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RGDX > SEC Filings for RGDX > Form 10-K on 31-Mar-2014All Recent SEC Filings

Show all filings for RESPONSE GENETICS INC

Form 10-K for RESPONSE GENETICS INC


31-Mar-2014

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, 2013. 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.

Our Approach

Clinical studies have shown that not all cancer therapy 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 analyses of tumor tissues. We are focusing our efforts in the following areas:

· Continued commercialization of our ResponseDX® tests;

· Broadening our offerings with the introduction of the former Pathwork Diagnostics Tissue of Origin test that was acquired when we purchased the Pathwork Diagnostics assets in August of 2013;

· Enhancing our capabilities in the way we deliver our services to oncologists and pathologists. In late 2013, the Company introduced its TC/PC system to competitively offer its services to pathologists;

· Developing additional diagnostic tests for predicting therapy response and determining the diagnosis and prognosis of solid tumors in cancer patients;

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

· Selectively building our pharmaceutical services business.

Our technologies enable us to reliably and consistently extract the nucleic acids, ribonucleic acid ("RNA") and deoxyribonucleic acid ("DNA"), from tumor specimens that are stored as formalin-fixed and paraffin-embedded ("FFPE"), 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 FFPE patient biopsies for the development of new diagnostic tests.

ResponseDX®

The outcome of cancer therapy is highly variable due to genetic differences among the tumors in cancer 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.

Until recently, most cancer treatment regimens were administered without any pre-selection of patients on the basis of the particular genetics of their tumor. However, advances in molecular technologies have enabled researchers to identify and measure genetic factors in patients' tumors that may predict the probability of success or failure of many anti-cancer agents. In order to increase the chances of a better outcome for cancer patients, we offer and continue to expand our offering of tests for measuring predictive factors for therapy response in tumor tissue samples. We provide tests for non-small cell lung cancer ("NSCLC"), colorectal cancer ("CRC"), gastric and gastroesophageal cancer ("GE"), melanoma, thyroid cancer, and breast cancer patients' tumor tissue specimens through our ResponseDX: Lung®, ResponseDX: Colon®, ResponseDX:
Gastric®, ResponseDX: Melanoma®, ResponseDX: ThyroidTM and ResponseDX: BreastTM test suites at 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 optimal therapeutic decisions for cancer patients. The results from our tests may help oncologists choose among therapies to treat their cancer patients.

In August 2013, the Company acquired substantially all of the assets of Pathwork Diagnostics, Inc. including its FDA-cleared Tissue of Origin cancer test. This newly acquired test was launched commercially by the Company in February 2014 as the ResponseDX: Tissue of OriginTM test. The ResponseDX: Tissue of OriginTM test is a microarray-based gene expression test that aids in identifying challenging tumors, including metastatic, poorly differentiated, and undifferentiated cancers. The ResponseDX: Tissue of OriginTM test uses a proprietary microarray platform and proprietary software to compare the expression of 2,000 genes in a patient's tumor with a panel of 15 known tumor types that represent 90% of all cancers. The test received FDA clearance in June 2010.

As of December 31, 2013, our ResponseDX® sales team consisted of 21 members located in the West, Southeast, and Northeast areas of the United States.

Expansion of our ResponseDX® diagnostic test panels

Our research and development activities primarily relate to the development and validation of diagnostic tests in connection with our ResponseDX® diagnostic services. In 2014, we plan to build out our product offering to include a Response DX® Glioma profile as well as additional tests in our existing panels.

Addition of Next-Generation Sequencing to our suite of technologies

The Company is pursuing mutational analysis by next-generation sequencing ("NGS") to complement our suite of molecular diagnostics platforms for the analysis of cancer specimens. We plan to use NGS to detect genomic changes from FFPE tissue samples and to provide physicians with reports that are comprehensive with respect to clinically actionable alterations.

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.

Research and development is crucial to the Company's development as we seek to expand our series of diagnostic tests for cancer patients. Our research and development expenses were $2,128,610 and $1,606,662 for the years ended December 31, 2012 and 2013, respectively, representing 11.4% and 8.1% of our net revenue for the years ended December 31, 2012 and 2013, respectively. Major components of our research and development expenses include supplies and reagents for our research activities, personnel costs, occupancy costs, equipment warranties and service, patent fees, insurance, business consulting and sample procurement costs. We expect research and development expenses to increase as we work to develop additional aspects of our technology and to study diagnostic indicators for various forms of cancer.

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 completed. 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.

In March 2010, the Company entered into a non-exclusive license agreement with GlaxoSmithKline, LLC, which called for certain milestone payments to be made to the Company when certain events specified in the agreement occur, specifically GlaxoSmithKline, LLC submitting an application to use the license to the FDA, the FDA approving the application, and issuance of certain patent applications to the Company. The Company has no further obligations related to these events and therefore has recorded the milestone payments that were due under the agreement into revenue at the time the event occurred. The Company incurred no additional cost related to these revenues at the time these events occurred.

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 2013 annual Medicare fee schedule update was announced which included proposed changes to Medicare reimbursement rates that significantly reduced the reimbursement rates for certain of the testing services we provide. The Company participated with other impacted organizations to provide guidance to the local Medicare Administrative Contractor ("MAC") that resulted in the local MAC updating certain pricing through September 2013 which reflected an increase in many of the tests originally priced in January 2013. In addition, on October 1, 2013, the Centers for Medicare and Medicaid Services ("CMS") issued fees for some, but not all, of the CPT codes used by the Company. It is uncertain if continued guidance provided to Medicare and the local MAC by impacted organizations will result in additional fee increases or additional positive coverage determinations in 2014. If, however, the current level of reduction in reimbursement rates is adopted as is, it may have a material adverse effect on the Company's operations.

As a result of these CPT code changes and Medicare price changes, we have experienced a departure from our normal reimbursement patterns with Medicare and other payors. Specifically, we have experienced delays in certain reimbursements for services and an increase in initial denials of claims for certain services provided. Accordingly, we re-evaluated the assumptions employed in our model for estimating revenue to be recognized for ResponseDX® testing. We view the code and price changes described above as affecting only the assumptions we used in pricing our services. The nature of the testing we provide, the evidence we gather to establish the creditworthiness of our payors and the delivery method of our services have not changed from prior periods, and there are no indicators that these assumptions require change.

We performed an analysis that considered our historical patterns of revenue by payor in conjunction with the fluctuations we experienced in the twelve months ended December 31, 2013 to arrive at the revenue recorded during 2013. We believe that the changes in CPT codes and pricing that are causing confusion and erratic payment experience in the payor community will take some time to resolve. The time needed for resolution will depend upon Medicare and the local MAC releasing additional pricing changes and potentially, revisions to previously revised prices, and upon the private payor community adopting the new CPT codes and some level of revised pricing. Accordingly, our revenue recognition estimates could be materially affected in future periods as pricing and payment patterns change and develop, and we may be materially affected by future or retroactive price changes.

On July 8, 2013, CMS released a new proposed rulemaking entitled "Medicare Program; Revisions to Payment Policies under the Physician Fee Schedule, Clinical Laboratory Fee Schedule & Other Revisions to Part B for CY 2014". This proposed rule contains a number of provisions that may adversely impact the level of reimbursement for a variety of tests for which the Company receives reimbursement from the Medicare program beginning in 2014. Among other things, CMS has proposed examining approximately 1,200 laboratory tests that appear on the Clinical Lab Fee Schedule ("CLFS") over a period of five years to determine whether advances in technology may have reduced the cost of providing such tests and whether or not the level of reimbursement should be revised. The Company is currently performing molecular testing which is reimbursed using CPT codes that fall on the CLFS. CMS has also proposed changing the methodology used to determine reimbursement rates for the technical component of certain tests reimbursed off of the Physician Fee Schedule ("PFS"). Among other provisions, CMS has proposed limiting the Relative Value Units ("RVUs") ascribed to the Practice Expense component of their reimbursement formula for tests performed in "Non-Facilities" (which would include most clinical laboratories like the Company) to the RVUs that have been ascribed for the same procedures under the Hospital Outpatient Prospective Payment System, or the Ambulatory Payment Classification ("APC") system which are used to reimburse "Facilities" (such as hospitals and ambulatory surgery centers). The Company currently performs FISH testing, which may be impacted by this PFS rule change if it is enacted.

A number of proposals for legislation or regulation continue to be under discussion which could have the effect of substantially reducing Medicare reimbursements for clinical laboratories or introducing cost sharing to beneficiaries. Depending upon the nature of regulatory action, if any, which is taken and the content of legislation, if any, which is adopted, the Company could experience a significant decrease in revenues from Medicare and Medicaid, which could have a material adverse effect on the Company. The Company is unable to predict, however, the extent to which such actions will be taken.

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 $332,504 and $305,616 for the years ended December 31, 2012 and 2013, 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 $336,285 and $280,325 for the years ended December 31, 2012 and 2013, 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 and the types of tests ordered.

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, 2012 and 2013.

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. As part of its process for evaluating the collectability of aged accounts receivable, Management identified delays in the Medicare administrative law appeal process for aged accounts receivable that would extend the process significantly (up to two years). Accordingly, management considered this factor in estimating the allowance for doubtful accounts and concluded that an additional allowance of approximately $690,000 was necessary as of December 31, 2013 to reserve for the balance of Medicare accounts receivable as of December 31, 2013 that were going to age greater than one year during the first quarter of 2014. Therefore, we have recorded an allowance for doubtful accounts of $991,990 and $2,404,659 as of December 31, 2012 and 2013, 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, 2013 and December 31, 2012

Revenue. Revenue was $19,801,359 for the year ended December 31, 2013, as compared to $18,736,669 for the year ended December 31, 2012, an increase of $1,064,690 or 5.7%. The increase was primarily due to an increase in pharmaceutical revenue of $937,449. ResponseDX® revenue increased $127,241, an increase of 1.1%. ResponseDX® revenue accounted for 60.7% of total revenue in the year ended December 31, 2013 compared to 63.4% for the year ended December 31, 2012. ResponseDX® revenue increased slightly over the prior year as a result of increased staffing of our sales force offset by the lead time required to secure new customers as the Company's sales and marketing efforts shifted toward larger customers. For the year ended December 31, 2013, our two most significant pharmaceutical clients accounted for approximately 23.8% of our revenue, as compared to approximately 24.1% of our revenue for the year ended December 31, 2012.

Cost of Revenue. Cost of revenues for the year ended December 31, 2013 was $10,456,082 as compared to $10,415,913 for the year ended December 31, 2012, an increase of $40,169, or 0.4%. While total cost of revenue was consistent with the prior year, costs increased for laboratory reagents and supplies by $315,845, personnel expense by $268,071 and depreciation and amortization by $162,941. These increases were offset by reductions in costs related to our agreement with Hitachi that ended in September 2012 by $526,823 and lower consulting expenses by $166,182. Cost of revenues as a percentage of revenues was 52.8% for the year ended December 31, 2013, as compared to 55.6% for the year ended December 31, 2012.

Research and Development Expenses. Research and development expenses were $1,606,662 for the year ended December 31, 2013, as compared to $2,128,610 for the year ended December 31, 2012, a decrease of $521,948 or 24.5%. The decrease primarily resulted from lower laboratory supplies, reagents and microarray costs of $302,256 and legal services related to our intellectual property of $137,453. 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 $10,262,623 for the year ended December 31, 2013, as compared to $8,783,414 for the year ended December 31, 2012, an increase of $1,479,209 or 16.8%. This increase resulted primarily from increases in bad debt expense of $1,814,325 to increase the allowance for bad doubtful accounts while the uncertainties in the payor environment around molecular pathology reimbursement are still being resolved and as the time required to appeal reimbursement decisions and policies with CMS has increased substantially from prior years. Additionally, personnel expenses increased by $215,861 related to higher staffing. The total increase in general and administrative expenses was offset by decreases in legal and accounting fees of $244,444, repair and maintenance of $143,100, telecommunication expenses of $88,753, and insurance expense of $75,500.

Sales and Marketing Expenses. For the year ended December 31, 2013, our sales and marketing expenses totaled $5,421,797 compared to $5,065,998 for the year ended December 31, 2012, an increase of $355,799 or 7.0%. The increase primarily resulted from restructuring and expanding our sales force and marketing activities during 2013, which resulted in higher personnel costs of $474,788 and increases in travel expenses of $154,132. These increases were offset by decreases in trade show expenses of $130,279, printing expense of $92,727 and speaker fees of $51,757. We expect that sales and marketing costs will increase as we continue to 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 and capital leases as well as our realized and unrealized foreign currency exchange gains or losses on our Euro-denominated receivables. Interest expense increased to $91,844 for the year ended December 31, 2013 compared with $85,838 for the year ended December 31, 2012. Realized and unrealized losses on currency exchange rate fluctuations were a net gain of $17,086 for the year ended December 31, 2013 compared to net loss of $14,002 for the year ended December 31, 2012.

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