Veracyte Inc (VCYT) 2014 Q3 法說會逐字稿

Good afternoon, ladies and gentlemen and welcome to Veracyte's third-quarter 2014 financial results conference call.

(Operator Instructions)

As a reminder, today's conference call is being recorded.

I'd now like to turn the conference over to your host, Ms. Shelly Guyer, Chief Financial Officer. Please go ahead, ma'am.

Good afternoon, everyone and welcome to our third-quarter 2014 financial results conference call. Joining me today are Bonnie Anderson, President and Chief Executive Officer and Chris Hall, Chief Operating Officer.

Before we begin, I'd like to remind you that various remarks that we make on this call that are not historical, including those about our future financial and operating results, our plans and prospects, the success of our business strategy, attributes, benefits and value of our tests and patients, physicians and payers, growth opportunities and the size of potential markets, future products product launches and our product pipeline, international expansion, demand for our tests and drivers of demand, payer coverage, contracts in progress and reimbursement and patient access, our ability to collect from payers for tests performed, clinical outcomes and timing of clinical studies, and the impacts of potential FDA regulation constitute forward-looking statements within the meaning of the Safe Harbor provision of the Private Securities Litigation Reform Act.

We refer you to our quarterly report on form 10-Q for the quarter ended the September 30, 2014 filed with the SEC and in particular to the section entitled risk factors for additional information on factors that could cause actual results to differ materially from our current expectation. These forward-looking statements speak only as of the date of this call and we disclaim any obligation to update these forward-looking statements. Our financial results press release for the third quarter ended September 30, 2014 crossed the wire earlier and is available on the Investor Relations page of our website at www.veracyte.com.

I will now turn the call over to Bonnie.

Thank you, Shelly.

Good afternoon, everyone and welcome to our third-quarter 2014 financial and business update as we cross the one-year mark as a public company. We would like to thank many of you for joining us for our first Investor Day last month where you heard directly from leading physicians the impact that Afirma is having, creating a new standard of care for managing patients with thyroid nodules, as well as their enthusiastic anticipation of our planned lung cancer test and our test to help diagnose patients with idiopathic pulmonary fibrosis or IPF.

We believe these pulmonology tests offer significant potential to expand our strategic imperative to improve outcomes for patients and reduce the cost of care. For those of you who missed the event, the webcast can be found in the investor section of our website.

Now turning to our third-quarter results, in many respects, the third quarter of 2014 was transformative for the Company. We continued to execute on growing our Afirma franchise and at the same time achieve strategic and pipeline developments that position Veracyte extremely well for both near and long term sustainable growth.

There are three key areas of focus I want to spend time on today: they are the growth of Afirma, payer progress and advancement of our pulmonology pipeline. Number one, growth of Afirma, our strong financial results speak to our success in this regard. We experienced a 76% increase in year-over-year revenue for the third quarter, reporting $9.8 million compared to $5.6 million in the same quarter of 2013.

These solid results were driven by continued robust market adoption of Afirma in both the community-based physician market, as well as in institutional accounts where we continued to see accelerated growth. We received 16,781 thyroid nodule fine needle aspiration biopsies or FNAs during the third quarter, an increase of 35% compared to the same period last year.

Over 7% of those FNAs were received from institutions that were enabled to send us samples for GEC testing only. Together with the GEC test reflex from cytopathology, our GEC volume grew 45% compared to the same period last year. We continue to build upon our extensive library of clinical evidence supporting the use of Afirma. Manuscripts have been submitted or accepted for publication for both our medullary thyroid cancer or MTC and our BRAF tests.

These Afirma malignancy classifiers assist physicians in determining which kind of surgery to perform on patients who are heading to surgery. Additionally, two poster presentations on Afirma were given at the American Thyroid Association's annual meeting a couple of weeks ago. One of those was the first study to demonstrate the durability, safety and long-term clinical utility of a benign Afirma GEC result for up to three years.

The other study shows that fibroid nodules of greater than three centimeters in size were identified as benign by the GEC with 100% sensitivity. This is important given physicians' historical bias of taking patients to surgery when they have nodules of a greater than three centimeters size. Both of these studies should give physicians further confidence in moving patients with benign Afirma GEC results from diagnostic surgery to routine monitoring and payers confidence in the durability of the GEC to help patients avoid surgery.

We executed an amended co-promotion agreement with Genzyme Corporation, which reduces the fees we pay for US Afirma revenue was from 32% to 15% beginning January 1, 2015, with Veracyte assuming the lead role in sales and marketing. To prepare for our expanded role and further drive our business, we grew our endocrinology sales and marketing team this quarter, achieving 70% of our expanded goals stated in our 2Q call as 10 new hires before the end of the year.

Additionally, we signed a letter of agreement with Genzyme to negotiate exclusively the ex-US co-promotion of the Afirma GEC in six initial countries. We've initiated a number of marketing programs to support our expanded sales effort. Our marketing campaigns now encompass the use of multi-media including digital, social and print and we are expanding the use of patient-focused content to drive awareness of and demand for Afirma.

As we close out the year, we are reiterating our full-year 2014 guidance for the number of FNA samples received to be in the range of 66,000 to 73,000 FNA samples. Now that we are pretty far into the fourth quarter and have greater visibility, we expect to end 2014 with revenue of approximately $38 million, at the low-end of the guided range, reflecting approximately 74% growth in year-over-year revenue. As we continue to secure more payer contracts, where we had great success this year, we are confident that our revenue will become more predictable.

Number two, payer progress, our continued progress with payers is impressive and serves as the foundation for Afirma's success, but also will provide a vector of significant leverage for our commercial efforts in pulmonology. We are pleased to report that during the third quarter, we established in-network contracts for Afirma with United Healthcare and Cigna, two of the largest commercial health plans in the country with over 27.3 million and 13.7 million covered lives respectively along with Providence Health Plan.

These contracts are all expected to become effective during fourth quarter of 2014. The total number of covered lives for Afirma is now over 135 million and the total lives under contract will now exceed 100 million. As a reminder, in addition to those plans named above and Medicare, we now have contracts with a number of leading regional plans. These include Select health, a part of Intermountain Healthcare, Optima health plan, Paramount health plan, Pacific IPA, and Ohio State's health plan.

In-network status is important because it facilitates test adoption, as we believe doctors are more likely to order a test from a health plan's in-network provider, through which the patient bears a lower portion of financial responsibility and over time it will enable a more predictable quarterly revenue. Number three, advancement of our pulmonology pipeline. We made key advances during the third quarter with our pipeline products in pulmonology.

Specifically, we have accelerated our entry into this high opportunity market with our acquisition of Allegro Diagnostics, which we completed on September 16. I will let Shelly fill you in on the financials, but want to take a moment to reiterate the market opportunity this acquisition gives us. With Allegro, we now have a clinically validated lung cancer test based on novel proprietary technology that addresses a significant unmet clinical need and which we plan to launch in the second half of 2015.

Allegro's lung cancer test is designed to help physicians determine which patients with lung nodules are at low risk of cancer and can be safely monitored with routine CT scanning instead of undergoing invasive procedures following a non-diagnostic bronchoscopy result. The number of bronchoscopies performed in the US alone is currently estimated at 250,000 per year. This number is expected to rise given that recent medical guidelines now recommend annual CT screening for the more than 8 million Americans at high risk of lung cancer.

Screening, which private payers are now required to cover, beginning in January 2015, according to provisions in the Affordable Care Act. Further, on Monday of this week, the Centers of Medicare and Medicaid Services or CMS, proposed that Medicare will now also cover annual CT screening for high-risk patients. One of the concerns with Medicare coverage of annual CT screening was the potential for a large number of patients with false positive results undergoing unnecessary and costly diagnostic workup.

We believe our lung cancer test will be a valuable complement to this increased screening paradigm. The integration of Allegro has gone smoothly with two employees joining our team and with the full breadth of collaborators excited to help transition this product through to commercial availability. All samples, data and company files now reside at Veracyte. We are on track to submit by the end of the year, the agent's validation study for publication.

We are also focused on conducting the market development and remaining product development items required to achieve CLIA lab certification and commercialization of our test in the second half of next year. We believe the commercialization of our lung cancer test will pave the way for a second product targeting pulmonologists, our IPF test. With the news of new drugs approved by the FDA in October, there is a greater urgency in improving the diagnosis of this devastating disease.

We have expanded the number of clinical sites in our prospective clinical trial to 23 in the US and Europe and have made strong progress in translating the test to trans-bronchial biopsies obtained without the need for surgery. We remain on track to launch our test in 2016. Also worth noting in the quarter, we added two new issued patents to our portfolio, bringing the total number of issued patents for Afirma to six.

Also, as we look into the future, we were sad to announce yesterday the resignation of Sam Colella from our Board of Directors, effective November 30, 2014. On behalf of Veracyte, we'd like to thank Sam for his years of service and contributions as a member of our founding Veracyte board. His leadership, wisdom and guidance have been invaluable to our Company and he will be missed.

At the same time, we are thrilled to diagnostics industry veteran John Bishop, the Chairman and CEO of Cepheid, a leading global molecular diagnostics company, to our team beginning December 1. Since joining Cepheid almost 13 years ago, John has grown sales across multiple product lines from single-digit to almost $0.5 billion dollars, translating to a market capitalization for the Company of approximately $3.7 billion, all while navigating through a highly regulated environment. We believe his deep experience and insights will be instrumental as we continue to build our Business.

Now, I will turn the call over to Shelly who will review our financial results for the third quarter.

Thanks, Bonnie.

As Bonnie mentioned, we experienced strong growth of our Afirma business during the third quarter of 2014. Revenue for the third quarter ended September 30, 2014 was $9.8 million, an increase of 76% compared to $5.6 million for the third quarter of 2013. Our growth continued to be driven by increased adoption of our Afirma solution and by our success in establishing payer coverage for the Afirma GEC.

Revenue for the nine months ended September 30, 2014 was $26 million, compared to $15 million for the same period in 2013, an increase of 73%. We received 16,781 FNA samples in the third quarter, compared to 12,430 FNA samples during the same period in 2013, an increase of 35%.

Combined with the first two quarters, we have received or to 47,612 FNA samples year to date, a 34% increase. Our GEC rate continued to be within the 20% to 22% range of total FNAs received.

In terms of reimbursement, when we look at a blended GEC rate, the average reimbursement for GEC has increased slightly to about $2,100.

That includes everything from contracted payers with known amounts to those that are paying zero for the test and after a lag of several quarters which it takes for us to collect. As Bonnie indicated, we are reiterating the guidance we provided during our second-quarter call for full year 2014 FNA samples received to be in the range of 66,000 to 73,000 and we expect to end the year with revenue of approximately $38 million, at the low-end of our guided range, reflecting a year-over-year growth rate of approximately 74%.

With the new payer contract scheduled to go into effect during the fourth quarter, we estimate that approximately 50% of our revenue will be under contract. Cost of revenue for the quarter ended September 30, 2014 was $4.2 million, compared to $3.1 million in the same period of 2013. This increase was primarily due to increases in variable costs consistent with the increase in the number of FNAs received, offset in part by continuing refinements in our testing process and economies of scale related to the increase in FNAs processed.

Research and development expense for the quarter ended September 30, 2014 was $2.2 million, compared to $2 million in the same period of 2013. This increase was primarily due to direct R&D expenses due to the timing of genome sequencing and other laboratory expenses and increases in personnel and stock-based compensation expense due to increases in headcount.

We expect that in the next 12 months the increase in research and development expenses will be for the continued development and support of a support of Afirma and other new products and programs under development, including our lung cancer and IPF programs. Specifically with respect to our lung cancer program, the costly clinical validation testing was completed prior to the acquisition and we are now conducting the analytical verification studies and preparing the test for commercialization in our CLIA lab prior to lunch.

Selling and marketing expense for the third quarter 2014 was $5.5 million compared to $3.3 million in the same period of 2013. This increase was primarily due to increases in fees associated with the Genzyme co-promotion agreement, consistent with increases in cash related revenue, higher personnel and stock based compensation expense, related to greater headcount as we expanded our sales force, increases in marketing supplies and promotional spending and an increase in allocated costs.

I would note that our selling and marketing expenses for thyroid will continue to ramp through the end of the year as we prepare for the newly amended Genzyme agreement to kick in. In terms of our lung cancer test, we have begun to spend small amounts and expect these amounts to be modest through the next 12 months as we prepare for launch of this test. General administrative expense for the quarter ended September 30, 2014 was $5.7 million compared to $3.2 million in the same period of 2013.

This increase was primarily due to higher costs associated with operating as a public company, personnel professional fees and insurance expenses and other merger acquisition costs and increases in headcount and in stock-based compensation expense due to additional option grants to new and existing employees. I note that about $1.8 million flowed through our P&L this quarter related to the acquisition of Allegro Diagnostics, including one-time charges of over $1.2 million related to transaction bonuses and severance payments and over $500,000 in acquisition related costs, primarily legal, accounting and valuation related expenses.

We do not expect a material increase in G&A going forward as a result of the Allegro transaction. Net loss for the quarter ended September 30, 2014 was $7.9 million or $0.37 per common share, compared with a net loss of $6.3 million or $6.59 per common share for the same period in 2013. I would note again that there were one-time charges of approximately $1.8 million from the acquisition that flowed through to our net loss.

Further explanation of the acquisition is warranted. We closed the acquisition on September 16 for $17.1 million, comprised of $10.1 million in Veracyte stock or 964,377 shares and $7 million in cash. Of this cash amount, $2.7 million in cash was paid to the Allegro shareholders and $4.3 million of Allegro's outstanding indebtedness was settled in cash by the Company. The total transaction consideration of $17.1 million appears on our balance sheet as $16 million of in process research and development and $1.1 million of goodwill.

The IP R&D is now accounted for as an indefinite long-lived intangible asset. But once development is complete and the product is launched, amortization of the acquired IP R&D asset into earnings will commence. We now estimate that the acquired IP R&D asset will have a useful life of less than 20 years, but we'll determine the exact period at the time that development is completed.

Cash and cash equivalents as of September 30, 2014 totaled $44 million compared to $58 million at June 30. The decrease in cash was due to funds being used for operations, cash remitted for the Allegro acquisition and related acquisition expenses. Our total net burn absent the Allegro one-time charges and cash outflows was approximately $5.3 million.

I will now turn the call back over to Bonnie for closing remarks.

Thank you, Shelly.

In closing, I thought it would be helpful to preview some of the trends we are anticipating going into 2015. We would expect continued pricing pressure on cytopathology consistent with commodity testing trends. Our Afirma GEC reimbursement rates are expected to be relatively consistent with current rates, given that 50% of our testing will be under contract with the other 50% comprised of a large number of non-covering payers.

We expect the number of FNAs received will continue to grow at roughly the same pace we experienced in 2014 with GEC test volume continuing at a strong trajectory of over 50% year-over-year growth. Finally, I'd like to highlight the key near-term catalysts that we believe will drive our business in 2015. These include additional coverage decisions, specifically with more Blues plans and the issuance of final ATA guidelines, both driving continued Afirma growth.

In pulmonology, we expect publication of clinical validation data for our Asia studies, the commercial launch of our lung cancer test and the unveiling of data demonstrating the performance of our IPF classifier on clinical trans-bronchial biopsies, a key milestone on the path to commercialization for our IPF test. In short, we are very excited about the phenomenal upside we have ahead of us.

I'd like to now ask the operator to open up the call for questions.

(Operator Instructions).

Dan Leonard from Leerink Partners.

I'm [Ken Chen] filling in for Dan. My first question is, doing the math, it seems like you have a big increase in FNA in 4Q and I know there was a bit of impact on the network contracts. I was wondering if you have any other dynamics in play here.

Thank you for the question. We had a little bit of a hard time hearing you. I'll try to answer the question around the dynamics in Q4 and FNA volume and then come back if we didn't capture every one of those points in your question.

I think that when we look at Q4 and the full year and what we are expecting on FNA volumes, reiterating guidance on the FNA numbers, we're looking at the continued growth of the equivalent FNAs that come in the door, both continuing FNAs received for both cyto and GEC and a continued strong percent of those GECs coming in for the GEC only. Our estimation by the end of this year, is that we'll capture roughly 18% of the 525,000 FNAs performed. Could you repeat the other aspect of your question?

I was wondering, I know some of the uptick will be from the in-network contract, wondered if there are any other new dynamics in play that we haven't accounted for.

Okay. Something important to keep in mind with the contracts that we've entered with United and Cigna, those will become effective in Q4. But both of those payers have been fairly strong payers up to this point as well. Because, as you remember, the big gain in payments that we get are more when we transition them into coverage decisions from being non-covered payers.

We've had both United and Cigna now under coverage decisions for about a year and have been very effective at getting those claims paid at a pretty nice rate of payment. So in shifting those two payers over to contracts, we actually don't expect to see a big uptick in payments from those payers, because we've already transitioned for that big uptick moving from no coverage to coverage a year ago.

(inaudible) Maybe I missed it earlier, but (inaudible) anticipate the rollout, the lung products next year. What are your plans to drive adoption, [do an experience] you've had with the thyroid platform?

We're sorry to ask this. We must have a tough connection. Could you repeat that one more time?

I was wondering, given your experience with the thyroid platform, what are your plans to drive adoption of the lung products for the second half of next year?

A very good question. It will be a little bit of a different dynamic, especially on the reimbursement side as we bring that product to market. You may recall that when we launched the Afirma product back in 2011, we had the opportunity to build stack codes, which were basically a way of using existing CPT billing processes and capture the value that we felt Afirma was valued at through those stacked codes.

We had to shift away from that process in the first quarter of 2013 with the new legislation around payment. So, we will take the approach of launching the test off of very strong validation data, which will be submitted for publication, we expect, by the end of this year and choose sites that will be very strategic at sites beginning to commercialize the test; under which we will begin the development and collection of ongoing clinical utility data, which is part of the package of evidence that we expect to be required to get our early coverage and decisions made.

Right now, we are predicting, based on when we plan to introduce the test, that coverage would likely come in 2016 and that's why we have in the past said that meaningful revenue from the lung cancer test is likely to happen more in 2013. 2017. Thank you, Shelly. Just to reiterate the market opportunity, because as I said in the script, there have been some dynamics that have really unfolded very recently, that make us quite excited about the opportunity. And that has to do with these decisions to cover the uptick in screening of high-risk patients.

In the past, we have mentioned that we estimate about 250,000 bronchoscopies are done annually in the US on patients that have these suspicious nodules for cancer. With the influx of these patients that are high risk that will enter CT screening programs, this rate could actually more than double. With 40% of those estimated to be non-diagnostic today, it gives us a very substantial test population from which we will test these patients to help them avoid the next step of invasive procedures. So, we're very excited.

It's a very substantial, rich market opportunity for us. We have a great set of 29 investigators that have been involved in the studies that will be attractive sites to begin the commercialization. We think that once we get the early studies started next year for utility that we should be in great shape to get coverage for these tests to augment those otherwise unnecessary and added cost of unnecessary, invasive procedures.

Amanda Murphy from William Blair.

I had a question on Genzyme. I'm curious, can you give us some context around what percentage of your volume today or this quarter was generated by Genzyme? Then, some high-level commentary on how that's trended? I'm trying to get a sense, I know the new contract isn't formal yet, but wondering how that dynamic has shifted, if at all, given the new terms of the US-based payments.

I'm going to hand it over to Chris since he's been managing that transition.

Amanda, the way we've always gone about doing the commercialization with Genzyme, was that we did it together. The Genzyme reps worked on converting clients in conjunction with our reps. Because of that collaborative approach and that collaborative spirit that we engaged in, we never broke out the revenue that was generated from Genzyme or the revenue that was generated from Veracyte. We always collaborated and we split the revenue consistent with the revenue share.

As we moved towards this new arrangement, where we took on the sales process and Genzyme focused on identifying leads through their activities with their core compound; understanding the market well and talking about the product, then they would also do maintenance on the backend. We started that process of transitioning this summer after we had the discussion, after we renegotiated, had the high level agreement done. We started that transition and largely have completed that already, now.

So, we've been operating in a way where the Genzyme reps have been identifying leads and providing those leads to the Veracyte reps and the Veracyte reps have been focused on bringing them through the sales process and then on the backend, in ongoing relationships that we have with clients. Genzyme has been including those in their call cycle. That's gone really well. It's been really helped by the fact that we finally have a team that's built out, that's really starting to hit its stride this second half of the year and being able to talk about the product and et cetera. So I feel like we've really made -- warped through that transition as the second half of this year has gone on. (multiple speakers)

Just to add to that, in terms of some numbers, when you think about we entered the year with eight territories plus our management at the field level and now stand at 23 person sales team, 19 of those in the field. By the end of the year, we are projecting that we will have 16 territory sales reps. They will be complemented by six institutional channel managers to help us continue to accelerate in that part of the market, three regional managers and a VP. And they will be complemented with the full Genzyme team as Chris described on the front-end and back-end of the process. With that shift and our investment, just to reiterate, the overall fees, then are expected to drop to 15% of revenue in total from what has been 32%.

Sounds like, given you've managed the transition in advance, that we shouldn't think about a meaningful change. Obviously, the Veracyte reps are ramping. Overall, we shouldn't see a meaningful change in per rep productivity, if you will?

Yes. I think that's correct.

I think we've already gone through that transition. It was a relatively seamless transition to go through, quite frankly. We work so well together, that the teams have from the beginning, that it was really just a next phase of the relationship and flowed through very well.

Got it. Okay. Wondering if you could talk a little bit about the community of academic center dynamics. It sounds like that was pretty stable relative to last quarter, but tell us what you're seeing there. Obviously, you had a little bit of a shift there in terms of where the volume was coming from. Any thoughts there? And thinking about going forward, how that might trend.

Absolutely. Historically, due to vacations and such, Q3 is usually typically a fairly flat quarter in terms of volume. But we did see a greater than 7%, actually, of the GECs come in the door from [institutions] only. The number of those samples continued to edge up because it is a percent of a large number of samples coming in the door. We don't expect any big jumps in that any time soon.

To reiterate, the 20% to 22% rate of GEC test volume that we have talked about in the past, given that the indeterminate rate can still fluctuate plus or minus a percent here and there, net-net that's still a good range to think about; and we've been, obviously, on the upper end of that. In terms of growth, GEC only samples coming in the door, we're 73% over prior year.

So as we continue to penetrate that market where today we have a fairly small market share compared to our share in the community-based practices, we think we're very set going into the last quarter this year and into next year to see continued acceleration in both of those markets. But we think the shifting has settled out

Got it. Last one. I don't think I heard it, but the accrual revenue in the quarter?

Yes. The accrual revenue in the quarter was just about 25%. You remember that last quarter it was about 30%. That was, in large part, due to larger payments from the unaccrued payers. So we do have lumpy revenues on a cash basis. To the extent that a lot of that comes in on a cash basis, it will work those numbers a little bit. We did mention that United Healthcare and Cigna came in under contract. But, it will take probably several quarters for us get the historical payment patterns to be able to move to accruals. So those are not, obviously, accrued at this point.

Okay. Thanks very much.

Bill Quirk from Piper Jaffray.

First question for me, Bonnie, is concerning a topic that's been around the lab space here for while. In terms of LDT regulation, we're at amp currently and it certainly sounds like the FDA is digging it's heels in here, in terms of pushing forward with that. I'd love to hear your updated perspective on how Veracyte is thinking about that.

Right. Yes. I think that FDA has made it very clear that they do want to push forward with some level of regulation. I think that pending some of their more recent meetings and interacting with them a bit on this, I don't think any surprises, yet. They are intent on figuring out the best risk-based approach to try to move forward with. I think [they've] also committed to the laboratory industry, that they will, in fact, try to resolve some of the more challenging disconnects between, regulating an IVB manufacturer and a laboratory service provider, under a pathologist's direction before issuing final, final guidance.

So, we and others alike, continue to be involved in the conversation and continue to try to use case studies to flesh out how these could be applied, but not impact the level of innovation and the level of testing that's being offered to patients that otherwise would not be able to happen.

They issued the draft guidance October 1. We are expecting a minimum of 90 to 120 days for comment period. We expect many of the stakeholders across the industry will submit comments and try to refine and improve on the details and specifics of what we will be will regulated to. I think we are part of that process and believe that the work that we do and the studies that we've done will withstand the regulations once they get established.

Understood. Shelly, thank you so much for the early color on the 2015 topline and the mechanics, but I'll go into that. I was hoping you could touch a little bit, particularly considering there's the timing associated with the Genzyme change, here. Recognizing that you are building out your own team to supplement that, nevertheless, could you help me think a little bit about [pulmonarily] anyway, how we should be thinking about cash burn for next year?

Shelly, why don't you take that?

If you look at our cash burn for this last quarter, it's a little bit obscured because of the Allegro transaction. If you strip out the amounts that we paid in cash to Allegro, the burn was about $5.3 million. In the last quarter, for comparison sake, it was about $6.2 million and the first quarter about $7 million. So you see that's been going down. We would expect that, given our continued investment in sales and marketing, our own feet on the street, et cetera, we will spend more from our perspective.

We will be adding a small amount of sales and marketing for lung, a very small amount next year. I think, in aggregate, the dollars go up absolutely. As a percentage of the revenue, it will go down over time.

From an R&D perspective, I think you should realize that the clinical validation studies for lung cancer have been done and therefore the clinical utility analytical verification and [clutch] that will take place in the lung cancer product for next year will be fairly low, relatively. We will spend on the amounts for the IPF studies and those are the higher costs for the R&D side. In G&A, we would expect to grow somewhat, but remember there's $1.8 million in there from this quarter that we will not experience in the future. That was because of the Allegro transaction. Again, the Genzyme fees are going down from 32% to 15% and that helps us from a burn perspective.

I think those are the critical facts. One other small piece is that the Genzyme -- you may recall in the past -- we had deferred some of our payments to Genzyme. Counteracting some of those reductions over time in our burn, as we have more top line flowing to the bottom, we will have to have a few of those makeup payments. I hope that gives you enough to sort of estimate future burns.

That's great. Thanks so much.

Doug Schenkel from Cowen and Company.

This is Chris on for Doug today. To start, I think while both FNA volume and revenue grew on a sequential basis this quarter, I think GEC volume may have actually declined slightly Q over Q. Is this right? If so, can you talk about the drivers of the Q over Q decline? I know there is some seasonality, but given the higher revenues, FNA volume, and success at institutional accounts, I'm just trying to reconcile the decline.

We haven't given out specific details of rates of test volume. But actually, our GEC test volume grew about 4% quarter over quarter and as I said, 45% over prior year. The GEC only samples coming in the door being over 7% of FNAs received actually grew 10% over prior quarter. So we are still seeing very strong GEC growth.

Okay. I think earlier this year you accelerated the pace of hires for your sales force and you are making strong progress, but the [ten incremental] hires since you announced the updated Genzyme agreement. It takes a few quarters for the sales reps to become productive, but I think we are nearing that point for the earlier hires.

Keeping in mind that you had several (patients) where there's educational (inaudible) earlier this year and you're making good progress with contract (inaudible), is it a reasonable assumption to expect 2015 revenue growth, understanding you are providing guidance at this time to accelerate relative to 2014 revenue growth rate?

We won't be giving revenue guidance until our Q4 call. But in terms of pace of the hiring, yes, we are very much -- in fact, a little bit ahead. We thought at the of Q2 that we would be adding 10 sales and marketing heads by the end of the year and we actually already have seven of those on board and trained. The reps that we hired at the beginning of the year, where we had the large-scale of hiring definitely have hit their stride and are adding FNA conversions consistent with what our more seasoned reps have added.

So we are expecting to come into the year with a very full, well trained, and full coverage team across both the community and the institutional accounts. Again, by having that layered with the entire Genzyme team, continuing to play the front-end and back-end of the maintenance role, we feel like we'll be coming into 2015 with a very strong position.

Okay. Lastly, you noted modest increases in sales and marketing expense over the next 12 months for the lung cancer test. Can you provide additional commentary and what is being done there?

Yes. There's some market development work that always has to begin in advance of sales and marketing at branding, as an example. We have to design the collection kits and do some work on that front. The planning for the sales training, the types of sales, how we will position the product, the process of selling into, in this case, more institutional accounts, which will give us a little bit of leverage on the institutional work that we have strengthened on the thyroid side; but it will be a new channel that we will be building.

That's all happened concurrently with the work that has to be wrapped up on the analytical verification studies and the work to get our CLIA laboratories certified and be able to commercialize and offer the test. So it will remain at a fairly low level, as Shelley said, for the course of that work. And given that we will not have immediate reimbursement or coverage for the test, we will begin the process, we believe, similarly to the way we launched Afirma, where we will seed the market in very specific territories and specific accounts upfront and build a slow ramp to the broad access. Very similar to what we did in thyroid, which we thought worked very, very well.

Okay. Great. Thanks for taking my questions.

Steve Beuchaw with Morgan Stanley.

Bonnie, I wondered first of all, if you could help think about the path forward in terms of the continued accumulation of covered lives. You mentioned again that the Blues are an important target. Do they come along in chunks or is it a few million here and there and how to think about how that progresses?

We've made, as you know, great progress in getting the covered lives. But the big hole in our success are two major Blues players that jump out because they cover such a substantial number of covered lives and that would be WellPoint and HCFC. We don't expect those, necessarily, to move in a group. We have a lot of activity and effort under way to bring the latest data and continue to work those systems. We were successful at getting 10 million lives under coverage, actually in Q2, which was a big nice step into the Blues.

But, because those Blues plans cover about 30% of our patient load, that's why, as we think about GEC reimbursement substantially increasing in any way going into next year, we would caution. Because the majority of our contracted rates will come from payers that have paid very well because they have been under coverage for a year and we have done a very good job of getting those paid at high rates under appeal. So we won't see a big pickup from those.

Since a large number of the Blues are still uncovered, they tend to be, obviously, our weaker payers and it takes us a lot longer to collect the cash from them. Net-net, when you balance those two out, we want to help you think through how that will look as we think about a per GEC reimbursement going into 2015. When we are successful at getting the Blues under coverage, that then could be a catalyst for change and ultimately, there's more contracts that we can get.

As we move people from coverage to contract, we wouldn't expect a big uptick because we typically would have a payer at the higher rate of payment after coverage before we would enter into those discussions on contracting anyway. The benefit to contracting is more being an in-network provider, which will open up more sites, more physicians comfortable using the test. And ultimately, as Shelly said, once we get predictability of payments, it will help us smooth out the lumpiness of our cash-based revenue today.

Got it. Really helpful. On the malignancy classifiers, I wonder how you think we might consider the contribution to malignancy classifiers now that we've seen them all in the market here, albeit briefly, into next year. Thanks so much.

The malignancy classifiers were predominantly launched, as I'll remind you, to really offer the only full solution for managing every patient, that is presenting for work-up on a fibroid nodule. Once we move the benign patients to watchful waiting, many times the physician wants some additional indication on whether a full or a partial thyroidectomy would be most appropriate for the patients going to surgery. So in May, we introduced the malignancy classifiers to aid in that question.

We have up always totalled the total potential market for that product to be relatively small, probably about 10% of what the GEC market is, for example, in the US. But it has two benefits. One being it does provide greater value, which was built into our price increase of the GEC last January and the overall value that the GEC delivers. And it also answers that additional question, so that instead of thinking about using competitive products to answer questions before going to surgery, we can now offer the full solution.

But we are still working through with these products, the publication strategy, getting validation studies and more of the utility studies published, which we will have to do to ultimately get those under coverage. We would expect that to take some additional time as it hasn't yet happened since we launched the product. Those will move, as the GEC did, onto coverage decisions ultimately and we should be able to get some additional revenue out. It will take time for that to happen in and the additional revenue, in context of GEC revenue, will be small in comparison.

Great. Bonnie, Shelley, thank you so much.

Paul Knight from Janney Capital Markets.

It's Brian Kip on behalf of Paul. Have a couple quick follow-ups. One was in regards to the accrual revenues, but looking on a back-dated basis. I know you had some GEC tests that you are still arguing with for pay coverage. In light of the context of the in-coverage network here, the 100 million lives, can you give us any color on that backlog and the potential for that to convert over time? Is it sizable or is it something that you think could be a bolus in the first half of next year? Or does it continue to run Q over Q as you start to accrue things?

Think about, for the 100 million contracted lives at this point, about 52 million of that is for the Medicare. That's been consistent and that is accrued at this point, both the GEC as well as the patient portions of those. So that's consistent. As for the additional lives, which we've just announced, that will take several quarters to be able to have those come into the accrual basis when we have predictability. I think one was 27 million and one about 13 million.

Those are the other big ones. There are a few other payers that have smaller regional payers who have contracted and we continue to evaluate every quarter, which of those are predictable in their payment schemes. In terms of how much of a pickup you would expect, in terms of timing and such, once they get into the coverage decisions, we find that they're paying pretty consistently between three and four months as opposed to the more traditional eight or nine months or even longer.

So if you're getting most of those payments in a quarter, you're not going to see huge pick up when you split from the cash accounting to the accrual accounting. It will help us because we'll have better visibility in any one quarter. We won't be waiting until the end of the quarter to see where the cash comes in. But you should not expect a huge bolus of bringing forward into a particular quarter because we flip somebody from the cash basis to the accrual basis.

We would expect -- I mean, we are down at 25% this quarter, which is lower than the traditional low 30%s that we've had for the last several quarters. I think, over time, you would expect that that would move up into more like the 50% to 70% range. You're never going to get to 100% accrual because you have a lot of small payers who will always be on a cash basis. So I hope that answers most of what you were asking.

Yes. All the backlog stuff too will be accrued as is at that point when you guys recognize it. As well as going forward.

No, so If United was being treated under a cash basis and we still have some payments due from them, say, this quarter or next quarter and they haven't paid some of those, yet, those would still be under a cash basis. We'll continue under a cash basis with this new start date of the date at which they begin the contract and then we'll have to see how the predictability of the collections goes under that new regime and the new rates.

So, you have to forget about the past history. You have to look forward. We won't go back and accrue anything from historicals, et cetera. We'll actually wait for several months or quarters to be able to predict that under the new regime they are now paying at that contracted rate and we understand how much goes to the patients to pay, et cetera.

In addition, I think there was some color commentary talking about FNA samples on an outward basis growing at a similar rate, maybe a little bit of a decrement year over year next year. The maintenance of the GEC growth rate on a year-over-year basis into 2015, trying to get some color around that penetration of the institutional clients. How long do you think that tail will last where you can support the GEC only market at a 50% year-over-year growth rate, when you have 525 potential in that? I think, within that, what is institutional, like 30% to 40%? Trying to think about that over the long-term, GEC only test growth rate

I think a few things. Just to remind the market split in the way we look at the two markets. We estimate about 60% to 65% of the market is in the ambulatory sector. That market is where we get the cytopathology, typically. But also, the GEC comes with that as a reflex. When we predict out that we believe the GEC volume will exceed a 50% year-over-year growth, that's growth that GECs will come from the cytopathology reflex as well as the GEC directs that come from the enabled labs, which are predominantly institutions.

The institutional market makes up about 30% of the overall market, academics another 10%. We have done very well at penetrating the ambulatory market. We would estimate probably low 20% market share in that market this year, where the institutional market share will be more like, say, 10% to 12% when you look at equivalent FNAs and how they break out across those two.

The reality is, as we continue to have a tremendous amount of growth opportunity ahead of us in both segments of the market, and we believe have positioned ourselves with the new selling team and the new structure with Genzyme to effectively grow in both of those segments at good pace. So with that, we're predicting a little bit ahead of this year's growth rate on FNAs that come in for both cytopathology and GEC. That will continue to grow nicely. But, that we'll get a little pickup in the GEC as a result of the accelerated add of the GEC only from institutions.

It's Chris. I would add that this was the sector that we had largely ignored. We had only really handled it when people reached out and wanted access to the product. As we started to see that tremendous growth in Q1 and Q2 and we talked about that in previous calls, it was starting to become clear that that market was starting to explode. We've gone from having one channel manager focus on that and at the end of this year we'll have six channel managers focusing on that across the country.

So we staffed that commercial organization to focus on that hospital segment pretty aggressively going forward. Because we believe that it's not an area that we've really focused on or tapped, so we're really excited about pursuing it aggressively.

Appreciate the color, guys. Thanks again.

(Operator Instructions).

Zarak Khurshid from Wedbush Securities.

First on the collection efficiency, building on the last question, how many of the GECs performed in the quarter are actually getting reimbursed in the quarter, currently? How has that been trending?

The way that we model out reimbursement is that on the cash side, so as Shelley said, we still accrue predominantly just Medicare. Medicare, as we've said, from a test volume standpoint, makes up somewhere between 21%, 22% of the test volume. So that revenue is booked in the quarter that the samples are run because it's accrued. The remaining part of the revenue actually has quite a lag. It's one of the reasons that the business is quite challenging to predict to a precise level of accuracy.

It's because the cash comes in at varying levels from various payers and at various points in time. As you think about a United and a Cigna that has now moved under contract, they will probably be paying us under the cash basis even without contract, at probably the best rate, but it would still take three, four, six months to collect that cash payment. The revenue would not be recognized until the cash comes in the door.

At the other extreme we still have, as we said, some of the Blues and other plans that still not moved to make coverage decisions yet and those would be our lowest level of payers. Those, we would collect a smaller amount, but it also could take a very long time to collect. As an example this quarter, we have still been collecting on claims that may have been submitted in the early part of 2013.

As we model it out, we take the test volume and then have to model and predict; the percent that's accrued is the easy piece and for everyone else, the percent of that test volume by various payers, how much and how long we expect to take it to be collected. That's the reason that predicting the cash in the door and the lumpiness of all of that is a bit of a challenge.

Zarak, the one other thing I would say is one of the numbers that I had in my prepared remarks, was that if you combine everything, the blended GEC reimbursed amount with payments from all payers, from Medicare, which is known at $3,200 all the way to those who pay nothing and those who pay everything, the blended rate is just above $2,100 at this point. That is after a lag to collect. We look at that number over two or three quarters after the test has been produced. So that's marched up over time. But that is, I think, where we feel like there may not be a lot of change over the next year from that rate.

Got it. That's very helpful. At a high level, where do you think this business is going over time? Do think it's reasonable to expect 90% of payers to be on board and paying at a significantly higher level than this $2,100 average level?

Yes. We've always realistically sized a market using what we believe to be, ultimately, a very fair reimbursement rate of around $3,500. We definitely believe the business can get there. The Blues are the big plans right now that hold that back because they haven't covered yet and they cover a large percent of the patients. We'll continue to push that forward. We're very confident that we will get there.

In fact, we would hope that next year we would make a lot of progress with the Blues. So we'll continue to drive up the rate. We will continue to focus on getting that under our contracted rate, so that ultimately we can have predictability that allows us to accrue. That will probably never get, as Shelley said, to even the 80% level. But, realistically, we could get to 60% to 70% rate of accruing over the next couple of years. Ultimately, I believe we can penetrate 60%, 70% of the sizable market opportunity.

Got it. Thanks for that. Last question for Chris. How many of the total potential ordering US customers have you touched at this stage? Where are the gaps, if any and what is the pushback from those docs that may still be holding out? Thanks.

We think, as Bonnie was saying about 60% to 65% of the samples are done in the ambulatory setting. To mass that group in general, that group in general is serviced by about 3,500 endocrinologists. The rest of it, which is in a hospital situation, is largely serviced by radiology labs and hospitals. We've barely gone at the hospital segment. We just started that process.

Of the 3,500 targeted endocrinologists that we would go after for that 60% to 65%, we have had about 1,200 of those folks that have ordered from us this year so far. So we've got a long ways still to go within that group. We continue to work on them. I think there's always a group of people that lag in these adoptions. I think the guidance, the guidelines being published will certainly help as the final guidelines come forward, and get published.

The other thing that really holds physicians back, is that while we've been covered, we haven't been in-network and there's a lot of barriers in the healthcare system that hold back doctors from ordering tests from out-of-network providers. Insurance companies discourage it. They really push down on physicians that are doing that.

One of the reasons we are really excited, other than the revenue assurity that Shelly talked about from getting into contracts and ending some of that lumpiness from those payers, it also opens up those networks to physicians that quite frankly, are reluctant to order tests that are out-of-network or from labs that are out-of-network. We think, as we get these contracts locked down, it really opens up segments of the market that have been locked out to us before.

Makes sense. Thanks.

I'm showing no further questions. I would now like to turn the call back over to Bonnie Anderson, President and Chief Executive Officer for closing remarks.

Briefly, thank you all for joining us today. We really appreciate your ongoing support of our mission and our business and we look forward to seeing many of you at upcoming meetings. Thank you.

Ladies and gentlemen, that does conclude the conference for today. Again, thank you for your participation. You may all disconnect. Have a good day.