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BMRA: Moving Price Target to $7/Share With Inclusion of InFoods

By Brian Marckx, CFA


Q2 2018 Results: Revenue, particularly in Asia, was very strong. Now modeling InFoods... 

Biomerica (BMRA) reported financial results for their fiscal 2018 second quarter ending November 31, 2017.  And just prior to releasing Q2 results, they made several potentially very substantive announcements related to operational progress of both their legacy business as well as to InFoods – the latter which prompted significant updates to our long-term revenue forecasts as well as to our price target.

Relative to the financials, revenue was relatively very strong in Q2 as compared to both our estimate as well as to recent history.  That, however, did not translate into quite as impressive improvement in operating loss as a result of some narrowing in gross margin (the latter which appears to be mostly accounting-related).  Nonetheless, we are encouraged by the total revenue number as well as itemized sales from certain territories – particularly Asia and to a lesser extent, Europe.  

The continued strength in Asia sales is highly encouraging given the outsized contribution that this territory provides to total revenue.  And we think sales from Asia will almost certainly grow from here given recent China Food and Drug Administration Approval (CFDA) of EZ Detect, an over-the-counter fecal occult blood (FOB) test for colorectal cancer.  While Biomerica has never publicly disclosed product-specific sales numbers, we believe EZ Detect is one of the (if not the #1) best-selling products for the company.  We also think Asia could be particularly receptive to the product given certain cultural principles in many parts of Asia related to hygiene which may discourage use of FOB tests which require fecal handling.    

Q2 revenue of $1.61M was up 13% yoy (from $1.43M in Q2 ‘17), up 12% sequentially (from $1.45M in Q1 ’18) and about 7% higher than our $1.51M estimate.  

U.S. revenue, at $138k was down 20% yoy and down 26% from Q1 of this year.  U.S. sales have trended relatively soft since 2015 when they fell 17% to $1.0M in that year.  They dipped another 4% in 2016 and shed 12% the next year, ending 2017 at just $874k.  The run-rate through the first six months of the current year puts U.S. sales on-track to end 2018 at around $650k – an implied 26% yoy contraction and the lowest level since at least 2010 (i.e. the furthest back that we looked).

We, however, model U.S. sales to stabilize at or around recent levels (related to the company’s current product portfolio) over the near-term.  A possible catalyst to U.S. sales growth could come from a new h. pylori test, clinical trials for which just recently commenced enrollment (and which we discuss in more detail below).  

And while we had not previously modeled any potential contribution from InFoods given development preparations and progress had not reached a point where we felt it was substantive enough to gauge (with any reasonable semblance of confidence) chance of successfully gaining FDA regulatory clearance, the recent disclosure and announcement of initial clinical trial design and collaboration to conduct clinical trials with two major U.S. university research centers has prompted us to update our assumptions.  As we discuss in more detail below, we are now modeling initial contribution from InFoods in 2022.  We continue to believe that eventual FDA clearance of this novel IBS product would result in a significant increase in Biomerica’s U.S. sales and provide the majority of total revenue from that point into the foreseeable future.  

Meanwhile, Q2 revenue from Asia was $873k – this is relatively extraordinarily strong and the highest level of sales from Asia since Q2 2013 ($1.04M).  It is also up 22% on a yoy basis (from $716k in Q2 ’17), up 41% sequentially (from $620k in Q1 ’18) and about 19% better than our $736k estimate.  As we have noted in the recent past, while Asia has been a territory which has historically experienced relatively high short-term sales volatility, longer-term trends continue to point towards regular revenue growth.  Relatively robust and consistent revenue growth from Asia has resulted in this territory becoming the greatest contributor to total revenue as well as the most significant catalyst to recent total top-line growth. 

BMRA generated just $1.0M in sales (~21% of total revenue) from Asia in 2015 - this grew 71% to $1.7M in 2016 and another 39% to $2.4M in 2017.  In fact, Asia was effectively the only reason why total revenue posted positive growth in 2016 and is credited with almost 90% of the topline growth in 2017.  Asia sales grew another 16% through the first half of 2018.  And among the territories which did post positive revenue growth through the first six months of fiscal 2018, Asia contributed 62% of the total.  Given the outsized contribution from Asia (which now accounts for 49% of total revenue) even incremental growth from current levels in this territory will have a meaningfully positive effect.  We think the recent sales momentum, coupled with CFDA approval of EZ Detect (and presumably an impending launch), which just came in early January 2018, bode well for continued double-digit annual growth in Asia sales over the next couple of years. 

Relative to Europe - sales from this territory were a bright spot in 2017, although not nearly as robust or significant as that from Asia.  Nonetheless revenue grew 3% in 2017 – which was a welcome result, particularly given the 20% battering that this territory endured in the prior year.  Fast-forward to the most current period, Europe sales were $538k in Q2 – up a very healthy 16% from the comparable quarter in 2017 and about 1% better than the $532k posted in Q1 ’18.  Through the first half of fiscal 2018, Europe delivered 5% revenue growth.  And while that annualized run-rate would still result in full-year revenue markedly below what European sales were at their peak (i.e. $2.8M in 2013), we are encouraged to see incremental growth and some firming up of revenue as well as less short-term volatility.

Europe accounts for about 35% of total sales, making it the company’s second most important market and causing any meaningful variability to have a significant influence on overall financial performance.  While BMRA has always kept operating metrics close to the chest, making forecasting territorial-level revenue a challenge, we like recent trends in European revenue as well as certain macro fundamentals which could further benefit sales.  This includes the implementation by European regulators of stricter regulatory and oversight of medical devices and diagnostics – which could slow the entry of competitive products, at least for the next few years.

And while as of the date of this report we have begun modeling forecasted InFoods contribution in the U.S., we still do not model any assumed commercialization of the product candidate in any other parts of the world.  That could change depending on BMRA’s future strategic objectives as well as if we feel there is enough information to make (comfortably) informed projections about certain commercializability-related gating factors.  At this point we have no information or insight into if or when BMRA might consider targeting markets outside of the U.S. or if they do, which areas of the world they would focus on next.  Europe, however, would be our best-guess as a potential front-runner if management does eventually look to expand OUS with InFoods given not only the economic similarities of most of the highly developed European countries with that of the U.S. but, perhaps more importantly, diets that are (generally) similar to that of most Americans.  

Gross Margin, Operating Expenses
Gross margin, at just 31.4%, was less than impressive – for context we were looking for 36% and the yoy and sequential comparisons were 38.9% and 35.6%, respectively.  Relative to the relative weakness in margin, BMRA noted that “the combination of fully establishing our maquiladora production facility and reduction of finished goods/WIP inventory resulted in a higher cost of goods sold”.  We are not exactly sure what that means in terms of the effect on gross margin, although it sounds as if it relates to certain (non-cash impact) accounting treatment – such as burning through inventory that was marked at a higher cost and, perhaps, maybe some additional depreciation on PP&E – in other words, we’re not particularly concerned. 

Q2 OpEx was $795k, or 49% of revenue, compared to our $803k and 53% estimates.  While SG&A has ticked up slightly through the first half of 2018 ($975k) as compared to the same period in 2017 ($894k), the increase is not overly significant and was not unexpected given anticipated headcount additions and expanded activity in both operational and product development areas.  

As a reminder, we had previously noted that we were not modeling any potential revenue or direct costs (such as those related to clinical trials and other direct R&D and regulatory expenses) related to InFoods due to significant uncertainties related to development outcomes and regulatory deliverables including requisite clinical trial programs (including scope, size, design and outcome measures) and additional validation of the performance, replicability and clinical utility of the product.  We also noted, however, that we would revisit our assumptions on a regular and ongoing basis and consider updates to our model (potentially including InFoods-related revenue and expenses) with additional and substantive development and/or regulatory progress.

We are now modeling InFoods…
In our experience covering med-tech and biotech, there is rarely an event or moment that is so obviously significant that it acts as the revelation that it is now time to initiate modeling a novel product candidate.  We feel that we were reasonably prudent in our decision to previously not model InFoods given the list of unknowns that we have discussed in prior reports.  But we do view the disclosure on January 8th of the InFoods clinical validation strategy and definitive agreements signed with Beth Israel Deaconess Medical Center and the University of Michigan to conduct the clinical studies as highly significant in terms of front-end development progress and believe this warrants inclusion of InFoods in our model.  We also note that (as almost any long-term BMRA investor knows) the company has never been particularly chatty in terms of disseminating “non-essential” information so, had we waited to model InFoods until a ‘material event’ forced an announcement, we would risk being late to the party.  This is a long way of saying that we are now modeling forecasted InFoods-related revenue and expenses.  

Cash balance at the close of Q2 was $818k, down from $1.1M at the end of fiscal Q1.  Cash used in operating activities in Q1 and 1H was $239k and $363k ($216k and $357k, ex-changes in working capital), respectively.  Another $33k and $53k was used in investing activities in the same periods.  On June 30, 2017 Biomerica filed an S-3 registration statement with the SEC (which became effective July 20th), registering for sale (up to) $45M in common stock.  Then on December 1st the company entered into an ATM agreement with B. Riley FBR, authorizing the sale of up to $7M of common shares.  As we noted following filing of the registration statement, we think proceeds would almost certainly be mostly targeted towards advancement and further development, including clinical validation, of InFoods.
Additional, non-dilutive funds, could come from BMRA’s agreement with Telcon Pharmaceuticals (fka Celtis Pharm Co.) of S. Korea which calls for that company to pay Biomerica up to $1.25M in exclusivity fees based on "certain milestones including Biomerica’s starting clinical trials in the United States, receipt of US FDA clearance and Celtis’ first sales of IBS Products in Korea".  The agreement was initially cancellable if BMRA had not obtained FDA clearance/approval of InFoods by December 31, 2017 but that deadline was subsequently extended until December 31, 2019.     

Moving Price Target to $7.00/share
Inclusion of InFoods in our model has moved our price target to $7.00/share.  See our full report on BMRA (link below) where we detail our InFoods modeling assumptions and valuation methodology.  We also discuss the significant unmet need for an effective IBS therapy, drawbacks of prescription IBS drugs and why we like the chances for eventual robust adoption of InFoods.  

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