Executives: Doug Sherk - EVC Group, IR Nancy Lurker - President and Chief Executive Officer Graham Miao - Chief Financial

Officer
Analysts: Scott Henry - ROTH Capital Partners Roberto Fatta - William

Blair
Operator: Greetings and welcome to the PDI Inc. Second Quarter 2015 Financial Results Conference Call. At this time all participants are in a listen-only mode. A question and answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded.

I will now like to turn the conference over to your host, Mr. Doug Sherk. Thank you. Mr. Sherk, you may begin.

Doug Sherk: Thank you, Tim. Good afternoon, everyone. Thank you for joining us for the PDI conference call to review the company's financial results for the second quarter which ended on June 30, 2015. The news release detailing the second quarter results was issued just

after 4:00 pm Eastern and is now available on PDI's Web site at www.pdi-inc.com. In addition, an archived replay of the event will be available on the PDI Web site.

Before we get started, during the course of this conference call the company will make forward-looking statements. We caution you that any statement that is not a statement of historical fact is a forward looking statement. This includes remarks about the corporation's financial projections, expectations, plans, beliefs and prospects. These statements are based on judgment and analysis as of the date of the conference call and are subject to numerous important risks and uncertainties that could cause actual results to differ materially from those described in the forward-looking statements. These risk and uncertainties associated with the forward-looking statements made in this conference call and webcast are described in the Safe Harbor statement in today's news release as well as PDI's public periodic filings with the SEC, including the discussion and the Risk Factors section of our 2014 Annual Report on Form 10-K and our Quarterly Report on Form 10-Q for the period ended March 31, 2015.

Investors or potential investors should read these risks. PDI assumes no obligation to update these forward-looking statements to reflect future events or actual outcomes and does not intend to do so. In addition to supplement the GAAP numbers, we have provided non-GAAP information. We believe these non-GAAP numbers provide meaningful supplemental information and are helpful in assessing our historical and future performance. A table reconciling the GAAP information to non-GAAP information is included in our financial release which is available on our Web site.

Now I would like to turn the call over to Nancy Lurker, President and Chief Executive Officer of PDI.

Nancy Lurker: Thank you, Doug. Good afternoon, everyone and thank you for joining us for a review of our 2015 second quarter results. Joining me today on the call is Graham Miao, our Chief Financial Officer. I will begin the call by recapping the second quarter results for both our commercial services and molecular diagnostic businesses as well as provide an update on recent corporate developments.

Graham will then review the financial highlights from the quarter and comment on our full year outlook. We are capitalizing on the momentum built over the previous six months in both our commercial services and molecular diagnostic businesses. Our second quarter total revenue grew 15% year-over-year. Our commercial service business continues to improve its results with an increase in revenue of 10% versus the prior year. We are also beginning to generate tangible results from Interpace Diagnostics.

Revenue showed slight sequential growth but more importantly, total test volumes grew by 19% over the first quarter. As a reminder, Interpace Diagnostics revenue includes only a limited contribution from our recently launched thyroid tests as well as a lag in collections from PancraGen. Beginning with our commercial service business, we began the year with excellent results and we carried that success over into the second quarter. Commercial services revenue grew by 10% over the previous year while gross margins returned to normalized levels after the strong first quarter. Our strategy remains the same which is to focus on delivering first class results to our clients based on our team's commercial expertise and proprietary offerings like PD1, while leveraging our active pipeline for new business.

Our commercial team executed its strategy and generated additional new, multiyear contracts with cumulative value of approximately $45 million with more than 45% of this value expected to be recorded as 2015 revenue. Our new contracts cover the healthcare industry spectrum from pharmaceuticals to medical devices. As we look forward to the second half of the year, we continue to see an active and solid RFP pipeline of approximately $275 million, up from the first quarter of this year and in line with year ago levels. The excellent performance from our commercial service team in the first half of the year was also reflected in their ability to collect close to 100% of their incentive fees. The team's ability to deliver exception results sets them apart from our peers and we look forward to leveraging our industry knowhow as we continue to bring Interpace Diagnostics products to the market.

Speaking of Interpace, we continue to make traction in growing our brands to increase test volumes, new managed care coverage and significant clinical data. We have three commercialized molecular diagnostic assays on the market. The first is PancraGen, the first and only molecular test commercially available in the U.S. for the diagnosis and prognosis of pancreatic cancer from cysts. As I will discuss in a moment, new clinical data has reinforced or belief that the test has the potential to lower pancreatic cyst related healthcare costs by reducing the number of unnecessary pancreatic surgeries which are highly invasive, carry a high morbidity and even a mortality risk.

Recall that approximately 80% of these pancreas surgeries are not necessary due to most cysts being benign. Our next two tests, ThyGenX and the recently launched ThyraMIR, provide what we consider to be the best in class option for determining benign or malignant thyroid nodules. When doctors order ThyGenX and ThyraMIR, they are gaining unprecedented accuracy with established clinical evidence. This excludes a combination of high-sensitivity with high specificity, provides the physician with unique ability to both rule in and rule out cancer from once specimen sent to our lab. ThyGenX and ThyraMIR combined ultimately lead to fewer high risk and costly surgeries to remove what are too often benign nodules.

Since our launch of ThyraMIR in April, we have seen a substantial test volume uptake and multiple payers agreeing to cover one or both tests. In total, our combined test volumes for the second quarter were approximately 2000, up from 1650 tests in the first quarter or a 19% improvement. As of this call, the total combined lives covered for our three tests are approximately $100 million. We recently received a favorable coverage decision from Aetna for ThyGenX as well as we just announced three other major new managed care wins. Two of these are for PancraGen and one is for the combination of ThyGenX and ThyraMIR.

I will provide more color on this development in a few moments. In addition to our three commercialized tests we also have BarreGen, a molecular diagnostic for Barrett's Esophagus. As a reminder, Barrett's Esophagus affects over 3 million Americans and is associated with an increased likelihood of developing esophageal cancer. Our test will help physicians differentiate between patients at high-risk of progression from those at low-risk of progression prior to the onset of cancer and well before observable changes in the cells. As announced last quarter, we will rolling out the test in an introductory [sale] [ph] beginning in the third quarter of this year with a full commercial launch in 2016.

Now I would like to touch on key development in the quarter, the favorable coverage policy for ThyGenX published by Aetna. We announced on July 6 that ThyGenX has been approved for coverage by Aetna for assessing fine needle aspiration samples from indeterminate thyroid nodules. Aetna's coverage decision now means that ThyGenX is considered medically necessary. It is the first major commercial coverage for ThyGenX and it validates our claim that ThyGenX is critically necessary to help doctors identify which patients need surgery. Additionally, we have also received favorable coverage policies from three other managed care providers, one of which is a top ten national managed care network.

Two of these plans cover PancraGen, and the top ten network covers ThyGenX and ThyraMIR. The combination of these plans brings our total covered lives for our three commercial tests to approximately 100 million. Covered lives for reimbursement is a key indicator of success in the diagnostics industry and in our short history, we have been able to deliver impressive coverage results. Our data also continues to impress clinicians with three new studies in the quarter that reaffirm our confidence in the cost efficiency and clinical efficacy of our tests. The first manuscript was published in the June issue of Endoscopy International Open and highlighted the positive economic benefits of PancraGen as a cost effective strategy.

The study concluded that PancraGen can help to reduce healthcare cost and improve patient outcome by accurately determining which patients are at high risk of malignancy and in need of surgery. Also in June, the American Journal of Gastroenterology published data on BarreGen's ability to predict progression to esophageal cancer approximately four years prior to any visible signs of cancer, which will help physicians differentiate between high or low risk patients well before any observable changes occur in the cell. Finally, just last month the journal of Clinical Endocrinology and Metabolism published a study concluding that the combination of ThyGenX and ThyraMIR could provide substantial improvements to thyroid cancer patient management and cost saving opportunities by accurately classifying benign and malignant thyroid nodules that are indeterminate by traditional cytopathology. Each one of these studies along with our accelerating test volumes and our addition to four managed care networks which include Aetna, illustrate why we are optimistic about the future of Interpace Diagnostics. We are confident that our three commercialized tests along with BarreGen will improve patient outcomes while reducing overall healthcare cost by avoiding unnecessary and often painful surgical procedures.

While we are excited about our prospects for Interpace Diagnostics, we still have work to do. We are making excellent progress in achieving test coverage and contracting from leading managed care payers. We are preparing to introduce BarreGen to select key opinion leaders and we are generating meaningful test volume growth. At the same time, we need to work from reducing collection timeframe for some historic billings. And work hard to capitalize on our recent managed care coverage decisions.

We are very confident that we will realize the full potential of Interpace Diagnostics. Now I would like to hand the call off to Graham Miao, PDI's Chief Financial Officer for a review of the second quarter's financial performance. Graham?

Graham Miao: Thank you, Nancy and good afternoon everyone. Today I will focus on the key elements in our financial statements and then review our 2015 financial guidance. As a reminder, PDI operates in two business reporting segments.

Commercial services and Interpace Diagnostics, which is our recently molecular diagnostics business. Starting with the second quarter income statement, total net revenue representing an increase of 17% over the first quarter of 2014. By segment, commercial services net revenue was $34.1 million, a year-over-year increase of 10%, primarily due to new business contracts and expansion of existing businesses, offset by completed programs. Interpace Diagnostics net revenue was $2.3 million, slightly up from 2015 first quarter. We did not own our diagnostics business in the second quarter of the last year.

As Nancy mentioned, we are making progress in successfully obtaining coverage of our molecular diagnostic tests by several major managed care providers. Supported by the publication of clinical validity and utility data in peer-reviewed journals, we are continuing to drive test volumes and adoption. We believe at this point, Interpace's development, test volumes and coverage decisions, are the leading indicators of the growth potential of our GI and thyroid diagnostics. As a reminder, our pancreatic cancer test, PancraGen, is covered under Medicare local coverage determination or LCD and reimbursed at approximately $3100 per test. It is customary for companies like ours to experience an initial lag between test volume growth and a subsequent reimbursement and revenue recognition.

In addition, Interpace has some legacy billing situations that we acquired and our team has been focused on resolving these historic items. Once we resolve them and see the recent coverage decisions implemented, our revenue ramp should be accelerated. Gross profit for the second quarter was $6.1 million, or 17% of net revenue. During the quarter, commercial services gross profit was $5.1 million or 16.7% of net revenues. Interpace Diagnostics' gross profit during the quarter was $0.4 million or 17.8% of net revenue.

As we have previously discussed, Interpace Diagnostics is still in an early stage, as such we expect certain volatility in gross margin due to our revenue base. As the business scale increases, we anticipate the gross profit margin generated from the business will improve meaningfully. Total operating expenses in the second quarter were $12 million as compared to $6.3 million in 2014 primarily due to the investment spending in sales and marketing as well as research and development required to expand Interpace Diagnostics. Net revenue for the six months ended June 30, 2015 was $74.7 million, an increase of 19% over $62.8 million in the first six months of 2014. Net revenue from commercial services was $70.3 million for the first six months ended June 30, 2015, an increase of approximately 12% from the same period a year ago.

And Interpace Diagnostics' net revenue was $4.4 million for the first six months of 2015, mainly derived from PancraGen tests. Gross profit for six months of 2015 was $13.7 million or 18.4% of net revenue as compared to $10.3 million or 16.4% of net revenue in the same period of 2014 representing an increase of $3.4 million or 33% growth. Interpace Diagnostics' had a positive contribution to the improvement in gross margin. Total operating expenses for the six months period ended June 30, 2015 were $22.6 million as compared to $11.8 million for the same period in the prior year, due primarily to the investment spending related to the molecular diagnostics strategic initiative. Operating loss adjusted for acquisition related amortization expense or adjusted operating loss for the first six months of 2015 approximates $7 million versus $1.5 million for the same period in 2014.

Cash utilization during the second quarter ending June 30, 2015 was approximately $2.6 million as compared with $6.1 million used in the first quarter of 2015. We finished the quarter with cash and cash equivalents of $14.4 million. Given our anticipated revenue growth, improved gross margin due to diagnostics business mix and a continued effective cost management, we expect our cash utilization to further improve during the second half of 2015. We are reaffirming our total net revenue guidance for 2015. We expect total net revenue of $136 million to $140 million.

This includes increased commercial service revenue of $125 million to $128 million from the previous $123 million to 126 million, which would represent 5% to 8% growth over 2014. We are revising the outlook for Interpace Diagnostics' net revenue to $11 million to $12 million from the previous $13 million-$14 million, due to the expanded collection time frames for some historic biddings that Nancy mentioned during her comments. We are also anticipating gross margins to improve by 250 basis points to 18% from 15.5% in 2014. The increase is largely due to the higher level of Interpace Diagnostics' revenue mix. Finally, we are now expecting adjusted operating loss to be reduced to $16 million-$18 million for the full year as compared to our previous guidance of $17 million-$19 million we provided back in March.

As a reminder, we define adjusted operating loss, in non-GAAP financial measure, as operating loss from continuing operations excluding amortization expenses of acquisition related intangible assets. With that let me turn the call back to the operator for questions.

Operator: [Operator Instructions] Our first question comes from the line of Scott Henry at ROTH Capital.

Scott Henry: A couple of questions. I guess first with regards to the historical billing issue.

Now should I assume that this relates to PancraGen and I guess is this is a catch up event or is this something that was under reserve for in the past? I am just trying to think of, we are getting to 2016, does that impair that year or is it a non-event going forward?

Graham Miao: Yes. This is Graham, Scott. For 2016 we do not expect to be an event. This is mainly a 2015 event that we inherit from past year.

Scott Henry: Okay.

And I guess just shifting gears, it sound like you are planning on giving out a test per quarter number going forward and I would like to see if you are meeting the targets you set out for 2015. Obviously, we are going to get this one time noise, it makes it harder to interpret that. But my question is, how many tests would you expect to do in 2015. I mean how should I think about that number, what kind of growth should we be looking for in Q3 and for the full year just so we can kind of gauge if you are meeting your targets.

Nancy Lurker: Yes, Scott, hi, it's Nancy.

Nice to talk to you again. Right now we are not giving guidance on test volume. We can -- let me say this, on test volume right now we are on track on the low end but we are on track, and the trajectory is accelerating. And some of that has to do with the combination of managed care wins that we are now beginning to pick up. That makes a big difference in terms of both physicians' willingness to order tests and then obviously on reimbursement and ultimately revenue collections.

So right now we are not getting projections on test volume but that is something certainly we can take a look at for the future.

Scott Henry: So I guess when you say the trajectory is increasing, that would lead me to believe that volume should be greater than 19% next quarter. Did I interpret...?

Nancy Lurker: You could -- yes. Again, we don’t want to give projections on that. Remember you are going to be building up quarter-over-quarter, so certainly in absolute volumes it's going to increase.

On a percentage basis, we are not going to give guidance on that right now.

Scott Henry: Okay. When I am thinking about 2016, this kind of goes back to the first quarter, if I am thinking about growth from 2015, should I be thinking of it off of a $13 million to $14 million base or an $11 million to $12 million base.

Graham Miao: It should be the latter. They are actual results.

Scott Henry: I mean, you got to get credit for it one way or the other. You can't say it would have been 13 to 14 but then tell me that growed up 11 to 12, little confusing. But shifting gears, now that we have a revenue number and a test number, we can get an idea of revenue per test and obviously there is a ton of noise at this point that works out to like $1100 in Q2 versus $1300 in Q1. How should I think about that revenue per test changing over time because that may give me an idea of what the true number is?

Nancy Lurker: Yes. So remember one thing, it's hard to draw -- it's hard to create a step up from test volume at this stage to revenue and why is that? Because you have got, number one, you have got a lag that you have to build in.

And that lag varies by product. Number two, you have to look at the, there is various reimbursement rates by payer. So the mix can change and certainly as we pick up more coverage, you will start to see that revenue collection per test goes up. So there is a lot of factors that come into play. I mean at this early stage, it's going to be more noise than it is an actual reflection of revenue per test.

For PancraGen, as we said in the past, the Medicare reimbursement rate is a fixed $3100. And as we said, usually you are going to see 60% to 65% of all PancraGen is going to be Medicare reimbursed. And then you have got a range of what you get reimbursed on the commercial side. On thyroid, you are going to have more on the commercial side than the Medicare side and right now we do not have Medicare reimbursement for thyroid, so of course it's something that we are starting to work on. Do you want to make a comment?

Graham Miao: Yes.

For thyroid, specifically for ThyraMIR. ThyGenX, we have a local coverage there.

Nancy Lurker: [indiscernible]

Graham Miao: Yes.

Scott Henry: And were there any ThyraMIR sales in the quarter?

Graham Miao: No.

Nancy Lurker: No revenue collection.

There certainly were -- well, the test did not get launched till April 15. So the vast majority of the test volume that you see is PancraGen and ThyGenX.

Scott Henry: So I mean although ThyraMIR, and obviously you shipped volume into the channel, will that show up as deferred revenue somewhere?

Nancy Lurker: No, it doesn’t work that way. Because we don’t -- there is no channel. These are tests that doctors order and it's specimens that they put in a test kit and then they ship it into our lab.

So the kits are given away for free, right.

Scott Henry: Okay. So it's almost like on consignment...?

Nancy Lurker: Well, the doctors don’t pay for the test. Then that gets to medical insurance for collection.

Scott Henry: Okay.

That’s helpful.

Graham Miao: So Scott, if I can supplement that, particularly to your question on the revenue recognition part. So for diagnostic tests reimbursement, and first of all we all recognize that there was a lag between volume growth and revenue recognition. So we need to accelerate that conversion cycle by accelerating managed care coverage and for ThyraMIR for Medicare coverage. So we will recognize revenue for, if we have Medicare coverage then when we fill claims, we would be able to recognize revenue.

And for commercial payers, third party payers, if we have contract in place with a price, than we would be able to recognize revenue. If we do not have contract in place, we do not recognize revenue. We recognize revenue only when we receive cash for those payers with whom we do not have contracts.

Operator: Our next question comes from the line of Roberto Fatta at William Blair.

Roberto Fatta: It's Robbie in for John today.

Just continuing on the Interpace line of questioning a little bit. Can you give us a sense of what your guidance contemplates for additional coverage, if any?

Nancy Lurker: Well, right now in our guidance we are simply looking at primarily the revenue collection we would get from PancraGen and ThyGenX. We are not really projecting anything in the revenue guidance for ThyraMIR because that’s going to take a little longer. So that’s just based on current reimbursement assumptions going through the end of the year today with no additional coverage assumptions.

Roberto Fatta: Got it.

That’s helpful.

Nancy Lurker: I will tell you, Robbie, we are ahead of plan on our managed care coverage and contracting.

Roberto Fatta: Okay. And any additional coverage I assume will be communicated.

Nancy Lurker: Yes.

I don’t know if you noticed just across the wire right

around 4:30, but we just announced three additional managed care coverage and contracts.

Roberto Fatta: Yes. That’s great.

Nancy Lurker: When we get new ones, we certainly plan to announce those.

Roberto Fatta: Great.

On the profitability of those tests, the way that we had thought about it was that we had thought about it was that the profitability would ramp significantly as the year progressed and clearly there is a little bit of volatility associated with that. But we had expected gross profit to be in the 50% range by the end of this year and then longer-term 60% to 70%. I am not sure to what extent you are willing or able to comment on that. But are these reasonable assumptions or will the volatility that you are seeing in collections and the ramp affect those throughout the year.

Graham Miao: Yes, Rob, it's Graham.

Thank you for your question. Longer-term, to your second question first, at a steady state it's reasonable to assume and we anticipate, expect the gross margin to be in that 70% range. At the early stage, because we have relatively two new products in our portfolio this year including ThyGenX and most recently ThyraMIR and then PancraGen as well. So at this early stage of ramp up and because of the lag between volume growth, so we are fashioned with process -- we receive orders of samples and we process them in our lab, we incur cost versus the later revenue recognition. So there is a lag in between, particularly at the early stage of this business, diagnostics, you will some volatility initially at the relatively lower margin.

But gradually as you see, at the end of the year and starting next year, you will gradually see a very meaningful significant increase in the gross margin improvement.

Roberto Fatta: Okay. So we should think about gross margin improvement as really a '16 event versus late '15, is that fair?

Graham Miao: That’s fair.

Roberto Fatta: Okay. And then turning to the commercialization business for a second.

It seems like the trends there are pretty strong. Can you give us any color on the pharma business that you guys won? How much of that was the big pharma versus smaller biotech companies?

Nancy Lurker: Yes. It was about -- the majority of that was mid-size companies, as well as we picked up, one in particular that was, certainly in the top five. Okay.

Roberto Fatta: Yes, that’s great.

In your view, that pipeline, how strong do you expect that to remain given that funding has been good and it seems like spending trends have been picking up of late.

Nancy Lurker: Yes. So right now what we would expect, I gave you a number where we are in the pipeline right now. So really what you see Robbie is, as we are headed into the, certainly, third quarter and fourth quarter, you start to see the pipeline grow. Because that’s when people began making their plans and put out RFPs for 2016.

So we would expect some growth going into third quarter and fourth quarter.

Roberto Fatta: Great. Has the pricing on these contracts changed materially over the past year or so?

Nancy Lurker: No, it has not. I mean generally we are seeing that they are, right now in line with what we have expected. And we right now foresee that remaining the same.

Graham Miao: It's certainly competitive landscape out there and we are seeing ourselves also winning new contracts.

Roberto Fatta: Yes. I noticed that some of the new wins that you guys called out. Are you guys able to give us a little more color on your win rate? Does it remain above what your current market share is?

Nancy Lurker: Right now, yes. We are tracking above what our current market share is.

Let me just say this, we are very pleased with our win rate. We have done very well this year. As you know we did well in fourth quarter of last year and third quarter, which set us up for a good 2015. And as I mentioned, we just won $45 million in this year. Now we are not issuing press releases on that every time that we get a commercial services win but the cumulative amount of that is $45 million that we have won this year, which is above average in terms of what you would win during the year and around $21 million of that is falling into 2015.

As we said, usually when the big RFP season kicks in late third quarter into fourth quarter, is when you start to see the RFP season really begin to pick up. But right now we are very pleased. Some of those wins were highly competitive and we were awarded those.

Roberto Fatta: That’s great. It's definitely coming in above our expectations through the first half.

Do you think that double-digit top line growth can be sustainable for the next year or so?

Nancy Lurker: Well, we are not going to give -- we are not going to project right now 2016. I would rather wait till we see the strength of the RFP pipeline kick in, in this quarter and next quarter.

Graham Miao: And then Robbie, also I would say, if you look at our guidance versus the last year, certainly this year represents on a high end of growth rate.

Nancy Lurker: Yes.

Graham Miao: Yes.

If you average out, in looking out, probably this year is the stronger year.

Nancy Lurker: Yes. And let me just add. There is really three reasons why we had a good 2015. First and foremost, we are very good and we consistently deliver very very strong execution results to our clients.

As I mentioned, we have earned almost 100% of all of our incentive fees. And those incentive fees are based on performance. So we continue to do very well in delivering performance to our clients. That’s most important. Secondly, we are able to differentiate ourselves as PD1, that is a key competitive advantage and our established relationship team.

Those are two differentiators that we have been able to capitalize on.

Operator: [Operator Instructions] At this time there are no further questions. I would like to turn the conference back over to management for closing remarks.

Nancy Lurker: Thank you everyone for taking the time to listen to our quarterly call and really look forward to updating you as we continue to see progress in both of our businesses as we progress through the rest of the year. I look forward to talking with you.

Thank you.

Operator: This concludes today's conference. Thank you for your participation. You may disconnect your lines at this time.