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CEMI: Revenue, margin guidance and historical context indicates this could be opportune entry point

By Brian Marckx, CFA



Q4 2018: Total sales benefit from record contracts revenue, margins begin to improve and should continue

Chembio (CEMI) reported financial results for their fourth quarter ending December 31st and provided an operating update. Product sales were just about dead-on with our estimate and up 16% yoy to $5.6M. Total revenue jumped 27% to $7.6M, aided by a very healthy $1.7M in R&D contracts, milestones and grant revenue – which is the greatest quarterly revenue from this category in company history.

Product margin was also somewhat of a highlight – at 18.3%, it was well ahead of the prior two quarters. Product margin averaged 19.9% throughout the entire year but, management noted on the call that had their manufacturing been fully automated during 2018, product margin would have been approximately 40%. With the first automated line expected to begin production by the end of the current month and orders for two additional lines already placed, product margin should continue to show regular improvement.

Management provided revenue guidance for the first time since we’ve been covering the company (June 2010). Guidance includes total revenue of $36M - $40M for FY2019 and reaching $100M of revenue by FY2023. This implies growth of between 8% and 20% in 2019 and a topline CAGR of at least 25% through 2023. Moreover, management indicated on the call that the majority of this growth, as might be expected, is anticipated to come from product sales (as opposed to R&D contracts, milestones and grant revenue), which has accounted for an average of about 80% of total sales over the last several years.

For context, total and product revenue increased 39% and 38%, respectively, in 2019 and experienced CAGRs of 13% and negative 1%, respectively over the five previous years (i.e. 2013 – 2018). Meanwhile adjusted EPS fell from $0.11 in 2013 to ($0.55) in 2018. Over that same period, CEMI’s share price and market capitalization increased by about 65% and 200%, respectively.

Our point is that much of the restocking for future growth, which has included building and commercializing the fever portfolio, continued expansion of the STD product line (including high profile products such as DPP HIV/Syphilis), maintaining key customer relationships (such as Bio-Manghinos), bringing domestic (as well as some international) sales in-house, new collaborations and partnerships, and other growth catalysts (including the recent acquisition of opTricon), have been developed over the last few years but have yet to be fully realized – but should be over the coming years. As such, and given expectations that margins and profitability will similarly increase with the guided-for topline growth, this could represent a particularly attractive entry point in the stock, in our opinion.

Product Sales
Q4 product sales were $5.6M, up 16% yoy, down 28% sequentially and inline with our $5.6M estimate. For the year product sales increased 38%. In terms of the sources of growth of product sales in 2018, management noted on the call that sales in Africa, Latin America and Europe were up 142%, 48% and 28%. Much of the growth in Africa is likely coming from the $15.8M Ethiopian tender while sales in Latin America have benefitted from the recent $8.5M Bio-Manghinos (for Brazil’s Ministry of Health) order. Meanwhile, CEMI’s HIV self-testing products have been driving growth in Europe.

And, with a newly-won contract from Bio-Manghinos for $10.5M (for the production of DPP HIV and DPP Leishmania assays), we think revenue should remain relatively elevated. In addition, ~$11.5M of the Ethiopian tender is expected to be recognized during 2019 and 2020.

Other potential revenue catalysts in 2019 include DPP Ebola (which was recently granted U.S. Emergency Use), DPP Zika (in several areas of the world), one or more DPP Dengue assay launches (including stand-alone Dengue and multiplex Dengue/Zika/Chikungunya), a DPP fever panel, revenue via opTricon and initial sales of the DPP eosinophilic respiratory disease test developed in collaboration with AstraZeneca (which received CE Mark in January). CEMI is now working on a U.S. regulatory pathway for this test. In addition, if all goes well, DPP HIV/Syphilis could receive U.S. regulatory clearance and launch before year end – this, we believe, represents one of the most potent potential near-term revenue and margin drivers for Chembio.

A UNICEF contract, awarded to CEMI earlier this month, represents another potential incremental source of revenue. Contingent on receiving CE Mark of the DPP Zika/Chikungunya/Dengue test and Micro Reader, the contract will pay at least $1.5M and up to $3.5M – and, per management’s comments, do so at a price equal to 2x to 3x that of a typical rapid HIV test. Also noteworthy is that this UNICEF contract, which was announced the same day that CEMI announced Q4 earnings, would provide upside to management’s $36M - $40M 2019 revenue guidance.

And while maybe not a near-term catalyst, a program that could potentially hold tremendous upside value is CEMI’s cancer diagnostic. While this has been somewhat of an ‘under-the-radar’ program (our wording and characterization) with only scant details disclosed publicly, recent indications had been that this was progressing and with promising results. Management noted on the Q2’18 call in August that their cancer test had completed development “with excellent analytical performance” – the test subsequently moved to the validation phase. So far, we know that it is built on the DPP platform and is a multiplex test for cancer which uses just a finger-prick worth of blood and can deliver results in 15 minutes. While we do not have nearly enough information about the test and initial results to include it in our model, given that early, accurate and non-invasive cancer diagnosis could have multibillion-dollar potential, this remains a program that we will be eager to know more about.

Total Sales
Total sales, which includes license and grant revenue, were $7.6M in Q4, up 27% yoy and down 19% sequentially. Total sales benefitted from $1.7M in R&D, milestones and grant revenue, an all-time quarterly record. For the full-year, R&D, milestones and grant revenue was $5.7M, also a record, up 45% from 2017 and catalyzed by AstraZeneca, LumiraDx and BARDA. FY2018 total sales were $33.4M, up 39%.

Product and gross margin were 18% and 39% in Q4. While this is down from 30% and 43% in the prior-year period, it is up from an average of 14% and 30% over the prior two quarters. Product and gross margin averaged 20% and 36% for the full year 2018. Product and gross margins have recently been negatively impacted by a greater mix of sales to markets with lower selling prices - which, generally, refers to international tenders – and more specifically, likely largely relates to the Ethiopian tender. For context, product and gross margins over the three prior years were 37%/43% (2015), 31%/47% (2016) and 33%/46% (2017).

We expect revenue mix (including product vs grant revenue and international, particularly EM tenders, vs U.S. sales) to continue to move margin around to some degree. But, with automated manufacturing coming online by the end of the current quarter and CEMI anticipating sales mix shifting towards higher margin products, margins should begin to show fairly consistent improvement. While the first automated line should provide some margin enhancement, the benefits of automation should be even more pronounced once the second and third lines (for automating manufacture of the lateral flow tests) are fully operational (both have now been ordered). We also expect the opTricon acquisition – which means CEMI now owns the proprietary quant reader – will benefit gross margins as they no longer pay mark-up on the devices. Interestingly, these readers may also generate revenue for CEMI as disclosures suggest there is an active market (beyond CEMI themselves) for these products.

Meanwhile, CEMI is pursuing WHO prequalification for their Malaysian production facility, which is capable of producing ~10M tests (for context, CEMI manufactured a total of 20M tests in 2018). If all goes well, manufacturing will begin there this year and bring down production and shipping costs of certain tests sold overseas. This includes STAT-PAK HIV for sale in Africa.

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