expect to see the service revenues continue to grow. Because of the nature of those programs with pharma, we will speak fluctuations. But we absolutely expect to see that number grow and continue to be a sizeable portion of our revenue stream.

Adam Callahan

Can you tell us how many edges between units were sold in the second quarter?

TJ Johnson

Yes. We sold one unit in the second quarter.

Adam Callahan

Okay. What about, did you receive any, for the CE mark; did you receive any for the ALKPlus? Can you tell us about the end of 2016, your expectation?

TJ Johnson

Sure. Yes, we have obviously obtained CE/IVD marking for our DLBCL Cell of Origin Assay. In order to submit and obtain CE/IVD marking for the ALKPlus we will need to complete our clinical trials. Upon completion of the clinical trials, we would then have our technical file dossier required for the CE/IVD marking which could be obtained within weeks upon submission of the PMA. So we are expecting to have CE/IVD marking on the ALKPlus fusion asset yet this year. And then PMA approval through FDA. Hopefully buy her before mid-2017.

Adam Callahan

Okay. Do you think you elaborate more on the cost and patient number needed?

TJ Johnson

Yes. We are not fully disclosing that information but the cost of our clinical trials while a large percentage of our spend in relation to most therapeutic clinical trials is very nominal. The number of patients we are dealing with is a retrospect of study so therefore, it's really a matter of executing those trials across three sites and capturing that data and preparing submissions. So compared to most clinical trials these retrospect of method comparison studies are fairly fast and low cost.

Adam Callahan

Okay. Until now I have been asking sort of retrospective questions. What I am really interested in the future and the so called modularity of your system in regards to adding markers as I am available or even as they are discovered, can you provide a more granular answer or expectation of how quickly recently added to the system as they are discovered, what do you think the cost is. I mean obviously it is very, depending on what this is, what are our plans for this?

TJ Johnson

Yes. That's good question. I will answer that with two different strategies. I think our ALKPlus strategy Adam is an example of how we are trying to approach flexibility as it relates to more universal type of diagnostic so we will be seeking PMA approval for the ALK rearrangements on our panel but we're also offering the ROSS/RED [ph] and other markers. We will have those fully analytically validated in our first verification validation and submission so as those markers become medically proven, we will be able to simply supplement the existing approval of our PMA and add these markers as additional intended use for the panel. Where, in essence, we need to go back and recalibrate or readjust and add markers to an existing panel. For our technology it's fairly easy and fairly quick and fairly low cost. That's one of the major benefits of our technology, is the flexibility really involves a redesign of the sequences of those target genes to assure great specificity and reordering those steps and bringing them in and running them through our QC and functional validation.

One of the benefits we have of our products is that we can very quickly change and add and/or delete genes to our sets. We demonstrated that earlier this year with the release of our version 2 of our micro-RNA profiling panel. Obviously when you are talking about products that have CE/IVD mark or cleared or approved through the FDA, that process is more complicated, which is why we have gone out with the approach of, let's build all these genes into the panels and then supplement them as the medical utilities proven.

Adam Callahan

Okay. I mean I don't want to ask a question what you just say or we can answer that or without testing for anything inside - have there been any sort of water cooler discussions about like oh yes, let's look at this or this is interesting target that we might go after, you know?

TJ Johnson

Yes, we have more potential opportunities of things that we can do than time or resources to do them. So we have really outlined a very specific action plan on clinical programs over the next 18 months. It's developing and commercializing our DLBCL Cell of Origin. As indicated we believe we can take advantage of the updated World Health Organization's guidelines as we believe DLBCL Cell of Origin is likely to be a predictor of response for a number of drugs that are in Phase 2 or moving into Phase 3. Same thing with our ALKPlus. Assay, that will be a primary focus on finishing that and commercializing within the US and as well as the European Union. Our project Mercury that I'll add more color to in the near term is really focused on what we would call integrating next-generation sequencing gene expression into the anatomical workflow.

Unless we believe we have a dozen or more potential opportunities for different classifiers or different past encompassed within project Mercury. We also have 34 different programs going on within Pharma and each and every one of those programs has the potential to provide new medical utility as the campaigning diagnostic down the road. So we have a very significant pipeline of opportunities of which we are trying to execute against those in a very methodical way.

Adam Callahan

Thank you so much, I don't want to take up all the time. Let me ask one quick question. So you say on previous color at and you answered that you hoped to go from 50 to 50-50 from academic clinical based to a more treatment based. Can you tell us how you plan on doing that? What sort of marketing or what sort of strategy are you going to accomplish these goals?

TJ Johnson

Yes one of the main keys for us we are being very targeted about how we are approaching the academic market with us not having the objectives of being a broad based life size tools company or not competing in a breadth, an area of focus so predominantly the large translational science, translational medicine centers in the comprehensive cancer centers or similar size of scope so in order to cover a number of customers which is less than a 100 across the US and Europe, we will need a fairly small, very well equipped team. And we are putting that team in place and we will expect to continue to grow our placement in that segment. Our primary market is large pharma. We have recently added resources, nearly doubling our commercial team into pharma both in the US and Europe and we are heavily focused into the bio-marker discovery and development and the clinical development team in pharma and again as we deploy our resources and allocate them, that will then drive our placement mix from the last 12 months to the next 12 months to mix more towards pharma than the academic market.

Adam Callahan

Okay. Thank you so much for taking my question.

TJ Johnson

You are very welcome.

Operator

Thank you and I am showing no further questions at this time. I would like to turn the call back over to Mr. T J Johnson for closing remarks.

TJ Johnson

We would just like to thank everyone for their time and interest in HTG and also a big thank you to all the employees of HTG for a great quarter. Thank you.

Operator

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program and you may now disconnect.

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