Strong Organic Growth and Increased Contracts Drive Road to Profitability

Strong 1Q17 organic revenue growth of 15% YoY. CGIX increased revenue to $7 million in 1Q17, up 15% from $6.1 million in 1Q16. Growth was primarily driven by revenue increases in biopharma and clinical services

Biopharma and Clinical services segments continue to ramp up revenue in FY17. Biopharma services revenue increased to $3.7 million in 1Q17, up 11% from $3.3 million in 1Q16. Revenue from clinical services increased 20% YoY to 3.0 million. Clinical services test volumes increased to 12,310 in 1Q17, compared to 10,327 in 1Q16; an increase of 21%, driven by increases in immuno-oncology testing, companion diagnostic testing for PD-L1, and solid tumor profiling.

We expect Biopharma services revenue to show strong growth overall in 2017. This view is validated by the Company’s signed contracts for expected future revenue with pharmaceutical and biotech companies, which total approximately $40 million (most of this revenue should be generated during FY17-FY18).

We believe a significant opportunity exists in the clinical services side of the business, and we are forecasting revenue growing at a modest rate, although this could be adjusted depending on data presentations and sales and marketing efforts of some of the Company’s proprietary tests, in particular FHACT and TOO. Longer-term, we believe that reimbursement rates and clinical adoption will improve significantly.

Immunotherapies and other targeted therapies require genomic information that can only be given by sophisticated, multi-gene panels such as those developed by CGIX. As more therapies are approved, demand for CGIX’s tests should continue to grow. Net loss in 1Q17 was $9.6 million or ($0.51) per diluted share, compared to $5.3 million in 1Q16. The increase in net loss was primarily attributed to a non-cash charge of $7.5 million related to the change in fair value of derivative instruments. Adjusted net loss per share decreased 72% to ($0.11) in 1Q17, down from ($0.39) in 1Q16. We are projecting further improvement to net loss in 2017, as Biopharma services revenue increases and the effects of operational improvements and expense reductions are realized. Our model assumes modest quarter-on-quarter growth through 2017, although our assumptions could change if we see meaningful volume increases in some of the Company’s proprietary tests. We believe that FHACT and the Tissue of Origin test are the most likely candidates to show volume increases over the near-term.

CGIX Launched its Next Generation Sequencing (NGS) Liquid Biopsy Test for Lung Cancer Patients in May 2017. The liquid biopsy market is expected to reach $1.66 billion by 2021, up from $0.58 billion in 2016, growing at a CAGR of 23.4% (MarketsAndMarkets). CGIX’s NGS-based liquid biopsy test provides comprehensive coverage of 11 critical genes and 150+ hotspots related to lung cancer. The test has numerous advantages in comparison to tissue biopsy. Primarily, the test is significantly less costly and less invasive when compared to tissue biopsy. We believe with the introduction of this test, the Company has broadened its reach with various customers in the oncology market and has significant potential to increase its revenue run rate in subsequent quarters.

Gross margin improvement and operating expense reduction moving CGIX toward profitability. CGIX continues to show consistent improvement in margins and operating expenses. We have been impressed by the Company’s ability to grow revenue and innovate with new tests and collaborations while reducing expenses. Operating expenses have fallen to $5.6 million in 1Q17, down from $7.1 million in 1Q16.

1Q17 gross profit margins were 40%, up from 32% in 1Q16. The YoY increase was driven by greater operating efficiencies and the successful integration of Response Genetics, headcount reduction, reorganization of technology, and benefits from shared services with CGI’s India team. We expect strong improvement in gross margins in 2017 as test volumes increase. Management estimates gross margins in the high 50% to low 60% range once it reaches approximately $10 million in quarterly revenue. Margin improvements should play a large role in moving the Company toward profitability.

Continuing to build test portfolio, infrastructure, and intellectual property/knowledge; we believe that this backbone will translate into near-term revenue opportunities in biopharma and set up longer-term opportunities in clinical services. CGIX has continued to build its intellectual property and test portfolio, with 16 genomic tests commercially launched, 18 collaborations with leading institutions, and 90 patents globally. Recent highlights include the launch of an NGS panel for Hereditary Breast & Ovarian Cancer; CLIA validation for FOCUS:: Renal™ ; New York state approval for FOCUS::Myeloid™; a partnership with ApoCell that leverages their proprietary, high-performance liquid biopsy platform for rare cell capture and detection; and a collaboration with BARC Global Central Laboratory to offer comprehensive clinical trial and companion diagnostic solutions for oncology clients.

Further R&D should lead to the launch of additional tests and improvements to current test offerings. This should lead to near-term growth in biopharma revenue and eventually longer-term in clinical services.

CGIX announced strategic agreements with Mendel AI and Lantern Pharma to jointly leverage genomics, biomarkers & artificial intelligence (AI) to rescue and repurpose drugs for cancer. A McKinsey & Company report recently concluded that the big data revolution is in its early days in the biopharma industry and the potential value creation is still unclaimed. According to the report, big data strategies could generate up to $100 billion in value across the US healthcare system. Big data provides biopharma companies essential data points that can be effectively used to identify new potential drug candidates, improving efficiency of research and clinical trials. CGIX’s partnerships with Mendel AI and Lantern Pharma provides the company with vast amounts of data that combined with artificial intelligence (machine learning algorithms) will play a significant role for the company to discover new tests, patient trials and in drug development.

Current expected future revenue from biopharma contracts is more than $40 million; forecasted to increase as the number of trials and trial complexity both increase. CGIX’s current expected revenue from biopharma contracts is more than $40 million (this revenue is expected to be realized between 2017-2018). CGIX continues to aggressively expand its biopharma services. The Company saw a 36% increase in the number of biopharma projects over the past 12 months, reaching 140 clinical trials in 1Q17, up from 103 in 1Q16. The Company also generated a significant increase in its immuno-oncology projects over the past 12 months to 32 in 1Q17, up from 3 in 1Q16. The immuno-oncology market is expected to reach over $35 billion by 2024 (source: IMS Health) and impact up to 60%-70% of cancer patients.

Given the expected significant growth in immuno-oncology over the next decade, providing services for immuno-oncology clinical trials should drive consistent revenue growth for CGIX’s biopharma services, along with providing significant long-term revenue potential in clinical services. As more immunotherapies are approved for use in the clinic, we anticipate clinical demand for multi-gene NGS panels to increase. CGIX’s current focus on biopharma services should generate a positive impact both for current results with longer-term potential in clinical services and companion diagnostics.

We derived a target price of $6.55 by applying a 3.5x EV/S to our FY17E revenue of $34.7 million. CGIX has built a significant backbone of intellectual property and proprietary genomic tests. This expertise has enabled the Company to consistently grow its Biopharma services business, which we believe will eventually lead to significant growth in clinical services revenue. The Company’s rapid increase in immuno-oncology trials is very promising, as many top analysts expect immuno-oncology to have a huge impact on future cancer treatment.

In particular, we believe that a strong economic case will be given for the use of NGS testing alongside immunotherapies, especially given their high cost (typically $100k+) and the increasing evidence of the need for variable treatment regimens dependent on specific patient characteristics. CGIX’s strong, disease-focused knowledge base should prove valuable as immunotherapies and targeted therapies are approved for indications where the Company has developed expertise. Any companion diagnostic approvals should greatly increase clinical services revenue. Ultimately, we believe that the clinical services opportunity is a matter of “when”, not “if.”

Given this backdrop, we believe the company is on a solid track to reach profitability. Strong improvements in operating expenses and margins were achieved in 2016 and 1Q17. We are not currently modeling any additional capital raises, although a small capital raise could be needed depending on how long it takes CGIX to further reduce costs. Controlling costs ensures that the Company minimizes dilution while the clinical opportunity develops.

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Cancer Genetic, Inc
201 Route 17 North 2nd Floor
Rutherford, NJ 07070.

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