ILIU: Major Overhangs Relieved. Study Published, Financing Complete

Zacks Small Cap Research

By Brian Marckx, CFA

2013:
  Big Capital Raise and Publication of Study Relieves Major Overhangs…

Interleukin Genetics (ILIU) reported financial results for the second quarter ending June 30, 2013 on August 14th.  Q2 revenue was significantly better than our estimate although operating income came in lower on increased spending on marketing activities related to the PST test.  There were some very meaningful highlights in the quarter, all of which bode well for the anticipated upcoming launch of the PST test.  Two of the most critical issues that needed to be addressed, those being securing additional financing and getting the PST study results published, are now done.  This relieves a significant overhang in our opinion.

In May Interleukin raised $12 million (gross) through the sale of 43.7 million shares of common stock.  This relieved the impending liquidity crunch as a result of the Pyxis credit facility being fully tapped.  Now the balance sheet and capital structure are cleaned up.  Along with the financing, the $14.3 million balance owed under the Pyxis facility along with all of the outstanding preferred stock was converted to equity, leaving no debt or preferred stock outstanding.  The financing and conversions did increase the basic outstanding share count by approximately 85 million shares, however.  Nonetheless, we view this as a major positive as the cash balance should provide sufficient liquidity to fund operations well into 2014 when we expect the PST test to be generating meaningful revenue.

The other major recent event was publication of the data from the University of Michigan PST study in June in the online version of the Journal of Dental Research.  As a reminder, a prerequisite for RHSC to begin marketing dental plans which provide reimbursement for the PST test was for a paper to be published in a peer-reviewed journal by May 31st.  With that now accomplished, the expectation is that RHSC affiliates will be marketing these plans to their customer base for coverage starting on January 1, 2014.

Management noted on the call that since the study publication that they have already received positive feedback from key opinion leaders on the PST test.  Interleukin is also focused on building awareness about the PST test which should complement's RHSC's marketing efforts and facilitate the chances for a strong launch.  The company recently hired a Chief Marketing Officer to spearhead the introduction and launch of PST and to generate early awareness.  Interleukin is already making headway with awareness building in an effort to introduce the PST test to dental professionals across the country.  In early August the company published a guest editorial in the Journal of the American Dental Association, which reaches over 200k dentists, titled Personalized Medicine Enters Dentistry: What Might This Mean For Clinical Practice.  The company also expects to be very active in attending and presenting at key dental industry conferences and events to help their awareness building efforts.  This includes the annual meetings of the <_st13a_placename _w3a_st="on">American Academy of Periodontology, the American College of Prosthodontists and a presentation at the National Institutes of Health which is expected to have several hundred dentists in attendance. 

Revenue

Q2 revenue of $852k was up 7% yoy, up 75% sequentially and about 68% better than our $508k estimate.  The majority of revenue continues to be generated from sales of the Weight Management test.  Since Amway began bundling the test as part of its promotional product bundle, sales of the test have been less regular q-to-q.  And while we think there's potential for future growth of the test, we view the PST and osteoarthritis tests as the major catalysts for long-term revenue growth of the company. 

GM / Operating Expenses / EPS

GM was 42% versus our 39% estimate.  Operating expenses were $1.8 million, meaningfully higher than our $1.2 million estimate as a result of the aforementioned PST test marketing expenditures.  Net loss and EPS were $1.8 million and ($0.02), compared to our $1.1 million and ($0.02).  ILIU recorded $287k in non-cash interest expense in the quarter related to the valuation of warrant liability from the financing in May.   

Cash

Cash used in operations in Q2 was $1.4 million, excluding changes in working capital cash used in operations was also about $1.4 million.  ILIU exited Q2 with $10.8 million in cash and equivalents, representing about 7 - 8 quarters worth of cash at the current burn rate, which should get them well into when the PST test is commercialized.   

Product Update

We think management remains intently focused not only near-term commercialization of their late-stage pipeline but also on reviving the recent lagging sales of their weight management test.  While the main and most important focus right now is to get the PST test commercialized and supported by dental insurance reimbursement, the osteoarthritis test which could have enormous potential, particularly (at least initially) as a companion diagnostic in drug development clinical trials, could be next in-line as a revenue driver for ILIU.

> Weight Management Test:  per the agreement signed last year with Amway Europe, the test became available in certain parts of Europe.  ILIU receives a royalty for each test sold.  Relative to the Amway (U.S.) bundled weight loss product, while it's currently unknown how this may affect sales over the long term, management remains focused on reviving growth of the weight management test (and the other Inherent Health products).  

> Osteoarthritis Test:  the game plan continues to be to collaborate with a partner to bring the test to market.  A paper with findings of the company's (in collaboration with Univ of North Carolina) 1,154-patient study validating the test as a predictor of progression of knee osteoarthritis was submitted for publication.  Following publication ILIU will seek to partner.  The test could have enormous potential value as a companion diagnostic in enrollment selection of clinical studies for the development of drugs to treat osteoarthritis, currently a huge unmet need.  

> Periodontal Disease Test (PST):  As a reminder, positive top-line clinical trial data of their PST test was released in early August 2012.  ILIU recently penned the initial agreement with Renaissance Health Service Corp (RHSC) relative to reimbursement of the test.  The dental plans covering the PST test will reimburse for one cleaning per year as standard or two cleanings if the PST test determines the patient is at high risk of periodontal disease. With the UofM PST study published in the Journal of Dental Research in June, that prerequisite has been met and RHSC's affiliates (Delta Dental) will market dental plans that cover the PST test to their customers.  The next steps involve Delta Dental putting together the marketing material and selling the plans for plan periods beginning Jan 2014 to their customer bases (which initially covers 8 states).  If all goes well, the Delta Dental plans incorporating the PST test will be finalized and plan participants will be notified by mid-to-late this year for those policies that renew in early 2014.  ILIU noted that they are already preparing for the roll-out which included increasing processing throughput of their lab to handle the anticipated increase in demand.

Management noted on the Q2 call that since the study publication that they have already received positive feedback from key opinion leaders on the PST test.  Interleukin is also focused on building awareness about the PST test which should complement's RHSC's marketing efforts and facilitate the chances for a strong launch.  The company recently hired a Chief Marketing Officer to spearhead the introduction and launch of PST and to generate early awareness.  Interleukin is already making headway with awareness building in an effort to introduce the PST test to dental professionals across the country.  In early August the company published a guest editorial in the Journal of the American Dental Association, which reaches over 200k dentists, titled Personalized Medicine Enters Dentistry: What Might This Mean For Clinical Practice.  The company also expects to be very active in attending and presenting at key dental industry conferences and events to help their awareness building efforts.  This includes the annual meetings of the <_st13a_placename _w3a_st="on">American Academy of Periodontology, the American College of Prosthodontists and a presentation at the National Institutes of Health which is expected to have several hundred dentists in attendance.

University
of Michigan PST Study

In August 2010 Interleukin announced an agreement with the <_st13a_placetype _w3a_st="on">University of Michigan for a large study to test whether certain risk factors, including genetic variations, can help guide better medical intervention of periodontal disease and improve patient outcomes. Funding for the study was provided by Renaissance Health Service, parent company of a large and diverse set of insurance companies focused on dental health. A new version of Interleukin's PST test was used in the study for identification of predictive risk factors of periodontal disease to confirm results of earlier studies. The prospective study examined 16 years worth of data from over 5,000 patients taken from a large dental claims database. The hypothesis for the study was to determine whether more than one dental cleaning per year is value-added for low risk patients and how many cleanings are optimal for high risk patients. Primary endpoint of the study was tooth loss at 10 and 15 years. The study was the largest ever done to evaluate the application of genetic information for the prevention of periodontal disease.

The study commenced in late 2010 and top-line data was released in August 2012. The data showed exactly what Interleukin had hoped, that high risk patients are likely to benefit from more than one cleaning per year while low risk patients are not.  Specifically the data showed that there was no significant difference between two dental cleanings and one dental cleaning in reducing the number of tooth extractions in the low-risk patient population (13.8% vs. 16.4%, 95% CI, p=0.092).  By contrast there was a significant difference between two dental cleanings and one dental cleaning in reducing the number of tooth extractions in the high-risk patient population (16.9% vs. 22.1%, p=0.002).

Per the trial protocol, high risk were categorized as having one or more of the following risk factors; smokers, diabetic or interlukin-1 genotype (ie - PST test positive). Low-risk was categorized has having none of these risk factors.  Of particular interest is that the data also shows a highly significant (p
In early June 2013 the study, titled, Patient Stratification for Preventive Dental Care, was published in the online version of the Journal of Dental Research. 

 

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PST Test market:. Approximately 200 million Americans go to their dentist every year, representing about 400 million total visits with 75% related to regular exams and cleanings. Based on the large market size, the prevalence and potential seriousness of periodontal disease, support from clinical studies that the PST test works, vast distribution (via Renaissance) and support from significant use in clinical practice we think that the test may offer a multi-million dollar opportunity for Interleukin. Using rough estimates the periodontal disease market could be worth as much as $8 billion to Interleukin (assumes 200MM tests at $40 net (our estimate) to Interleukin per test). Capturing just 10% of this (which might be very conservative) equates to an $800 million potential market.  Renaissance Health alone, through its family of companies including Delta Dental, touches as many as 54 million covered lives, which is a great start.   


We note that ILIU already has a similar PST test commercialized but that the cost of the test (~ $150) is borne by the consumer, which limits its use.  Reimbursement from dental insurers could be a huge catalyst to driving demand and adoption for the test - as such, this agreement with RHSC could be the beginning of a new inflection point for ILIU.  Periodontal disease is preventable and treatable and if diagnosed earlier, the better likelihood of improved outcomes. The test has already been used over 10,000 times in clinical practice. Interleukin notes in their literature that its PST test is one of the top ten genetic tests in terms of volume and one of the first of a new generation of predictive genetic tests for common diseases in medicine.

Maintaining Outlook

We think it's likely that ILIU's suite of currently commercialized products will experience only flat to moderately positive sales growth, which is unchanged from our recent previous assumptions and that the major future growth driver of the company lies with its PST test (and potentially other pipeline tests including their osteoarthritis test).  

We are maintaining our Outperform rating and $1.30/share price target.

A copy of the full research report can be downlo osteoarthritis test).  

We are maintaining our Outperform rating and $1.30/share price target.

A copy of the full research report can be downloaded here >>  Interleukin Report


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