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RGDX > SEC Filings for RGDX > Form 10-K on 27-Mar-2013All Recent SEC Filings

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Form 10-K for RESPONSE GENETICS INC


27-Mar-2013

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.

Special Note Regarding Forward-Looking Statements

The following discussion of our financial condition and results of operation should be read in conjunction with our audited consolidated financial statements and related notes to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K for the year ended December 31, 2012. This discussion contains forward-looking statements that relate to future events or our future financial performance. These statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, levels of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by these forward-looking statements.

Overview

Response Genetics, Inc. (the "Company") was incorporated in the State of Delaware on September 23, 1999 as Bio Type, Inc. for the purpose of providing unique molecular profiling services of tumor tissue that has been formalin-fixed and embedded in paraffin. In August 2000, we changed our name to Response Genetics, Inc.

Clinical studies have shown that not all cancer chemotherapy works effectively in every patient, and that a number of patients receive therapy that has no benefit to them and may potentially even be harmful. Our goal is to provide cancer patients and their physicians with a means to make informed, individualized treatment decisions based on genetic analysis of tumor tissues. We are focusing our efforts in the following areas:

• Continued commercialization of our ResponseDX® tests;

• Developing additional diagnostic tests for assessing the risk of cancer recurrence, prediction to therapy response and tumor classification in cancer patients; and

• Expanding our testing services business by pursuing new technologies through collaborations and in-licensing to expand our business.

Our technologies enable us to reliably and consistently extract the nucleic acids RNA and DNA from tumor specimens that are stored as formalin-fixed and paraffin-embedded, specimens and thereby to analyze genetic information contained in these tissues. This is significant because the majority of patients diagnosed with cancer have a tumor biopsy sample stored in paraffin, while only a small percentage of patients' tumor specimens are frozen. Our technologies also enable us to use the formalin-fixed paraffin embedded ("FFPE") patient biopsies for the development of diagnostic tests.

ResponseDX®

The outcome of cancer therapy is highly variable due to genetic differences among patients. Some patients respond well with tumor shrinkage and increase in life span. Other patients do not obtain benefit from the same therapy and may actually experience toxic side effects, psychological trauma and delay in effective treatment.

At present, most cancer treatment regimens are administered without any pre-selection of patients on the basis of their particular genetics. However, recent development of very sensitive molecular technologies has enabled researchers to identify and measure genetic and biochemical factors in patients' tissues that may predict the probability of success or failure of many currently used anti-cancer agents. In order to increase the chances of a better outcome for cancer patients, we have and continue to expand our development of genetic tests for measuring predictive factors for tumor response in tumor tissue samples. We offer tests for non-small cell lung cancer ("NSCLC"), colorectal cancer ("CRC") and gastric and gastroesophageal cancer ("GE"), and melanoma cancer patients' tumor tissue specimens through our ResponseDX: Lung®, ResponseDX: Colon®, ResponseDX: Gastric® and ResponseDX: Melanoma® test suitesat our laboratory located in Los Angeles, California, which is certified under the Clinical Laboratory Improvement Amendments of 1988 ("CLIA"). These tests serve to help oncologists make optional therapeutic decisions for cancer patients. The results from our tests may help oncologists choose among therapies to treat their cancer patients. As of December 31, 2012, our sales team consisted of 14 members located in the West Coast, Midwest, and East Coast areas of the United States.

Diagnostic Tests for Other Cancers

In addition to ResponseDX: Lung®, ResponseDX: Colon®, ResponseDX: Gastric®and ResponseDX: Melanoma®,we intend to develop and commercialize tests for other types of cancer. We also are identifying genetic profiles of tumors that are more or less responsive to a particular therapy. Following the development of tests to determine the most active therapy regimen for the individual patient at risk, we intend to leverage our relationships in the healthcare industry to market, sell or license these tests as a means for physicians to determine the courses of cancer treatment.

Pursue Additional Collaborations and In-licensing to Expand Our Business

We intend to pursue additional collaborations with pharmaceutical companies or in-licensing of products or technologies that will enable us to accelerate the implementation of our plans to expand the services we provide to oncologists and pathologists. We expect to implement this plan by way of licensing of technology and know-how, investments in other companies, strategic collaborations, and other similar transactions. We expect these collaborations to provide us with early access to new technologies available for commercialization.

There are no assurances that we will be able to continue making our current ResponseDX®tests available, or make additional ResponseDX®tests available; or that we will be able to develop and commercialize tests of other types of cancer; or that we will be able to expand our testing service business through collaborations.

We anticipate that, over the next 12 months, a substantial portion of our capital resources and efforts will be focused on sales and marketing activities related to our ResponseDX®diagnostic tests, research and development to expand our series of diagnostic tests for cancer patients, and for other general corporate purposes.

Research and development expenses represented 4.7% and 8.1% of our total operating expenses for the years ended December 31, 2011 and 2012, respectively. Major components of the $1,321,897 and $2,128,610 in research and development expenses for the years ended December 31, 2011 and 2012, respectively, included supplies and reagents for our research activities, personnel costs, occupancy costs, equipment warranties and service, patent fees, insurance, business consulting and sample procurement costs.

Critical Accounting Policies and Significant Judgments and Estimates

This discussion and analysis of our financial condition and results of operations is based on our consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles ("U.S. GAAP"). The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities and expenses and the disclosure of contingent assets and liabilities at the date of the financial statements, as well as revenues and expenses during the reporting periods. We evaluate our estimates and judgments on an ongoing basis. We base our estimates on historical experience and on various other factors we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results could therefore differ materially from those estimates under different assumptions or conditions. We believe the following critical accounting policies reflect our more significant estimates and assumptions used in the preparation of our financial statements.

Revenue Recognition

Pharmaceutical Revenue

Revenues that are derived from pharmacogenomic testing services provided to pharmaceutical companies are recognized on a contract specific basis pursuant to the terms of the related agreements. Revenue is recognized in accordance with ASC 605, Revenue Recognition,which requires that four basic criteria must be met before revenue can be recognized: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred and title and the risks and rewards of ownership have been transferred to the client or services have been rendered;
(3) the price is fixed or determinable; and (4) collectability is reasonably assured.

Revenues are recorded on an accrual basis as the contractual obligations are completed and as a set of assays is processed through the Company's laboratory under a specified contractual protocol and are recorded on the date the tests are resulted. Certain contracts have minimum assay requirements that, if not met, result in payments that are due upon the completion of the designated period. In these cases, revenues are recognized when the end of the specified contract period is reached, if the minimum assay requirements are not met.

ResponseDX®Revenue

Net revenue for the Company's diagnostic services is recognized on an accrual basis at the time discreet diagnostic tests are completed. Each test performed relates to a specimen encounter derived from a patient, and received by the Company on a specific date (such encounter is commonly referred to as an "accession"). The Company's services are billed to various payors, including Medicare, private health insurance companies, healthcare institutions, and patients. The Company reports net revenue from contracted payors, including certain private health insurance companies, and healthcare institutions based on the contracted rate, or in certain instances, the Company's estimate of the amount expected to be collected for the services provided. For billing to Medicare, the Company uses the published fee schedules, net of standard discounts (commonly referred to as "contractual allowances"). The Company reports net revenue from non-contracted payors, including certain private health insurance companies, based on the amount expected to be collected for the services provided. The Company analyzes historical payments from payors as a percentage of amounts billed by the Company to estimate expected collections for purposes of recording net revenue.

The Company has its Medicare provider number which allows it to invoice and collect from Medicare. Invoicing to Medicare is primarily based on amounts allowed by Medicare for the service provided as defined by Common Procedural Terminology ("CPT") codes. In January 2013, the initial annual Medicare fee schedules update was announced which includes proposed changes to Medicare reimbursement rates that significantly reduce the reimbursement rates for certain of the testing services we provide. The Company is participating directly and with other impacted organizations to provide guidance to the local Medicare Administrative Contractor that may result in an adjustment to the proposed reimbursement rates that it believes better reflects the value of the services being performed. If, however, the initial reduction in reimbursement rates is adopted as is, it may have a material adverse effect on the Company's operations.

License Fees

We have licensed technology for the extraction of RNA and DNA from FFPE tumor specimens from USC in exchange for royalty fees on revenue generated by use of this technology. These royalties are calculated as a fixed percentage of revenue that we generate from use of the technology licensed from USC. Total license fees expensed in cost of revenue under the license agreement with USC were $516,746 and $332,504 for the years ended December 31, 2011 and 2012, respectively. We also maintain a non-exclusive license to use Roche's PCR, homogenous PCR, and reverse transcription PCR processes. We pay Roche a fixed percentage royalty fee for revenue that we generate through use of this technology. Royalties expensed in cost of revenue under the Roche agreement totaled $552,113 and $336,285 for the years ended December 31, 2011 and 2012, respectively.

We are subject to potentially significant variations in royalties recorded in any period. While the amount paid is based on a fixed percentage from revenues of specific tests pursuant to terms set forth in the agreements with USC and Roche, the amount due is calculated based on the revenue we recognize using the respective licensed technology. As discussed above, this revenue can vary from period to period as it is dependent on the timing of the specimens submitted by our clients for testing.

Accounts Receivable and Allowance for Doubtful Accounts

We invoice our pharmaceutical clients as specimens are processed and any other contractual obligations are met. Our contracts with pharmaceutical clients typically require payment within 45 days of the date of invoice. We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our clients to make required payments. We specifically analyze accounts receivable and historical bad debts, client credit, current economic trends and changes in client payment trends when evaluating the adequacy of the allowance for doubtful accounts. Account balances are charged-off against the allowance when it is probable the receivable will not be recovered. To date, our clients have primarily been large pharmaceutical companies. Bad debts to date have been minimal and there is no allowance for doubtful accounts for our pharmaceutical revenue at December 31, 2011 and 2012.

We bill Medicare and private payors ("Private Payors") for ResponseDX®upon completion of the required testing services. As such, we take assignment of benefits and the risk of collection with Medicare and Private Payors. We continue to monitor the collection history for Medicare and Private Payors. Based on the historical experience for our Medicare and Private Payor accounts, we have determined, based on a detailed analysis, that accounts receivable associated with certain billings are unlikely to be collected. Therefore, we have recorded an allowance for doubtful accounts of $838,750 and $991,990 as of December 31, 2011 and 2012, respectively.

An allowance for doubtful accounts is recorded for estimated uncollectible amounts due from the Company's various payor groups. The process for estimating the allowance for doubtful accounts involves significant assumptions and judgments. Specifically, the allowance for doubtful accounts is adjusted periodically, and is principally based upon an evaluation of historical collection experience of accounts receivable for the Company's various payor classes. After appropriate collection efforts, accounts receivable are written off and deducted from the allowance for doubtful accounts. Additions to the allowance for doubtful accounts are charged to bad debt expense. The payment realization cycle for certain governmental and managed care payors can be lengthy, involving denial, appeal, and adjudication processes, and is subject to periodic adjustments that may be significant.

We cannot guarantee that we will continue to experience the same credit loss rates that we have in the past. Measurement of such losses requires consideration of historical loss experience, including the need to adjust for current conditions, and judgments about the probable effects of relevant observable data, including present economic conditions such as delinquency rates and financial health of specific customers. We consider all available information in our assessments of the adequacy of the reserves for uncollectible accounts.

Income Taxes

We estimate our tax liability through calculations we perform for the determination of our current tax liability, together with assessing temporary differences resulting from the different treatment of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are recorded in our balance sheets. Our management then assesses the likelihood that deferred tax assets will be recovered in future periods through future operating results. To the extent that we cannot conclude that it is more likely than not that the benefit of such assets will be realized, we establish a valuation allowance to adjust the net carrying value of such assets. The carrying value of our net deferred tax assets assumes that we will be able to generate sufficient future taxable income, based on management's estimates and assumptions. These estimates and assumptions take into consideration future taxable income and ongoing feasible tax strategies in determining recoverability of such assets. Our valuation allowance is subject to significant change based on management's estimates of future profitability and the ultimate realization of the deferred tax assets. The Company has established a full valuation allowance against its net deferred tax assets due to the uncertainty surrounding the realization of such assets.

Results of Operations

Years Ended December 31, 2012 and December 31, 2011

Revenue. Revenues were $18,736,669 for the year ended December 31, 2012, as compared to $22,642,728 for the year ended December 31, 2011, a decrease of $3,906,059, or 17.3%. The decrease was primarily due to a decrease in pharmaceutical revenues of $3,252,876. ResponseDX®revenues decreased $653,183. ResponseDX®revenue accounted for 63.4% of total revenue in the year ended December 31, 2012 compared to 55.4% for the year ended December 31, 2011. ResponseDX®revenues for the year ended December 31, 2012, decreased 5.2% as compared to the year ended December 31, 2011. This decrease was primarily due to the initial phases of restructuring efforts within the sales team during 2012 and the Company's focus on its relationship with its largest pharmaceutical client. For the year ended December 31, 2012, our two most significant pharmaceutical clients accounted for approximately 24.1% of our revenue, as compared to approximately 37.9% of our revenue for the year ended December 31, 2011.

Cost of Revenue. Cost of revenues for the year ended December 31, 2012 was $10,415,913 as compared to $11,733,700 for the year ended December 31, 2011, a decrease of $1,317,787 or 11.2%. The decrease in revenue resulted in lower direct costs to generate the corresponding revenue. The decrease as a percentage was not equivalent to the corresponding decrease in revenue as a large portion of our costs are labor related therefore limiting our ability to make adjustments based on fluctuations in volume. Cost of revenues as a percentage of revenues was 55.6% for the year ended December 31, 2012, as compared to 51.8% for the year ended December 31, 2011. Cost of revenues as a percentage of revenues was 45.7% for the three months ended December 31, 2012 indicating a focus on improving our laboratory operations in order to drive continued improvements in our cost of revenue as a percentage of revenues.

Research and Development Expenses. Research and development expenses were $2,128,610 for the year ended December 31, 2012, as compared to $1,321,897 for the same period in 2011, an increase of $806,713 or 61.0%. This increase resulted primarily from increased efforts related to the development of new molecular tests which were released in the second half of 2012. The increases primarily result from an increase in laboratory supplies, reagents and microarray costs, personnel related cost and legal services related to our intellectual property. We expect research and development expenses to increase as we work to develop additional aspects of our technology, launch Next Generation Sequencing and study diagnostic indicators for various forms of cancer.

General and Administrative Expenses. General and administrative expenses totaled $8,783,414 for the year ended December 31, 2012, as compared to $9,708,347 for the year ended December 31, 2011, a decrease of $924,933 or 9.5%. Generally, the Company has been focused on reducing costs in key areas during the second half of 2012. This decrease resulted primarily from decreases in personnel costs of $86,553, travel of $149,853, professional/consulting fees of $174,349, legal fees of $423,456, business taxes of $217,267 and a 2011 asset impairment charge of $157,241 offset by an increase in facility related costs of $45,017 and stock compensation expense of $227,422.

Sales and Marketing Expenses. For the year ended December 31, 2012, our sales and marketing expenses totaled $5,065,998 compared to $5,560,637 for the year ended December 31, 2011, a decrease of $494,639 or 8.9%. The decrease primarily resulted from the initial phases of restructuring sales and marketing activities for ResponseDX®, which included decreases in marketing related activities of $168,423 and personnel costs of $421,240, offset by increases in travel costs of $17,550 and marketing consulting of $72,801. We expect that sales and marketing costs will increase as we expand our sales and marketing team and related activities.

Other Income and Expense. Other income and expense primarily represents the interest expense we incur on our revolving credit facility with Silicon Valley Bank. Interest expense increased to $85,838 for the year ended December 31, 2012 compared with $20,718 for the same period in 2011. The Company's initial drawdown of $1,000,000 on the line of credit was completed in October 2011 and therefore the company only incurred interest expense for the fourth quarter of 2011.

Net Income/(Loss). As a result of the foregoing, our net loss increased by approximately $2,054,657 to approximately $7,757,079 for the year ended December 31, 2012 as compared to a net loss of $5,702,422 for the year ended December 31, 2011.

Liquidity and Capital Resources

We incurred net losses of $5,702,422 and $7,757,079 during the years ended December 31, 2011 and 2012, respectively. Since our inception in September 1999, we have incurred cumulative losses and as of December 31, 2012, we had an accumulated deficit of $57,276,664. We have not yet achieved profitability and anticipate that we will likely incur additional losses for the next year. We cannot provide assurance as to when we will achieve profitability. We expect that our cash and cash equivalents will be used to fund our selling and marketing activities primarily related to our ResponseDX®tests, research and development, and general corporate purposes. As a result, we will need to generate significant revenues to achieve profitability. Management intends to effectively manage cash flows in 2013 and expects that cash and cash equivalents will be sufficient to meet the Company's working capital requirements through the next 12 months. Nevertheless, until we can generate and maintain sufficient revenues to finance our cash requirements, which we may never do, we expect to finance additional cash needs primarily through public or private equity offerings, strategic collaborations, our line of credit and other financing opportunities. We do not know whether additional funding will be available on acceptable terms, if at all. If we are not able to secure additional funding when needed, we may have to delay, reduce the scope of or eliminate selling and marketing activities or research and development programs.

The Company is a party to a line of credit agreement with Silicon Valley Bank (the "Bank") entered into on July 14, 2011, as last amended on March 7, 2013. The line of credit is collateralized by the Company's pharmaceutical and Medicare receivables and the amended maximum amount that can be borrowed from the credit line is $2,000,000. As of December 31, 2012, the amount the Company can draw from the credit line was equal to the lesser of (i) the Company's calculated borrowing base, which was 80% of certain of the Company's accounts receivables, or (ii) the amount available under the credit line. As needed from time to time, the Company may draw on this line for use for general corporate purposes. However, the line of credit is subject to various financial covenants and, as of December 31, 2012, the Company was not in compliance with certain covenants. Pursuant to the March 7, 2013 amendment, the Bank waived the Company's existing breach of financial covenants under the agreement and the parties restructured the credit line to provide that, among other things: i) the revolving line of credit's maturity date was extended to March 7, 2015, (ii) the fee for the unused portion of the revolving line of credit was reduced from 0.375% to 0.250% per annum of the average unused portion of the revolving line of credit, (iii) the Company must continue to meet certain reporting requirements including providing financial statements and a certificate of compliance with the terms and conditions of the credit agreement by an authorized officer to the Bank within 45 days of the last day of each calendar quarter, provided that if the Company has less than $4,000,000 in its account at the Bank at any time during such calendar quarter, the Company must provide the financial statements and the certificate of compliance within 30 days of the end of such calendar quarter and providing a monthly report on revenues realized from private payors, (iv) the financial covenants were amended and restated to require the Company to maintain a ratio of quick assets to current liabilities of 1:50 to 1:00 and meet certain specified minimum adjusted EBITDA requirements as defined in the amendment and measured on a monthly basis and (v) the Bank is granted certain additional inspection of books, records and collateral rights. The Company may fail to comply with these amended financial covenants in 2013 due to, for example, the Company's calculated borrowing base for a covered period decreasing below a level that the Company is in an over-advance position in which case, the Company will be required to repay any outstanding amounts greater than the calculated borrowing base for such covered period back to the Bank immediately. The Company will be able to draw down on the credit line again with respect to such paid back amount once the Company is in compliance with the borrowing base requirement. This occurred on one occasion during the second quarter of 2012 based on the May 2012 borrowing base, as a result of which the Company was required to repay $298,000 to the Bank. The Company drew down the same amount one week later once the June 2012 borrowing base was determined to be sufficiently higher than the May 2012 borrowing base, thereby giving the Company the capacity to borrow such additional amount.

In addition, we expect to use our capital to fund research and development and to make capital expenditures to keep pace with the expansion of our research and development programs and to scale up our commercial operations. The amount and timing of actual expenditures may vary significantly depending upon a number of factors, such as the progress of our product development, regulatory requirements, commercialization efforts, and the amount of cash used by operations. We expect that we will continue to generate revenue through our pharmacogenomic testing services and ResponseDX®testing services that we provide to pharmaceutical clients and to the users of our ResponseDX®testing services which include oncologists, pathologists, hospitals, and cancer care centers. These revenues are not guaranteed and are not expected to substantially offset the costs associated with our expansion efforts.

Following is a summary of recent events and the expected impact these events have had or may have on our liquidity and future realization of revenues.

Sales of Common Stock

Under the Company's Articles of Incorporation, the Company has one class of common stock and its holders have no preemptive, subscription, redemption or conversion rights. As described below and in Note 12 in the Notes to Consolidated Financial Statements, the Company sold shares of its common stock during 2011 and 2012. In connection with certain of these offerings, the Company entered into registration rights agreements with the purchasers of the common shares.

May 2011 Registered Offering of Common Stock

On May 6, 2011, the Company issued 1,175,512 shares of its common stock at a price of $1.99 per share in a registered direct public offering to certain institutional investors and received net proceeds of approximately $2.2 million from the sales, after deducting its estimated offering expenses. The securities issued with this financing were registered under the Securities Act of 1933, as . . .

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