By Brian Marckx, CFA
READ THE FULL BMRA RESEARCH REPORT
Q1 2019: Asia Strong, Europe & U.S. Weak. Revenue up 13% QoQ But Down 12% yoy. Expense Control Minimizes Op Loss…
Biomerica (BMRA) reported financial results for their fiscal 2019 first quarter ending August 31, 2018. While revenue recovered as compared to fiscal Q4 ’18, it remained weak on a yoy basis. The weakness related almost entirely to Europe and the U.S., which were both down double-digit percentages from the year-earlier period. Both of these territories were similarly soft for the full year 2018, down 10% and 22%, respectively. Fortunately Asia, which accounts for ~50% of total revenue saw solid gains from both comparable periods, limiting the yoy total revenue slide and pushing it into positive territory sequentially. But, despite the 4% miss on revenue and 600bp miss on gross margin, operating loss and EPS came in slightly better than our estimates as a result of lower than anticipated operating expenses.
- U.S. revenue remains weak and has been on a regular downward slide since fiscal 2014. The $143k generated in the U.S. in Q1 ’19 is down 24% yoy and 6% qoq. It also looks to be the third lowest since at least 2009 and only slightly ahead of the lowest ($131k, Q4 ’17) and second lowest ($138k, Q2 ’18) revenue generated from the domestic market. BMRA noted that the yoy slide reflects higher contract manufacturing sales in the prior quarter. We also note that the longer trending decline in U.S. sales has been attributed to lower purchasing (of BMRA’s flagship EZ Detect colon disease test) from a certain drug store customer that, unlike some years, decided not to conduct a colorectal cancer screening program during fiscal 2018. We remain optimistic, however, that U.S. activity will come back and believe a possible catalyst to U.S. sales growth could come from the new h. pylori test candidate which just enter clinical studies
- Europe has similarly been weak and continues to come in softer than our estimates. Revenue from Europe fell 10% in 2008 and dove 26% yoy/15% qoq to $392k in Q1 ’19 and was the lowest since at least 2009. European revenue has now declined for three consecutive quarters. Lower sales to certain distributors as well as order timing were cited as contributors to the relative weakness in Europe
- Asia was the sole highlight as it relates to revenue in Q1. Sales increased 5% on a yoy basis and jumped 65% from Q4 ’18. They were also 12% better than our estimate. While the U.S. and European markets have softened over the years, Asia, the company’s most important territory, has done the opposite. Revenue from Asia grew at a CAGR of 35% from 2015 to 2018. The $648k generated in Q1 ‘19 is also the fourth highest since 2014 and slightly better than the $628k average during fiscal 2018. The seeming return to strength in Asia is encouraging as (we noted in our Q4 ’18 update on Sept 6th) softness in that territory in Q4 was somewhat confounding given that revenue growth had been on a fairly steep trajectory since late-fiscal 2015, which was shortly after BMRA restructured their distribution channel in China. We had also anticipated incremental revenue growth from the launch of EZ Detect, which received China FDA (CFDA) approval in January 2018 (i.e. late-fiscal Q2’18). It is not clear if Q1 ’19 revenue includes any meaningful contribution from that product.
Total revenue fell 12% yoy but managed slightly better than that, 13% to be exact, growth as compared to Q4 ’18. But, the $1.27M of revenue is not particularly impressive given that it is the second lowest in the last 11 quarters. But, to be fair, Q1 ’18 was a tough comp to beat given that it was the second best Q1 since at least 2009. As we noted in our prior update, we were hoping that Q4 ’18 revenue, which was extremely soft ($1.13M), would prove an outlier (it was 24% lower than the average through the first nine months of fiscal 2018) and that the top-line would rebound early in fiscal 2019. While that did happen, it was about 4% less than we had hoped – with almost all of that reflected in relative weak showings in Europe and the U.S. (partially offset by strengthening in Asia). So, while we are quite encouraged by Asia’s continued march higher, particularly given its outsized contribution to total revenue, it may not be enough to offset any continued significant weakening in Europe (and to a lesser extent, the U.S.). We hope Q2 provides more insight.
U.S. revenue, at $143k was down 24% yoy, down 6% qoq and the second lowest in nearly a decade (or more). U.S. sales have trended relatively soft since 2015 when they fell 17% to $1.0M in that year. They then dipped another 4% in 2016, 12% in 2017 and finished 2018 at $685k, down another 22%, and the lowest level since at least 2010 (i.e. the furthest back that we looked).
While difficult to predict, we had modeled U.S. sales to stabilize - unfortunately with the continued slide, ‘stabilized’ level has been notched lower. We do think it is unlikely that U.S. sales will fall much lower, however, and hope, given the company’s current product portfolio, that there is opportunity for growth over the near-term. A possible catalyst to U.S. sales growth could come from a new h. pylori test, clinical trials for which recently commenced enrollment (and which we discuss in more detail below).
And with the recent disclosure and announcement of initial clinical trial design and collaboration to conduct clinical trials with two major U.S. university research centers, we recently began modeling InFoods. As we discuss in more detail below, we are 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 growth from that point into the foreseeable future.
Meanwhile, Q1 revenue from Asia was $648k – up 5% yoy and up 65% from Q4 ’18. Q1 revenue is also about 3% than the quarterly average during fiscal 2018. Encouraging is that Q2 has historically been a stronger period for Asia revenue – perhaps a harbinger to 2019 proving a strong year for Asia. And while as we have noted in the past, 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.
And, as Asia has grown to account for a larger proportion of total revenue, the recent strength from this territory has been the most significant catalyst to driving BMRA’s topline. For historical context, Asia generated just $1.0M in sales (~21% of total revenue) 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. Despite a weak Q4 (down 42% yoy), Asia still managed 4% growth in 2018, accounting for 45% of total revenue. And among the territories which did post positive revenue growth, Asia contributed 40% for the full-year in 2018. Given the outsized contribution from Asia (which now accounts for ~50% of total revenue) even incremental growth from current levels in this territory will have a meaningfully positive effect – but even incremental contraction will have the opposite effect.
As noted, we had hoped EZ Detect (over-the-counter fecal occult blood (FOB) test for colorectal cancer) would have been a positive catalyst – although it’s possible we were a little too optimistic relative to timing. We continue to like the fundamentals in China as it relates to BMRA’s flagship product. 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.
Recent initiatives aimed at increasing colorectal cancer screening – by any modality – also support fundamentals for EZ Detect. Many parts of Asia, including in China, have relatively low rates of compliance to recommended colorectal cancer screening guidelines. For context, while ~65% of Americans adhere to CRC screening guidelines, studies indicate that compliance is only ~40% in Shanghai, China. Studies have shown that one of the most effective ways to increase CRC compliance is through providing more testing options. So, for all of these reasons, we think Asia could represent a substantial growth opportunity for BMRA’s EZ Detect product.
Relative to Europe – sales from this territory showed recent signs of growth, inching up 3% in 2017 following a 20% slide the prior year. While the mid-single digit growth through the first six months of 2018 was promising and an encouraging signal that European sales growth might be accelerating, that was more than offset by weakness in the second half of the year which saw sales drop more than 22%. For the full year, European revenue was down 10% to $2.0M, the lowest level since at least 2010.
It didn’t get better. Q1 ’19 European revenue of $392k was down 26% yoy and 15% qoq. Europe accounts for ~30% - 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. And while the not-so-long-ago indications that sales in that territory might be gaining traction were encouraging, the lack of sustained growth, which significantly affected BMRA’s topline performance over the last three years, has us questioning whether there is much upside in this area of the world with BMRA’s current product portfolio.
We now model flat to slightly negative sales in Europe (related to BMRA’s current product portfolio) and think opportunity for sustainable growth may mostly hinge on new product launches. While we have yet to model any assumed contribution from InFoods (or any other new products), that could soon 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
Q1 gross margin was weak but not record-level weak. At 26.5% it is lower than all but one quarter in 2018 (Q4 23.7%). It’s also better than a handful of other quarters over the last 8 or 9 years. Given that GM is negatively affected by lower sales volumes – as less fixed costs are absorbed – we think that was the issue in Q1.
OpEx was $792k, or 62% of revenue. This compares to an average of 58% throughout 2018 including 51% in Q1 and 81% in Q4. It is also well below our $950k estimate. Interestingly (given the clinical activity related to InFoods and h.pylori), R&D expense was a relatively moderate $392k in Q1, or 19% less than that in Q4 ’18 ($484k). We do, however, continue to model opex to increase at a higher rate than that of revenue growth through at least the end of the current fiscal year (ending May 2019) as a result of increasing development activity related to InFoods, and to a lesser extent, the h.pylori program.
BMRA raised $171, net, during Q1 ‘19 from the sale of common shares via their ATM program. Another $180k (net) was raised subsequent to quarter-end. Cash balance at the close of Q1 was $584k. While that is less than one-half the cash BMRA had at the end of fiscal 2018, much of the difference is explained by a $264k increase in current assets and a $103k decrease in current liabilities. Excluding changes in working capital, BMRA used $390k of cash for operating activities (and another $61k for PP&E).
In June 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. Through today, approximately 439k shares have been sold under shelf, representing net proceeds of ~$1.63M (per our estimates). 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.
Value BMRA at $3.00/share (base business) + $4.00/share (InFoods) = $7.00/share
We use sum of the parts to value BMRA; the base business (everything except InFoods) plus InFoods. We note that we are only modeling assumed U.S. InFoods sales and we do not yet model the novel h. pylori test that recently commenced clinical studies. All of our modeling and valuation-related assumptions will be updated if and when appropriate.
We continue to value the base business using a comparable cohort of five companies of various market capitalizations in the medical diagnostics space with products/services that target the POC and/or clinical lab markets to value BMRA. Based on several metrics, BMRA’s base business is valued at approximately $2.80/share.
Value InFoods at ~$40M (~$4.00/share):
We value InFoods separately from that of the base business given the former’s significantly greater growth potential. As we outlined above, we think our InFoods assumptions and related outlook/forecast are reasonable. Given the rapid growth rate and steepening revenue inflection that we estimate at approximately years 2023/2024 we think a 11x sales multiple is reasonable, particularly when looking at the ~12x trailing sales multiple Valeant paid for Salix (i.e. Xifaxin) in 2015. Applying 11x to our $8.4M 2024 forecasted InFoods revenue and discounting back to the present at 14%/year, results in InFoods present value of approximately $40M, or $4.00/share. If and when there is attrition of some of the substantive unknowns, our risk discount will similarly reduce and likely result in higher calculated InFoods value.
Our sum of the parts values BMRA at approximately $7.00/share.
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