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CBMX: Q4 Records On Almost Every Measure

02/28/2017
By Brian Marckx, CFA

NASDAQ:CBMX

Q4:  New Records On Almost Every Measure. Mgmt Still Guiding CF Positive Q4 ‘17

Some things only change for the better.  That continues to be the story with CombiMatrix’s (NASDAQ:CBMX) operational and financial results.  The company reported Q4 earnings last week which set new records on revenue, gross margin, profitability and cash collections.  The strong financial performance was largely the product of their bread-and-butter reproductive health microarray portfolio (i.e. prenatal, miscarriage and CombiPGS/IVF) – which turned in not only a record number of tests in the quarter, but did so at a record average revenue per test.  The most significant driving force in the reproductive health portfolio has been miscarriage analysis testing – which also set new records on both volume and average price per test.

As we have noted in the past, the company’s financial performance is a direct result of execution of management’s strategy.  CBMX has been actively engaged in their fate by targeting geographic areas with favorable reimbursement, sponsoring or otherwise supporting evidence-based studies, communicating with payers and optimizing their product portfolio to include cash-pay products.  The company’s recent implementation of a new compensation model and other efficiency initiatives has resulted in a rapid and substantial shedding of expenses.  And favorable changes in payers’ coverage decisions, CBMX’s investments in billing and collections resources, sales force training and their deft updates to their product portfolio have contributed to margin expansion and greatly improved cash collections.

Additionally, as financial performance has been the product of a diversified array of improvements related to the industry, market, reimbursement, customer base and the company, this in our opinion minimizes any ‘three-legged stool’ risk.  We also think it being a diversified basket of fundamentals which have contributed to CBMX’s recent financial successes is one of the reasons why management remains confident that growth in revenue, profitability and cash flow will continue to grow.

The full year numbers attest to the progress and significant success that management has made.  FY2016 revenue increased 28%, GM expanded 900 b.p. and operating loss fell by $2.3M (or 37%) compared to 2015.  Over the same period test volumes increased 10%, with reproductive health test volumes growing almost 14%.  Meanwhile, average revenue per test increased 16%, with revenue per test in the reproductive health segment increasing almost 21% (see table below).

As we explained in a recent investor note, while increasing test volumes have been an important catalyst to the company’s financial performance, an increase in average test pricing has been an even more significant component.  Average pricing of all tests ($1,266 in Q4 ’16, $1,151 in FY ’16) and of the reproductive health segment ($1,706 in Q4 ’16, $1,587 in FY ’16) set a new quarterly and annual record in Q4 and FY2016.

We think perhaps the most remarkable part of the improved financial performance has been management’s ability to actually shed operating expenses throughout 2016 while delivering what amounted to average sequential quarterly revenue growth of about 7.2%.  This highlights the significant operating efficiencies and improved productivity of the company’s sales force.  And on top of that, gross margins also showed consistent improvement throughout the year, growing from 46.5% in Q4 2015 to 58.4% in Q4 2016.  Gross margin improvement is coming from a combination of lower test-processing costs and higher average per test pricing.

We note that oftentimes rapid revenue growth comes with an even greater increase in operating expenses – an outcome that often proves more pyrrhic than shareholder friendly.  While this seems to be particularly prevalent in the microcap space, it has not been the case with CBMX as a result of management’s stringent focus on cost-control and wringing out laboratory and other operating efficiencies.  This is evidenced by their operating loss which has also shown consistent narrowing throughout the course of 2016 and came in at just $544k in Q4, the slimmest in history and down from $1.5M in the comparable prior-year period.  Management again reiterated their expectation of reaching a point of positive cash flow generation by Q4 2017.

The compilation of financial and test-related metrics in the table below, almost all of which set new quarterly and annual records through 12/31/2016, illustrates the broad-based improvement over the last 12 months.  And while test volumes in Q4 ’16 were not a new record, the reason was a 109 test sequential drop in (lower priority and lower margin) non-microarray volumes from Q3 ’16 – the period with the greatest volume of tests (2,835).  Meanwhile, reproductive health test volumes, at 1,512 in Q4 ’16 was a new record as was the 1,029 miscarriage tests.

Miscarriage analysis, which accounts for approximately 72% of the reproductive health microarray portfolio’s revenue, and just over 50% of CBMX’s total diagnostic services revenue, is the main driving force behind the significant increase in average reimbursement as well as the company’s total revenue growth.  Positive coverage decisions by payers (at least 23 have revised since beginning of 2016) as a result of more clinical evidence supporting the use of CMA in miscarriage testing along with CBMX's direct efforts in facilitating the customer billing and reimbursement process have helped push up average reimbursement in this segment (i.e. miscarriage testing) by 25% in just the last 12 months.  This, along with growing demand for miscarriage analysis testing, success of the recently launched PGS (IVF) test, laboratory and operating efficiencies, and concentrating sales efforts in reimbursement-friendly areas is pushing up revenues, margins and cash flow to new records.

Miscarriage analysis…

Over four consecutive quarters we have seen very strong pricing of miscarriage analysis testing, continued action by more insurers including CMA as ‘medically necessary’ for the evaluation of pregnancy loss and a growing database of evidence supporting the use of CMA.  Management, using their industry insight, has indicated that they believe this positive shift will continue.

Another reason for the rapid miscarriage revenue growth has been retraining of the company’s sales force – management noted on the Q4 call that at around mid-2016 they had their sales reps focus almost entirely on building their miscarriage franchise.

And while miscarriage analysis volumes came in slightly lower than our estimates over the last three quarters, at least a portion of this was due to a certain customer bringing testing in-house.  Importantly, CBMX recently noted that they added “several large accounts” and we fully expect miscarriage testing volumes to accelerate going forward.  And despite this miss to our volume estimate in Q4, miscarriage testing volumes continue to grow on both a sequential and yoy basis and revenue actually beat our number in the most recent quarter as a result of better than expected pricing.

Miscarriage analysis generated $1.9M in revenue in Q4 on 1,029 tests sold – this compares to $1.4M (+37%) and 939 (+10%) tests in Q4 2015 and $1.6M (+15%) and 990 (+4%) tests in Q3 2016.  Average pricing in Q4 was $1,810, a new record and up 25% from $1,452 in Q4 2015.  Average pricing through the full year 2016 was $1,677, 25% higher than in 2015 ($1,341).

While miscarriage testing had already been a major catalyst to the company’s growth, with it now accounting for just over 50% of total revenue, growing volumes and a rapid increase in average pricing, coupled with recent supporting industry fundamentals and CBMX’s plan to dedicate an even greater focus on this area could result in an ever-steepening revenue curve.  The recent jump in average pricing is not only benefitting revenue, it is also having a dramatically positive effect on margins and profitability.  In addition to certain lab efficiencies, the 25% yoy growth in average miscarriage pricing helped push gross margins up by 1,190 basis points (46.5% vs 58.4%) in Q4 and by 900 basis points for the full year 2016 (46.0% vs 55.0%).

IVF (CombiPGS, Multi-PGS, PGD)…

CombiPGS (IVF test) volumes were down 5% on a sequential basis and down 6% yoy in Q4.  Volumes seemed to stall around the 190 – 200 tests per quarter range throughout 2016.  Management addressed as much on the Q4 call, noting that they attribute the lack of growth to their recent hyper-focus on miscarriage analysis.  But with a renewed focus on growing PGS volumes through sales force retraining (included as part of their national sales meeting in January 2017), similar to what helped grow miscarriage analysis in 2016, as well as installing one of their lead IVF reps to head the IVF sales effort, management expects PGS volumes to return to growth.

And while PGS volume growth has recently fallen flat, average pricing has shown considerable growth.  Average PGS pricing per test was $1,463 in Q4, up 2% sequentially and 33% yoy.  For the full year 2016, average pricing was $1,373 per test, up 20% from $1,145 in 2015.  Management attributes at least a portion of the improved pricing to an increase in the average number of embryos per case (~3.5 in Q4 ’15 to ~5 in Q4 ’16).

So despite the mid-single digit contraction in volumes, the increase in pricing resulted in Q4 ‘16 PGS revenue falling just 3% sequentially and actually growing 25% from the same period in 2015.

CBMX recently launched PGS on a Next Generation Sequencing (NGS) platform which provides benefits of even greater accuracy and greater throughput should further benefit demand and testing volume.  CBMX’s IVF business could also see incremental benefit from their recently launched multi-cycle PGS offering as well as the more recently introduced PGD test.  PGD tests an embryo for specific genetic disorders or genetic abnormalities based on the genetic status of the parents (which may be carriers of certain genetic abnormalities).  Similar to PGS, PGD is offered on a per-embryo or multicycle basis.  If PGD adoption is as swift as PGS was after launch, it will be needle-mover for CBMX – this, along with the newly launched PGS-NGS test and the fruits from the retrained sales force will be something to keep an eye on.  And with all of these tests being cash pay, CBMX avoids being at the mercy of insurers’ coverage decisions, making cash flow and collections more predictable.

Prenatal…

Prenatal volumes were generally flat in 2016 compared to the prior year and averaged approximately 290 tests per quarter.  Q4 ’16 volume was 293 tests, while up almost 29% yoy, this was flat from the 294 tests in Q3 ’16.  For the full year 2016 prenatal volume was 1,153, roughly even with the 1,164 tests in 2015.

As we noted in the recent past, we think one issue since around early 2015 has been CBMX’s distribution partner, Sequenom, driving a push of their NIPT tests.  And LabCorp’s (LH) recent acquisition of Sequenom likely shook things up even more.  On the positive side, management recently noted that they were able to pick up some of Sequenom’s accounts to which they can now sell direct.

We see the prenatal business as somewhat more difficult to model than some other of CBMX’s products given that some industry dynamics and company fundamentals should benefit growth while others are likely to have the opposite effect.

But we continue to think there are reasons to be optimistic about the prenatal business.  This includes the recent improvement in average reimbursement (up 10% in 2016 vs 2015), recent updated recommendations from ACOG and SMFM (discussed below) supporting the use of CMA for prenatal diagnosis and additional recent clinical evidence highlighting the significant accuracy issues (i.e. susceptibility to high rates of false-positive and false-negative results) of NIPS.  And while NIPS demand remains robust, and could benefit further from a recent update by the American College of Medical Genetics and Genomics (ACMGG) recommending use of it for screening of Patau, Edwards and Down Syndrome in place of conventional screening, its accuracy issues mean that CMA will continue to be used as a confirmatory diagnosis.  In fact ACMG's recent recommendation notes that, "For some patients the goal in prenatal screening may be to maximize the detection of fetal genetic diagnoses. In this scenario, fetal diagnostic testing (e.g., chorionic villous sampling or amniocentesis) followed by chromosomal microarray (CMA) using fetal DNA should be offered, and NIPS may not be the best choice."

Pediatric…

Pediatric volume growth was flattish in 2015 and fell about 4% in 2016, although volume in the second half of ’16 was up about 2% yoy.  And despite the slip in volume for the full year, pediatric revenue actually ticked up 3% ($2,222 2015 vs. $2,293 2016) from 2015 due to a favorable 7% move up in pricing.  Despite the recent softness in volumes, we continue to think pediatric has some room for incremental volume growth going in 2017.

Non-array…

While not considered CMBX’s bread-and-butter focus, non-array has and continues to be an important contributor.  Non-array volume and revenue grew 15% and 20%, respectively, in 2016 accounting for approximately 9% of total diagnostic services revenue.  Q4 ’16 saw non-array volume increase 5% yoy but fall 13% sequentially.  But, despite pricing of non-array continuing to grow, it remains at roughly 25% of CBMX’s average microarray tests.  As such, while still meaningful contributor to revenue, we don’t expect this segment to be much of a driver of the top-line or of margins.

Q4 Totals… 

Billable tests:

- Volume: 2,770 total billable tests – up 8% yoy, down 2% sequentially (due to decrease in non-array)
- Diagnostic Revenue: Q4 set a new record at $3,506 - up 32% yoy and 9% sequentially

Reproductive Health: this is CBMX’s major area of focus.

- Volume: Q4 set a new record in total billable Reproductive Health tests at 1,512 - up 10% yoy and 2% sequentially
- Revenue: Q4 set a new record in reproductive health revenue at $2,579 is up 37% yoy and 11% sequentially

Relative strength in pricing particularly in the reproductive health segment, lab efficiencies and CBMX's direct efforts in facilitating the customer billing and reimbursement process, pushed service margin up to 58.4% in Q4 which is not only a new record but ahead of the prior best by an impressive 440 basis points.  Service margin in the comparable periods were 46.5% in Q4 2015 and 54% in Q3 2016 (the prior record).  While we believe there may be some more room for service margin to grow in 2017, we do not expect any further improvement to mirror the 900 b.p. widening from 2015 to 2016.  But, we think further growth in average reimbursement would likely benefit margins.  Management continues to expect that 50%+ GM is sustainable going forward.

Q4 OpEx was $2.6M and better than our $2.8M estimate.  CBMX continues to see greater leverage in OpEx with ramping revenue, productivity gains from the sales force and efficiency efforts.  Management also noted on a recent call that they implemented a compensation policy for new hires which places greater emphasis on production and which has also had a significant positive benefit to OpEx.

Noteworthy is that operating leverage has shown a regular and consistent improvement with Q4 witnessing the greatest leverage in operating expenses that CMBX has experienced on not only a percentage of sales basis, but due to the very strong service margin, even more so on a percentage of gross income basis.  Operating expenses were 1.25x gross income in Q4 2016 – this compares to 1.46x in Q3 ’16 (the prior best), 1.72x in Q2 ’16, 1.94x in Q1 ’16 and 2.37x in all of 2015.  This highlights how the growth in test volume and improvement in pricing and margins is moving CBMX closer to profitability.

The $3.3M in cash collections in Q4 also was a new record.  CBMX used $539k in cash for operations in Q4, down from $813k in Q3 ’16.  Cash balance at year end was $3.7M.  Management believes the current cash balance is sufficient to fund operations for at least the next 12 months.  Based on the current burn rate and expectations that revenue and profitability continue to improve, we think the current cash balance should be more than sufficient to fund operations until Q4 2017 - which is when management is forecasting being to the point of cash flow break even.

We cover CBMX with a $12/share price target. See below for access to our updated report on the company.

READ THE FULL RESEARCH REPORT HERE

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