This Medical Device Company Is Changing the Game in Skin Cancer

Every year it seems like the cost of healthcare just goes up. Even as standards of care get better, it often comes with more cost to the patient. But every once in a while there's a disruptive technology that turns that equation on its head. DermTech (DMTK 8.97%) is one of those companies. It's providing a better solution with lower costs and less physical pain for the patient. On a Fool Live episode recorded on June 24, Fool contributor Brian Feroldi takes viewers through the business of this skin cancer testing specialist and why it could be a massive winner for investors.

Brian Feroldi: I'm going to talk about, like Brian, one that I've talked about in the show before, but it's down big, and that would be DermTech. For those aren't familiar with DermTech, I will give you a quick overview on it. Ticker symbol here is DMTK, this is a $1.3 billion company and it's visited some interesting prices since it came public in 2019, it did nothing for a year, and then it went up sixfold in a matter of just a few months, and since then it crashed back down to like 30 and it's currently at about 45 bucks, so that's down about 44% from its peak, also up significantly from its IPO, so could be down big or up big depending on your starting point.

But what does this company do? DermTech is focused on dermatology, specifically finding non-invasive ways to diagnose skin cancer earlier. Skin cancer it turns out is a really big problem, more people are diagnosed with skin cancer than all other cancers combined. One out of every five Americans will develop skin cancer in their life by age 70. More than 50 million people are at risk of developing skin cancer and have some sort of skin damage to them, that's 50 million Americans. You zoom out to include the rest of the world, and the numbers just grow from there. It's a very deadly disease, hundreds of thousands of people are diagnosed and die annually from it.

Given the numbers, treating skin cancer is hugely expensive, billions of dollars a year in direct costs and the numbers are higher when you go to indirect costs. Why is this such a problem? One of the reasons it's such a problem is the current methods that we used to diagnose skin cancer. This is the latest and greatest before DermTech came along. Dermatologists would look at your skin or a physician would look at your skin. If they were worried about it, they would cut out a piece of it, take a biopsy of it, and then they will send it off to a histopathology lab that would look at it and determine if you had cancer. This is subjective, the accuracy rates were low and for the patients, that's an invasive proposition. I've had this done to me personally and I now have a scar on my back for the rest of my life because of this.

For every 25 times that biopsy is done, one melanoma is found, so the accuracy of these things are not very high. But if your doctor says to you, I suggest we get this a biopsy, what are you going to do? They think you might have skin cancer. Diagnosing skin cancer early is critical. If skin cancer is diagnosed when it's at the local stage, the five-year survival rate is 99%. When it's at a distant stage, the survival rate falls to 27%, so the earlier we can diagnose skin cancer, the better.

DermTech is following a pathway that's been produced by several other companies that have been successful, where they're disrupting the standard of care by using genomic testing. Here is DermTech's flagship product. It's a little Band-Aid like clear sticker that you put onto a lesion that you might be worried about, you circle around it, and then you send that patch off to one of DermTech's labs and within 72 hours, the physician gets a report back, that is highly accurate, and it tells you if you have skin cancer or not. It's very simple, and importantly, it's actually looking at the DNA makeup of the skin cells to determine that.

The advantages are, it's super easy to do, it's higher accuracy and for the patient there's no cutting. So a lot of wins for patients and providers. This is a little bit about how the science, about how it works. There are some potential big-time cost-savings to this, because every time you can find skin cancer earlier, not only can you treat it and save lives, but there's also big-time cost-savings down the road. This technology seems to really work and it makes financial sense and makes sense for the patient and makes sense for providers.

Now DermTech is very early on in the commercialization process of this. They basically hired a sales team last year and they deploy them, obviously launching a medical device into COVID ain't easy when you physically can't go to visit doctors to get them on board. After they've been pretty innovative with their inside sales team, they've been investing into search and display to build up awareness that way, and they currently have about 40 reps throughout the country, they are right now targeting dermatologists, longer-term, the company does see potential for them to actually target primary care physicians, too, because they think the technology is that easy to use.

Testing volume has gone up pretty considerably over the years, not bad given again the COVID headwind, and as they're adding more sales reps, and they just got the 40 as of two quarters ago, so they are still ramping their productivity, and this is some of the things that they're doing online to increase engagement, and so far the early signs are pretty successful.

Another angle that this company is pretty serious about is telemedicine. This technology is so easy to use, you put a sticker on, you circle the lesion and you send it off in the mail to the lab that they think that they can use this plus telemedicine. If you are a big believer in telemedicine, is going to continue to grow, this kind of diagnostic technology can be used at home. That's a really big long-term potential for this company.

Right now this technology is only approved for melanoma. They just launched a more advanced product called PLAplus, which is even higher accuracy, so that's in the commercial stage. They have [a] few products in development to kind of expand into other types of skin cancer, that includes UV damage skin cancer, risk assessment and Basal and squamous cell cancer, so the pipeline here is getting bigger.

What's the potential pie worth? In the U.S. company pegs it's opportunity at about $10 billion, also if it gets all of those approvals, the numbers grow from there. There is [a] big [opportunity] in international markets too.

Look at the most recent quarterly results, I realize this is a busy slide, but billable sample volumes were up 62%, that's revenue from the stickers that was up 175%, just to $2.2 million, so it's still a small number. But good to see that's growing at pretty high growth rate, the average selling price of the product increased 71% year over year to $234. There's likely potential upside for that number, too, as reimbursement start[s] to kick in and the gross margin on it just turned positive. That's pretty good given that there's only 2.2 million in sales on the product.

The rest of the company's financials are not impressive. It's losing money, the gross margin, it just turned positive, so there's nowhere close to being enough to offset the rest of the business. However, in the long term, management thinks that the gross margin on this product could be 70% plus, so that would be good to get when they get the scale.

They did end the quarter with about $258 million in cash, that should fund them for several years, and they announce some big time progress with payers, including several Blue Cross Blue Shield plans, Geisinger Health, etc.

This is a CEO, his name is John Dobak. He is not the founder, but he's invested successfully in lots of life sciences companies. I did an interview with them on Fool Live, it is in the archives, if you are interested in seeing that for what it's worth, he owns about 2% of shares outstanding, so again, not the founder, but that's not an insignificant stake in the business.

To give you a sense of what it's expecting, the company's going to do about $13 million in sales this year, it's going to double to $26 million next year. Given that the market cap was $1.3 billion, that puts the price-to-sales ratio at about 100x current sales, that's pricey. Keep that in mind.

Overall, I think that there's a lot to like about this company, technology is very innovative, the platform is de-risked it's already through the FDA approval profit, is already being reimbursed, the growth potential of this product for the long term is huge, the margins should be good. The technology just makes sense to me, as an outsider, and there's lots of room for label expansion claims to say nothing of international expansion.

What I don't like about this company is that it's losing money and it will continue to do so for a long time. Dermatologists might be hesitant to recommend this product because they themselves will lose out on revenue from doing the biopsy. The CEO told me that was about an $80 fee that they receive for doing that. There is a bit of dermatologists being willing to accept lower revenue to go with this procedure, but they also could use it a lot more than they could do the biopsy so that might be an offsetting factor there, and the high valuation is something to consider.

If you are looking forward a swing-for-the-fences type of investment, could this be a $10 billion company someday? In my opinion, I think they definitely have that potential, so you could talk about 10-plus bagger returns from here. If it works out, but hang onto your hat if you invest, it's going to be a bumpy ride, so that's DermTech, DMTK.