Q3 2011 Financial Results: DPP Products Driving Revenue
Brian Marckx, CFA
Chembio Diagnostics (CEMI) reported financial results for the third quarter ending September 30, 2011 on November 3rd. Revenue of $5.92 million crushed our $4.61 million estimate, the ~ $1.3 million difference split fairly equally between better than anticipated international sales of the lateral flow products and much stronger than estimated DPP product sales to FIOCRUZ. Q3 revenue was a record high for Chembio, surpassing their previous best quarterly sales of $5.67 million which came in Q4 2010.
Total product sales were $5.53 million, up 46% y-o-y and well ahead of our $4.14 million estimate. Product sales were highlighted by $1.71 million in revenue from DPP products sold to FIOCRUZ - this is an increase from about $50k in Q1 and $850k in Q2. DPP FIOCRUZ related revenue is expected to be a significant contributor to the top-line over the next few years and the big jump in DPP FIOCRUZ sales during Q3 provides evidence that this could ramp very quickly. It is also noteworthy that DPP-related sales were the major impetus for the all-time high quarterly revenue, marking a symbolic inflection point where DPP product sales (i.e. - Chembio's long-term future) are now beginning to drive top-line growth much more so than are their legacy lateral flow products.
Q3 product sales also benefitted from an almost 200% sequential increase in international HIV lateral flow sales, reflecting the reversal of an inventory backlog that stunted international HIV lateral flow sales in Q2.
Q3 EPS was $0.01 on net income of $476k, compared to our $0.00 and $277k estimates. All of the beat on revenue did not flow through to the bottom line as a result of slightly narrower gross margin compared to our estimate and higher SG&A expense, reflecting sales commissions paid on the higher-than-modeled DPP FIOCRUZ revenue number.
Cash from operations was an inflow of $633k in Q3 and $1,559k for the first three quarters of 2011. Excluding changes in working capital, operating cash flow was $660k and $971k through the three and nine months ending 9/30/2011. Investing activities used $282k through the first nine months of 2011. Chembio exited Q3 with $3.0 million in cash and equivalents, up from $2.1 million at the end of Q2. Along with cash generated from operations, cash balance was bolstered by a draw on one of the company's loan facilities during the quarter. Total debt was about $487k at Q3 quarter-end, all of which represents bank loans. Chembio has significant liquidity and we continue to expect the company will be able to manage to fund all operations (including clinical trials, regulatory filings, SG&A, etc.) through cash on hand and funds from operations.
Business / Pipeline Update
DPP HIV, U.S.
The first FDA PMA module filing was made in April 2011. Second module was filed in early October. Clinical trials are about 90% done (~75% done at end of Q2). CEMI expects trials to complete during Q4. Notable is that management now believes that both the blood and oral fluid sample data may be robust enough to meet FDA requirements. As a reminder, on the Q2 call management mentioned that the trial data up to that period indicated the oral fluid data may not meet FDA requirements - but that they hoped to gain more insight as the data analysis progressed. The most recent news, that the oral fluid data may indeed get through the FDA and afford regulatory approval for both blood and saliva, is very positive. We have again adjusted our model - which now reflects an increased chance that the test receives FDA approval for all sample types. We again reiterate, however, that a worse-case scenario, where the claim for oral fluid fails to get through FDA, would be far from a crushing blow for Chembio as we expect there to be considerable demand for the product with blood sampling alone.
DPP Syphilis (FIOCRUZ)
On May 3, 2011 Chembio announced that FIOCRUZ had received approval of its DPP Syphilis Treponemal test from Brazilian regulatory authorities. The Treponemal test is a single-parameter test for the detection of antibodies specific to Syphilis. Chembio and FIOCRUZ expect to submit a second Syphilis test for approval in Brazil either later this year or early in 2012. This second test is a multiplex screen and confirm assay that incorporates the Treponemal as well as non-Treponemal parameters. Launch of the multiplex test, which enables the detection and differentiation of past versus active infections, will likely significantly broaden the market for the DPP Syhpilis tests.
The agreement calls for minimum purchases of $5.7 million of these two tests over three years.
Chembio began evaluating this multiplex Syphilis product in China with a collaboration partner during Q1 2011 and noted on the Q2 call that results have looked encouraging.
DPP Syphilis Screen and Confirmation (U.S. / Europe)
Clinical trials in support of 510(k) had been expected to start during Q2 2011. This was slightly delayed but trials commenced during Q3. Testing is expected to be completed and a 510(k) application made in Q1 2012. This screen and confirmation (Treponemal / Non-treoponemal) test will be the first of its kind when approved. We expect the test to be a big driver of Chembio's revenue over the next several years.
The test received CE Marking in early October and Chembio is currently working to finalize distribution of the test in Europe - launch is slated for early 2012.
HIV Lateral Flow Tests CE Mark
Study data to support CE Mark of Chembio's HIV 1/2 Stat Pak and Sure Check HIV 1/2 lateral flow tests were filed in October.
HIV Lateral Flow Home Use Test
In June Chembio announced that it may pursue FDA approval of its Sure Check HIV 1/2 test for home use (i.e. - OTC). In September the FDA provided guidance that Chembio will need to perform additional studies in order to submit for an Investigational Device Exemption (IDE). Chembio noted on the Q3 call that they believe they can have these studies completed by the end of Q1 2012 and submit for an IDE at that time. If the FDA grants an IDE, Chembio would then need to conduct more clinical trials. Eventual approval is highly uncertain at this point and not a near-term event. As such we do not yet model a contribution from an OTC HIV test.
DPP Flu A/B Antigen
Chembio recently noted due to recent FDA updates to gaining clearance for this type of test, that the company was evaluating whether to continue to pursue development. At this point, we do not expect that the company will continue pursue this test and have removed all related revenue contribution from our model - this is a very minor setback as we had only modeled a small contribution from this test beginning in 2012.
DPP HCV Antibody
Chembio's Q2 10-Q notes that they are putting development of this on hold. As management had previously indicated that demand for such a test may not justify further development, the recent news is not overly surprising. We had been modeling a relatively insignificant revenue contribution from this product and removed this from our model prior to Q3 2011 financial results.
DPP Leptospirosis (FIOCRUZ)
Approved in July 2011. Triggered a $100k milestone which was recognized in Q3.
Battelle / CDC DPP Flu Test
In December 2009, Chembio entered into a $900k milestone-based development agreement for the development and initial supply of a multiplex, rapid POC influenza immunity test using the DPP technology with Battelle Memorial Institute which has a contract with the United States CDC. Chembio received the final milestone payment for this agreement in late 2010. In October 2011 Chembio entered a subsequent, related development agreement with Battelle/CDC to continue work on this project. This supplemental agreement commences in November 2011 and is expected to end in Q1 2012 - Chembio expects to receive approximately $250k over that period related to this agreement. Our model reflects a small portion of this total received in Q4, with the remainder in Q1 2012.
OUR 2011 OUTLOOK
We now look for 2011 revenue of $ 18.6 million - this is up from $16.9 million prior to Q3 results and mostly reflects the revenue beat in Q3. Our current 2011 revenue estimate implies growth of 11% from 2010 and, more importantly, implies product sales (i.e. - Chembio's fundamental business) growth of 23% - largely driven by contribution from DPP products (to FIOCRUZ). Meanwhile, we model revenue from licenses, grants and milestones (an ancillary part of the company's operations) to fall 39%. The expected drop in revenue from these ancillary sources is relatively meaningless from a longer-term perspective, however, as product sales (especially DPP) will be the ongoing driver of Chembio's revenue.
Net Income / EPS
We model Chembio to post net income of $904k and EPS of $0.01 in 2011, up slightly from the $727k and $0.01 that we modeled prior to Q3 results.
RECOMMENDATION / VALUATION
Competitors (OSUR and TRIB) trade at an average of 4.0x and 3.5x estimated 2011 and 2012 sales, respectively. We look for CEMI to post 2011 and 2012 sales of $18.6 million and $23.6 million which, based on competitor price/sales ratios, values CEMI at between $1.09/share and $1.21/share - averaging the two results in a value of $1.10/share. As a result, we are maintaining both our Outperform rating $1.10 per share price target.
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