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Citing Falling Share Price, Manchester Management Calls for Changes to Vermillion Leadership

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An exchange this week between Vermillion and a Boston-based hedge fund that holds a nearly 10 percent stake in the company has exposed a rift between the company's management and one of its largest shareholders.

On April 12, James Besser, a managing member of Manchester Management, sent a letter to Vermillion's management and board, claiming that they have eroded the value of the company's shares. The company answered this week with a letter to shareholders in which it said it had "spoken with [Besser] on multiple occasions in an attempt to address a number of his concerns" and suggested that he was aiming to create "a short-term stock price for his own benefit."

Now, Besser has responded with a letter restating his concerns about Vermillion's management and again calling for the company to allow a vote by shareholders on the continuing service of its six directors. The company disclosed the latest letter in a document filed with the US Securities and Exchange Commission on Thursday.

In his initial letter to Vermillion, Besser, who along with Manchester Management owns nearly 1 million shares or 9.2 percent of the firm's stock, asked the company's board to make three changes to its corporate governance "as soon as possible."

The first change was to eliminate a bylaw that prohibits shareholders from calling special meetings under any circumstance. He also called for the removal of a so-called "poison pill" that prevents shareholders from making changes in Vermillion's management and/or board. And lastly, he demanded that Vermillion hold a special meeting where the company's six directors would be up to a vote "so that all shareholders can weigh in on their continuing service in light of events since the last shareholder meeting."

Given the 90 percent drop in Vermillion's stock price in the last year, Besser said, "there should be a mechanism by which current shareholders are able to determine whether Vermillion's current management team and board have the judgment and skills necessary to evaluate all the alternatives that must be considered at this point to create a reasonable return going forward."

During the past 52 weeks, shares of the Austin, Texas-based molecular diagnostics firm traded as high as $24.50 on Nasdaq. Shares of Vermillion closed this week at $4.75.

In its response to Besser, Vermillion's board said it was reviewing its bylaws and rights plan to determine if changes were needed and taking Besser's views into account.

It also said it had offered to provide Besser non-public information about the company's operations to help address his concerns, but that he had turned down the offer "because coming over the wall would have necessarily required a confidentiality agreement and limited his ability to obtain 'liquidity' for his position."

In his letter filed Thursday, Besser disputed this characterization, saying that liquidity issues were not the only reason he declined the information. The refusal "also had to do with us wanting to preserve our right to weigh in and vote as a substantial holder of the [company's] equity."

He quoted from previous correspondence with Vermillion, offering what he said was "the exact wording of my communication with management on this matter." According to his quotation, in that initial communication he decided after consultation with counsel that "given the size of our position, [accepting the offer of non-public information] simply would not be consistent with the fiduciary duties that we owe to our investors and would handcuff us on any further actions we could take, depending on what we discovered."

Besser also reiterated his initial question as to why Vermillion considered it necessary to answer his concerns by offering non-public information, given that "businesses of far greater complexity and scale are able to communicate effectively with their shareholders without giving them material non-public information."

In his first letter, Besser listed specific actions by Vermillion's management that he claimed led to an erosion of the company's stock price, including overly optimistic projections of its OVA1 ovarian cancer test; irresponsible behavior in relation to the company's licensing agreement with Quest Diagnostics; a secondary offering priced at $5.45 per share that substantially diluted shareholders; a lack of stock incentives in employment agreements with management; an inability to build an effective sales force; and an unwillingness to do direct sales with hospitals that are not in Quest's network, which have limited the revenue potential for the OVA1 test.

In its response, the board said that Vermillion was "continuing to build out our market development efforts and the company is performing to its more information-based plan and continuing to explore opportunities for accelerating adoption."

It also said that projections the company made were good-faith forecasts, and that "management revised its projections quickly following launch once it became clear that its reimbursement estimates [for OVA1] were too conservative and adoption rate estimates were too fast."

In his Thursday follow-up, Besser noted that the revised projections came five months after OVA1's launch and were again lowered three months later.

In a document filed with the SEC on Dec. 4, 2009, Vermillion projected 2010 OVA1 sales of $9.7 million – roughly 97,000 tests given reimbursement rates at the time. It later put out a 2010 guidance of between 8,000 and 10,000 OVA1 sales, which it lowered in November to a range of 5,000 to 5,500 sales for the year. For the year, the company sold 6,155 tests (PM 01/07/2011).

Besser suggested in his response that while OVA1 sales in the current quarter might exceed the current guidance range, the quarter could nonetheless "represent a deceleration of the sales ramp from prior levels, just at the time when we believe the sales ramp should be accelerating."

"We believe the sales ramp should be accelerating because two new major insurers have kicked in and the sales force has been in the field long enough to start showing productivity, especially after all the physician outreach in Q4 and the positive scientific developments in Q1," he wrote. "We await the company's first quarter results."

Vermillion is scheduled to release its Q1 earnings on May 10.

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