Mixed 3Q for Genomic Health

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Genomic Health (GHDX) reported third quarter 2012 net income of $3.7 million, up from $3.2 million in the year-ago period. The company’s reported earnings per share (EPS) of 11 cents surpassed the Zacks Consensus Estimate of 6 cents, and were a penny higher than the year-ago quarter results.

Total revenue in the reported quarter climbed 13% year over year to $58.6 million, but missed the Zacks Consensus Estimate of $60 million. Product revenues climbed at the same pace to $58.4 million in the quarter, while Contract revenues accounted for the balance. The improvement in product sales was mainly on the back of significant international growth with diversification of business and successful utilization of an important global opportunity. In the reported quarter, Genomic provided more than 18,030 Oncotype DX breast cancer test results representing a growth of 7% year over year.

Gross profit increased 15.7% year over year to $49.6 million with a 225 basis point (bps) improvement in gross margin to 84.6%. However, a 16.3% rise in operating expenses to $45.9 million led to a 20 bps contraction in operating margin to 6.3%. The rise in operating expenses was based on higher research and development (27.6% to $12.2 million), selling and marketing (6.8% to $21.5 million) and general and administrative (24.9% to $12.1 million) expenses.

In the fourth quarter, Genomic expects operating expense to increase by $3 million as the company plans to keep on investing in its global commercial business as well as work on the market release of Oncotype DX prostate cancer test in the first half of 2013, and incur expenses related to the San Antonio Breast Cancer Symposium. All these are likely to keep margins under pressure.

Recommendation

Although Genomic derives the majority of its revenues from Oncotype DX breast cancer test, contribution from the colon cancer test should gradually improve with additional reimbursement decisions. We are also encouraged with the company’s third-quarter performance. However, the expansion plans involve higher expenses, which in turn will adversely affect margins. Besides, over the recent past, we have witnessed a lot of activity in the market targeting this specific niche of genetic sequencing. Life Technologies (LIFE) and Illumina (ILMN) are among the significant players in this business.

The stock carries a Zacks #3 Rank (“Hold”) in the short term. Over the long term, we maintain our ‘Neutral’ recommendation on Genomic Health.

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