By Brian Marckx, CFA
Q1 2018 Results: Fairly Solid, Timing Issue Should Benefit Q2. Looking Forward to Details on H. Pylori Test...
Biomerica ( BMRA) reported financial results for their fiscal 2018 first quarter ending August 31, 2017. While a slight miss to our number and flattish from fiscal Q4 2017, revenue was nonetheless fairly solid as compared to recent history and up in the low single-digits on a yoy basis. And based on the earnings release, Q1 revenue would have been even higher had it not been for late shipments of certain product materials which resulted in delayed revenue recognition – that should benefit Q2’s top-line. Also encouraging as it relates to the Q1 numbers was gross margin returning to the 35%+ level (up more than 500 bps from Q4, and wider than 10 of the last 12 quarters) and a moderating of opex – the net result was sequential improvement in operating loss, which also came in a hair better than what we were modeling.
And while revenue from all three of BMRA’s largest territories, which together account for over 90% of total sales, were below our respective estimates, none of the misses were overly significant. Part of that trio is Asia, which has long been the company’s most important territory and currently accounts for more than 40% of total sales. Importantly, revenue from this territory continued its streak of yoy growth (now at five consecutive quarters) which was the main catalyst in driving the top line.
Perhaps the most disappointing showing came from the U.S. – while sales were up a very healthy 43% from Q4 2017, this was down more 17% from Q1 of the prior year. Domestic sales have struggled to gain much traction. Despite accounting for only about 15% of total sales, softness from this territory has noticeably hampered total revenue growth.
Meanwhile, European revenue only fell in the mid-single digits compared to both the prior year and prior quarter periods. We continue to like the chances for OUS sales to return to sustainable growth as a result of BMRA's focus on growing the international business via expansion of their distribution footprint. In August they announced an agreement with a "multinational pharmaceutical company" (with annual revenue of $1.4B and 11k+ employees) to distribute one of Biomerica's POC products in Mexico and also indicated that they continue to look for additional distribution partnerships.
Q1 revenue of $1.45M was up 2% yoy (from $1.41M), flat sequentially and about 5% shy our $1.52M estimate. U.S. revenue, at $187k was down 17% yoy and well below our $226k estimate. While somewhat soft and underwhelming, perhaps more encouraging is that Q1 domestic sales were better than two of the last three prior quarters, including a 43% improvement from Q4 2017. But had U.S. maintained their 2016 average ($250/qtr) and the aforementioned materials shipment issue not delayed additional sales, total company-wide revenue might have shown growth in the double-digits on both a yoy and sequential basis.
Revenue from Asia was $620k in Q1, representing 8% growth yoy but a similar percentage contraction from Q4. 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. This is evident when comparing Q1’s 8% sequential contraction (i.e. high short-term volatility) to 31% growth of the combined most recent four quarters (i.e. longer-term growth trend). 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. And among the territories which did post positive revenue growth in Q1 2018, Asia contributed 42% of the total growth. Given the outsized contribution from Asia (which now accounts for 43% of total revenue) even incremental growth from current levels in this territory will have a meaningfully positive effect. We continue to model low double-digit annual growth in Asia sales over the next couple of years.
Europe was also a bright spot in 2017, although not anywhere near that of 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. Q1 2018 sales slid 4% on a yoy basis and 6% sequentially – the latter which also reflected the difference to our estimate. Europe accounts for about 37% 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 first few years.
Relative to the U.S., as noted, domestic sales have struggled to gain traction for some time now. U.S.-related revenue peaked in 2014 at $1.26M and have slid ever since - falling 17% in 2015, 4% in 2016 and were down another 12% in 2017. Q4 2017 was exceptionally weak so the 43% sequential growth through Q1 2018 was encouraging, although was facilitated by the easy comp. While we continue to model roughly flattish U.S. sales from the company’s currently commercialized product portfolio, that would almost certainly change if and when InFoods, the company’s novel IBS product, gains FDA regulatory clearance and launches. Another possible contributor could be a new h. pylori test, which is currently under development (and which we discuss in more detail below).
Gross Margin, Operating Expenses
Despite contracting from 40.9% in Q1 2017, we’d characterize gross margin as a highlight. At 35.6%, it was up 530 basis points from Q4 2017, wider than 10 of the last 12 quarters and slightly better than our 34.5% estimate. We continue to expect to see additional benefits in margin with sales growth. As a reminder, BMRA’s gross margin was almost 38% at historical annual sales of $6M – so while territorial sales-mix will also likely influence margins, this indicates our gross margin estimates (including 36% on $6.2M in sales in 2018) could prove conservative.
Q1 OpEx was $741k, or 51% of revenue, largely inline with our $771k and 51% estimates. Both R&D and SG&A expense were almost dead-on with their respective quarterly averages during 2017. Operating expenses have trended meaningfully higher versus 2016, however – some of this difference undoubtedly relates to lower revenue throughout that year (i.e. revenue levels have some influence on sales/mktg related spend). But also, some incremental headcount additions as well as activities related to InFoods development likely contributed to OpEx recently moving higher. But as we have noted in the past, given management's history of diligence on cost control coupled with expectations of continued topline growth, we continue to look for improved operating scale in future years - particularly if and when InFoods is commercialized.
We reiterate, however, that while our model reflects an expectation of incremental InFoods-related development and regulatory expenses, we continue to refrain from modeling any potential revenue for the product 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 will, however, continue to revisit this assumption on a regular and ongoing basis and consider updates to our model (potentially including InFoods-related revenue contribution) with additional and substantive development and/or regulatory progress.
Cash balance at the close of Q1 was $1.1M, down slightly from $1.2M at the end fiscal 2017 (i.e. May 31, 2017). Cash used in operating activities was $125k ($141k ex-changes in working capital). Another $20k was used for the purchase of certain PP&E. On June 30, 2017 Biomerica filed an S-3 registration statement with the SEC, registering for sale (up to) $45M in common stock. While the shelf/prelim prospectus includes the typical generic language of "for working capital and general corporate purposes" as it relates to the use of proceeds, if BMRA does conduct a secondary offering 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 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". This agreement is cancellable if BMRA has not obtained FDA clearance/approval of InFoods by December 31, 2017. But while it is highly unlikely that InFoods will be U.S. regulatory greenlighted by then, we note that this date can be extended if agreed upon by both parties.
BMRA has made meaningful operational progress over the last several quarters – most notably with their IBS test product candidate (‘InFoods’) including further development activities, assemblage of an expert scientific advisory board to help guide strategy and with intellectual property protection. So while recent financial performance has not been as strong as it had been in the past (although has recently returned to near-historical highs), it has greatly improved (particularly in Asia) and, importantly, BMRA continues to move down the road with what could potentially and eventually be their most significant product to-date.
Novel H. Pylori Test Begins Clinical Studies…
The company remains committed to expanding their product menu. While clearly the single major focus is successful development of InFoods, other high-potential projects continue in parallel. Another program, related to a novel Helicobacter pylori (h. pylori) diagnostic was the latest to be divulged. BMRA already has several h. pylori tests in their product catalog including ELISA blood antibody tests, a rapid antibody test for the OTC market and a rapid stool-based antigen test for the professional POC market.
H. pylori is a gram-negative bacteria found in the stomach. While it is relatively common – as much as 50% or more of the world’s population are infected with the bacteria – most people do not exhibit symptoms. But, of the 15% - 20% that do have a reaction, symptoms can include stomach pain, reflux, nausea and bloating. H. pylori is associated increased risk of ulcers and is the strongest known risk for developing gastric cancer. Additionally, length of exposure to h. pylori is positively correlated to the risk of gastric cancer. Once diagnosed, standard therapy consists of proton pump inhibitors and certain antibiotics.
In typical BMRA fashion, the company disclosed little about their new product candidate but did note in their September 12, 2017 press release that clinical studies have been initiated for their new and proprietary h. pylori test which “is designed to increase the sensitivity and specificity of H. pylori testing and monitoring of treatment.” It goes on to mention that the studies are being done in collaboration with the University of Southern California and Vanderbilt University, along with an unnamed European University. Biomerica is ballparking 6 – 12 months for the clinical studies, following which analytical studies will be conducted. BMRA anticipates an eventual application seeking U.S. regulatory clearance will follow FDA’s 510(k) pathway.
Additional details about the study, titled Specimen Collection Study for H. Pylori Testing in Patients With Dyspepsia, are listed on clinicaltrials.gov (ID: NCT02970110, link: http://bit.ly/2gRuwLD). Principal investigators are Dr. Anthony Lembo (Harvard Medical) and Dr. Douglas Morgan (Vanderbilt Medical). Dr. Lembo is also a member of BMRA’s Scientific Advisory Board and a recognized expert in GI disorders. Per clinicaltrials.gov, the study, which will be conducted at a minimum of two sites, will acquire human specimens from patients (n=200) undergoing endoscopy with gastric biopsy for the diagnosis of active h. pylori infection. The biopsy tissue (sampled from the stomach) will be evaluated with histology and rapid urease test (or RUT, a commonly used test which identifies the presence of urease, an enzyme secreted by h. pylori). The study design also notes that a stool sample will be obtained by the participants prior to undergoing endoscopy and that “results and specimens will be used in a future clinical trial [i.e. “analytical studies” referenced in BMRA’s PR] of a non-invasive in vitro diagnostic assay for the detection of H. pylori antigen”. Which we think suggests that BMRA’s novel h. pylori test will be stool-based.
Currently there are several methods to test for the presence of h. pylori. This includes histology, RUT and culture – all of which require invasive biopsy sampling, and non-invasive methods including urea breath test (UBT), serology and stool antigen tests (SAT). There are advantages and disadvantages of each. This includes expense and discomfort of invasive testing and lower accuracy of non-invasive serology testing. Below is a summary (compiled from data of several studies) of the different tests and their relative advantages and disadvantages – the table is from a study by JY Lee and N Kim, published in the January 2015 issue of Annals of Translational Medicine.
Our Comments: Currently available SAT tests are generally considered highly accurate, although as the table illustrates, there are drawbacks including that the use of PPIs, antibiotics or recent bismuths can affect sensitivity. We will be interested to hear future updates on the progress of the clinical and validations studies and more details about the test under development. Learning more about the novel nature, and how it differs from currently available SATs, will be of particular interest to us. We think that if the test was designed to address one or more of the shortcomings of current SATs – such as, for example, being unaffected by PPIs (with no meaningful compromise to accuracy) or even improving on accuracy, that that may provide for significant differentiation.
Approximately six million non-invasive h. pylori tests are performed each year in the U.S. – if we assume $100/test, that calculates to a domestic market size of around $600M. And this is expected to grow given increasing prevalence of h. pylori and a greater shift from direct (i.e. invasive) to non-invasive methods – which could be further catalyzed with the advent of novel technologies (potentially including BMRA’s test) addressing some of the drawbacks of currently available tests.
Given BMRA’s relatively tiny size ($24M MC, ~$6M annual revenue), capturing as little as one-quarter of one percent of the U.S. non-invasive h. pylori market (or ~$1.5M) would be highly significant for the company. One percent market share could mean doubling of revenue from current levels. We hope to know more about the test in the non-too-distant future which may help in assessing potential competitiveness to currently available diagnostics as well as provide some useful data points for modeling purposes.
We cover BMRA with a $4/share price target. See below for free access to our updated report on the company.
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