Fast growth negatively impacted by NZ IFRS 15

Pacific Edge 4 June 2018 Update
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Pacific Edge

Fast growth negatively impacted by NZ IFRS 15

Financial update

Pharma & biotech

4 June 2018

Price

NZ$0.26

Market cap

NZ$121m

NZ$1.43/US$

Net cash (NZ$m) at 31 March 2018

16.2

Shares in issue

466.3m

Free float

88.4%

Code

PEB

Primary exchange

NZX

Secondary exchange

N/A

Share price performance

%

1m

3m

12m

Abs

(21.2)

(32.5)

(44.4)

Rel (local)

(22.8)

(33.9)

(50.3)

52-week high/low

NZ$0.5

NZ$0.3

Business description

Pacific Edge develops and sells a portfolio of molecular diagnostic tests based on biomarkers for the early detection and management of cancer. Tests utilising its Cxbladder technology for detecting and monitoring bladder cancer are sold in the US, New Zealand and Australia.

Next events

LCD inclusion

CY18

Kaiser Permanente commercial agreement

CY18

Analysts

Maxim Jacobs

+1 646 653 7027

Nathaniel Calloway

+1 646 653 7036

Pacific Edge is a research client of Edison Investment Research Limited

Pacific Edge recently announced that it has adopted the new revenue recognition accounting standard, NZ IFRS 15, for FY18. This means that revenue from US customers will only be recognised once cash payment is received (previously it also included tests that had been billed but not yet paid). As a result, the company restated FY17 operating revenue from NZ$8.1m to NZ$3.2m and reported NZ$3.4m for FY18. Total revenue would have been up 26.3% without the accounting change but under NZ IFRS 15 this is reduced to 6.9% as the US is the main growth driver for tests. Pacific Edge is negotiating agreements with the Centers for Medicare and Medicaid (CMS) as well as private payers to provide for more timely reimbursement. Management will provide updated guidance later this year.

Year end

Revenue (NZ$m)

PBT*
(NZ$m)

EPS*
(c)

DPS
(c)

P/E
(x)

Yield
(%)

03/17**

4.4

(22.4)

(5.9)

0.0

N/A

N/A

03/18

4.8

(19.5)

(4.4)

0.0

N/A

N/A

03/19e

7.8

(17.7)

(3.7)

0.0

N/A

N/A

03/20e

12.7

(14.2)

(2.8)

0.0

N/A

N/A

Note: *PBT and EPS are normalised, excluding amortisation of acquired intangibles, exceptional items and share-based payments. Note: **FY17 restated for IFRS15.

Talks with CMS and Kaiser Permanente ongoing

The company continues to work with CMS (which represents approximately 50% of Cxbladder test volume) to gain inclusion in a local coverage determination (LCD) which would enable consistent payments from CMS as well as reduce the lag time between the test being performed and receipt of cash. Commercial discussions with Kaiser Permanente (which has 11.8m members) are ongoing.

Test volume increased by 29% over FY17

The number of tests processed, which is a key measure of the underlying growth of the business, increased by 29% in FY18 to 14,400 tests, of which 82% were billable. The company estimates that approximately 23,000 tests (up 60%) will be processed in FY19 although this includes throughput from both Kaiser Permanente and CMS, organisations where the agreements are still being finalised.

Veterans Administration launch ongoing

The Veterans Administration (VA), which covers approximately 20 million people, is under contract with Pacific Edge. The company is currently targeting a total of 14 larger VA centres and has early sales from two of the initial five targeted.

Valuation: NZ$348m or NZ$0.75 per share

Our DCF-based valuation has been reduced from NZ$434m (NZ$0.93/share) to NZ$348m (NZ$0.75/share). This reflects a combination of lower near-term estimates to reflect a more conservative view of the sales ramp for the Cxbladder franchise in the US and delayed cash inflow from product sales in the US. We have also pushed back profitability to FY21 from FY20. We estimate the financing needs of the company to be NZ$20m through FY20.

Strong test growth

Although the company has yet to finalise its agreement with Kaiser Permanente or gain inclusion in an LCD from CMS (which is regularly a multi-year process), test volume for Cxbladder increased by 29% in FY18 compared to the previous year, tracking well in comparison to other molecular diagnostic launches (see Exhibit 1). As a reference, Genomic Health’s Oncotype DX test has annualised sales of $340m per year.

Exhibit 1: Molecular diagnostic test volumes post-launch

Source: Pacific Edge

In its presentation accompanying the results, management estimates that if some tests from Kaiser Permanente and CMS are included in FY19e volumes, approximately 23,000 tests should be processed, up 60% compared to FY18.

Negotiations with large US insurers ongoing

The company is continuing to work with CMS to gain inclusion in an LCD. An LCD is a document that includes the coverage decisions of the Medicare Administrative Contractor (MAC). An LCD would provide the conditions of the coverage as well as the price, guidance on reimbursement and coding information. Unfortunately there is no set process for achieving an LCD and in many ways it is the epitome of arbitrary bureaucracy. Most companies tend to take between three and five years to gain an LCD inclusion so while Pacific Edge has been in this process for around four years, it is within the normal timeframe.

Once an LCD inclusion is attained, reimbursement from CMS (which currently represents approximately 50% of Cxbladder test volume) should become consistent and timely. Besides this immediate benefit of new tests being covered by CMS, the company may finally receive payment for old tests previously conducted. Pacific Edge has not sought payment for tests provided to patients covered by CMS until LCD inclusion so there could be a multi-year backlog of test revenue that is recognised in a single reporting period post-inclusion. In addition, private payers often base their own coverage decisions and reimbursement levels on the coverage listed in an LCD, so a success here could lead to success nationally for the company.

Pacific Edge is also in final discussions with Kaiser Permanente regarding a commercial relationship and is working with Kaiser’s staff to ensure that commercial tests can begin shortly after an agreement is reached. Commercial adoption by Kaiser could provide a significant ramp in sales. However, Management confirms that it is taking longer than anticipated to finalise the Kaiser agreements.

Valuation

Our DCF-based valuation has been reduced from NZ$434m (NZ$0.93/share) to NZ$348m (NZ$0.75/share). This reflects a combination of a more conservative view of the sales ramp-up for the Cxbladder franchise in the US and delayed cash inflow from product sales in the US. We will revisit these estimates once agreements are completed with CMS and Kaiser Permanente and we have greater clarity on the ramp-up once reimbursement is in place.

Exhibit 2: Valuation based on DCF

Discounted cash flow (NZ$000)

331,996

Net cash (NZ$000) at 31 March 2018

16,242

Valuation (NZ$000)

348,236

Number of shares (m)

466.32

Value per share (NZ$)

0.75

Source: Edison Investment Research

Financials

The company recently published FY18 results. As a reminder, the company previously announced that it had adopted the new revenue recognition accounting standard, NZ IFRS 15, for FY18 which means that revenue from US customers will only be recognised once cash payment is received (previously the company recognized tests that had been billed but not yet paid). As a result, the company restated FY17 operating revenue from NZ$8.1m to NZ$3.2m and reported FY18 operating revenue of NZ$3.4m. Total revenue would have been up 26.3% without the accounting change but under NZ IFRS 15 it was only up 6.9% as the US is the main growth driver for tests (see Exhibit 3). On the balance sheet the biggest impact was in receivables which had previously been reported at NZ$6.5m in FY17 and was restated to NZ$0.7m with NZ$1.1m reported for FY18.

Exhibit 3: NZ IFRS 15 changes

FY18

NZ IFRS 15

FY18

(previous method)

FY17

NZ IFRS 15

(restated)

FY17

(previously reported,

without NZ IFRS 15 impact)

Operating revenue

3.4

N/D

3.2

8.1

Other revenue

1.6

N/D

1.5

1.4

Total revenue*

5.0

12

4.7

9.5

Operating expenses

24.6

N/D

27.3

30.5

Net loss*

-19.7

N/D

-22.6

-21.0

Source: Pacific Edge. Note: N/D=not disclosed, full reconciliation expected to be available 30 June 2018 with release of full financial statements. *Definitions may vary slightly from figures shown in Exhibit 5.

Operating expenses fell from NZ$27.3m in FY17 (using NZ IFRS 15) to NZ$24.6m mainly due to the elimination of expenses related to the employee equity equivalent incentive scheme.

Due to these results, we have made some changes to our forecasts (see Exhibit 4), which take into account NZ IFRS in terms of delayed cash flows from US product sales. Our revisions also reflect the delay in getting Kaiser Permanente and CMS on board. We assume that reported revenues would be 40% of what would be reported under the previous accounting system, in-line with the changes to FY17 and FY18 (our revenue estimate for FY19 would be NZ$19.4m without the accounting change instead of NZ$7.8m). We also introduce FY20 estimates. Meanwhile, if LCD inclusion occurs before that, we would likely need to increase estimates materially as revenue recognition would normalise and the backlog of unpaid tests from previous years would provide a boost to revenue as they are paid.

Exhibit 4: Financial forecast changes

FY19e old

FY19e new

FY20e old

FY20e new

Revenue (NZ$m)

21.2

7.8

N/A

12.7

PBT (normalised) (NZ$m)

(3.9)

(17.7)

N/A

(14.2)

EPS (NZ$)

(0.0)

(0.0)

N/A

(0.0)

Source: Edison Investment Research

The company had net cash of NZ$16.2m at 31 March 2018. We have also pushed back profitability to FY21 from FY20 mainly due to the accounting change and lower sales estimates. We estimate the financing needs of the company to be NZ$20m through FY20 although this could all change once the company obtains reimbursement from CMS.

Exhibit 5: Financial summary

NZ$'000s

2017

2018

2019e

2020e

Year end 31 March

NZ GAAP

NZ GAAP

NZ GAAP

NZ GAAP

PROFIT & LOSS

Revenue

 

 

4,432

4,771

7,755

12,746

Cost of Sales

(1,446)

(2,060)

(3,102)

(3,824)

Gross Profit

2,986

2,711

4,653

8,922

EBITDA

 

 

(22,293)

(19,371)

(17,871)

(14,052)

Operating Profit (before amort. and except.)

(22,646)

(19,687)

(18,212)

(14,339)

Intangible Amortisation

(189)

(188)

(70)

(89)

Exceptionals

(43)

(83)

0

0

Operating Profit

(22,878)

(19,958)

(18,282)

(14,428)

Other

0

0

0

0

Net Interest

249

231

487

144

Profit Before Tax (norm)

 

 

(22,398)

(19,456)

(17,725)

(14,194)

Profit Before Tax (FRS 3)

 

 

(22,629)

(19,727)

(17,795)

(14,283)

Tax

0

0

0

0

Profit After Tax (norm)

(22,398)

(19,456)

(17,725)

(14,194)

Profit After Tax (FRS 3)

(22,629)

(19,727)

(17,795)

(14,283)

Average Number of Shares Outstanding (m)

382.5

438.4

482.2

501.5

EPS - normalised (c)

 

 

(5.9)

(4.4)

(3.7)

(2.8)

EPS - FRS 3 (c)

 

 

(5.9)

(4.5)

(3.7)

(2.8)

Dividend per share (c)

0.0

0.0

0.0

0.0

Gross Margin (%)

N/A

N/A

N/A

N/A

EBITDA Margin (%)

N/A

N/A

N/A

N/A

Operating Margin (before GW and except.) (%)

N/A

N/A

N/A

N/A

BALANCE SHEET

Fixed Assets

 

 

1,166

1,135

1,072

1,060

Intangible Assets

329

281

355

415

Tangible Assets

837

854

717

645

Other

0

0

0

0

Current Assets

 

 

16,541

18,530

7,103

9,162

Stocks

824

752

752

752

Debtors

663

1,064

1,064

1,064

Cash

14,564

16,242

4,815

6,874

Other

490

472

472

472

Current Liabilities

 

 

(2,734)

(2,999)

(7,999)

(22,999)

Creditors

(2,734)

(2,926)

(2,926)

(2,926)

Short term borrowings

0

0

(5,000)

(20,000)

Short term leases

0

(73)

(73)

(73)

Other

0

0

0

0

Long Term Liabilities

 

 

0

(26)

(26)

(26)

Long term borrowings

0

0

0

0

Long term leases

0

(26)

(26)

(26)

Other long term liabilities

0

0

0

0

Net Assets

 

 

14,973

16,640

150

(12,803)

CASH FLOW

Operating Cash Flow

 

 

(18,086)

(18,331)

(16,566)

(12,721)

Net Interest

249

231

487

144

Tax

0

0

0

0

Capex

(479)

(335)

(349)

(364)

Acquisitions/disposals

0

0

0

0

Financing

8,750

21,318

0

0

Dividends

0

0

0

0

Other

(91)

(1,261)

0

0

Net Cash Flow

(9,657)

1,622

(16,428)

(12,940)

Opening net debt/(cash)

 

 

(24,160)

(14,564)

(16,143)

284

HP finance leases initiated

0

(99)

0

0

Other

61

56

0

0

Closing net debt/(cash)

 

 

(14,564)

(16,143)

284

13,225

Source: Company data, Edison Investment Research

Edison is an investment research and advisory company, with offices in North America, Europe, the Middle East and AsiaPac. The heart of Edison is our world-renowned equity research platform and deep multi-sector expertise. At Edison Investment Research, our research is widely read by international investors, advisers and stakeholders. Edison Advisors leverages our core research platform to provide differentiated services including investor relations and strategic consulting. Edison is authorised and regulated by the Financial Conduct Authority. Edison Investment Research (NZ) Limited (Edison NZ) is the New Zealand subsidiary of Edison. Edison NZ is registered on the New Zealand Financial Service Providers Register (FSP number 247505) and is registered to provide wholesale and/or generic financial adviser services only. Edison Investment Research Inc (Edison US) is the US subsidiary of Edison and is regulated by the Securities and Exchange Commission. Edison Investment Research Limited (Edison Aus) [46085869] is the Australian subsidiary of Edison. Edison Germany is a branch entity of Edison Investment Research Limited [4794244]. www.edisongroup.com

DISCLAIMER
Copyright 2018 Edison Investment Research Limited. All rights reserved. This report has been commissioned by Pacific Edge and prepared and issued by Edison for publication globally. All information used in the publication of this report has been compiled from publicly available sources that are believed to be reliable, however we do not guarantee the accuracy or completeness of this report. Opinions contained in this report represent those of the research department of Edison at the time of publication. The securities described in the Investment Research may not be eligible for sale in all jurisdictions or to certain categories of investors. This research is issued in Australia by Edison Investment Research Pty Ltd (Corporate Authorised Representative (1252501) of Myonlineadvisers Pty Ltd (AFSL: 427484)) and any access to it, is intended only for "wholesale clients" within the meaning of the Corporations Act 2001 of Australia. The Investment Research is distributed in the United States by Edison US to major US institutional investors only. Edison US is registered as an investment adviser with the Securities and Exchange Commission. Edison US relies upon the "publishers' exclusion" from the definition of investment adviser under Section 202(a)(11) of the Investment Advisers Act of 1940 and corresponding state securities laws. As such, Edison does not offer or provide personalised advice. We publish information about companies in which we believe our readers may be interested and this information reflects our sincere opinions. The information that we provide or that is derived from our website is not intended to be, and should not be construed in any manner whatsoever as, personalised advice. Also, our website and the information provided by us should not be construed by any subscriber or prospective subscriber as Edison’s solicitation to effect, or attempt to effect, any transaction in a security. The research in this document is intended for New Zealand resident professional financial advisers or brokers (for use in their roles as financial advisers or brokers) and habitual investors who are “wholesale clients” for the purpose of the Financial Advisers Act 2008 (FAA) (as described in sections 5(c) (1)(a), (b) and (c) of the FAA). This is not a solicitation or inducement to buy, sell, subscribe, or underwrite any securities mentioned or in the topic of this document. This document is provided for information purposes only and should not be construed as an offer or solicitation for investment in any securities mentioned or in the topic of this document. A marketing communication under FCA Rules, this document has not been prepared in accordance with the legal requirements designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of the dissemination of investment research.
Edison has a restrictive policy relating to personal dealing. Edison Group does not conduct any investment business and, accordingly, does not itself hold any positions in the securities mentioned in this report. However, the respective directors, officers, employees and contractors of Edison may have a position in any or related securities mentioned in this report. Edison or its affiliates may perform services or solicit business from any of the companies mentioned in this report. The value of securities mentioned in this report can fall as well as rise and are subject to large and sudden swings. In addition it may be difficult or not possible to buy, sell or obtain accurate information about the value of securities mentioned in this report. Past performance is not necessarily a guide to future performance. Forward-looking information or statements in this report contain information that is based on assumptions, forecasts of future results, estimates of amounts not yet determinable, and therefore involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of their subject matter to be materially different from current expectations. For the purpose of the FAA, the content of this report is of a general nature, is intended as a source of general information only and is not intended to constitute a recommendation or opinion in relation to acquiring or disposing (including refraining from acquiring or disposing) of securities. The distribution of this document is not a “personalised service” and, to the extent that it contains any financial advice, is intended only as a “class service” provided by Edison within the meaning of the FAA (ie without taking into account the particular financial situation or goals of any person). As such, it should not be relied upon in making an investment decision. To the maximum extent permitted by law, Edison, its affiliates and contractors, and their respective directors, officers and employees will not be liable for any loss or damage arising as a result of reliance being placed on any of the information contained in this report and do not guarantee the returns on investments in the products discussed in this publication. FTSE International Limited (“FTSE”) © FTSE 2018. “FTSE®” is a trade mark of the London Stock Exchange Group companies and is used by FTSE International Limited under license. All rights in the FTSE indices and/or FTSE ratings vest in FTSE and/or its licensors. Neither FTSE nor its licensors accept any liability for any errors or omissions in the FTSE indices and/or FTSE ratings or underlying data. No further distribution of FTSE Data is permitted without FTSE’s express written consent.

Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

295 Madison Avenue, 18th Floor

10017, New York

US

Sydney +61 (0)2 8249 8342

Level 4, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

295 Madison Avenue, 18th Floor

10017, New York

US

Sydney +61 (0)2 8249 8342

Level 4, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

Edison is an investment research and advisory company, with offices in North America, Europe, the Middle East and AsiaPac. The heart of Edison is our world-renowned equity research platform and deep multi-sector expertise. At Edison Investment Research, our research is widely read by international investors, advisers and stakeholders. Edison Advisors leverages our core research platform to provide differentiated services including investor relations and strategic consulting. Edison is authorised and regulated by the Financial Conduct Authority. Edison Investment Research (NZ) Limited (Edison NZ) is the New Zealand subsidiary of Edison. Edison NZ is registered on the New Zealand Financial Service Providers Register (FSP number 247505) and is registered to provide wholesale and/or generic financial adviser services only. Edison Investment Research Inc (Edison US) is the US subsidiary of Edison and is regulated by the Securities and Exchange Commission. Edison Investment Research Limited (Edison Aus) [46085869] is the Australian subsidiary of Edison. Edison Germany is a branch entity of Edison Investment Research Limited [4794244]. www.edisongroup.com

DISCLAIMER
Copyright 2018 Edison Investment Research Limited. All rights reserved. This report has been commissioned by Pacific Edge and prepared and issued by Edison for publication globally. All information used in the publication of this report has been compiled from publicly available sources that are believed to be reliable, however we do not guarantee the accuracy or completeness of this report. Opinions contained in this report represent those of the research department of Edison at the time of publication. The securities described in the Investment Research may not be eligible for sale in all jurisdictions or to certain categories of investors. This research is issued in Australia by Edison Investment Research Pty Ltd (Corporate Authorised Representative (1252501) of Myonlineadvisers Pty Ltd (AFSL: 427484)) and any access to it, is intended only for "wholesale clients" within the meaning of the Corporations Act 2001 of Australia. The Investment Research is distributed in the United States by Edison US to major US institutional investors only. Edison US is registered as an investment adviser with the Securities and Exchange Commission. Edison US relies upon the "publishers' exclusion" from the definition of investment adviser under Section 202(a)(11) of the Investment Advisers Act of 1940 and corresponding state securities laws. As such, Edison does not offer or provide personalised advice. We publish information about companies in which we believe our readers may be interested and this information reflects our sincere opinions. The information that we provide or that is derived from our website is not intended to be, and should not be construed in any manner whatsoever as, personalised advice. Also, our website and the information provided by us should not be construed by any subscriber or prospective subscriber as Edison’s solicitation to effect, or attempt to effect, any transaction in a security. The research in this document is intended for New Zealand resident professional financial advisers or brokers (for use in their roles as financial advisers or brokers) and habitual investors who are “wholesale clients” for the purpose of the Financial Advisers Act 2008 (FAA) (as described in sections 5(c) (1)(a), (b) and (c) of the FAA). This is not a solicitation or inducement to buy, sell, subscribe, or underwrite any securities mentioned or in the topic of this document. This document is provided for information purposes only and should not be construed as an offer or solicitation for investment in any securities mentioned or in the topic of this document. A marketing communication under FCA Rules, this document has not been prepared in accordance with the legal requirements designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of the dissemination of investment research.
Edison has a restrictive policy relating to personal dealing. Edison Group does not conduct any investment business and, accordingly, does not itself hold any positions in the securities mentioned in this report. However, the respective directors, officers, employees and contractors of Edison may have a position in any or related securities mentioned in this report. Edison or its affiliates may perform services or solicit business from any of the companies mentioned in this report. The value of securities mentioned in this report can fall as well as rise and are subject to large and sudden swings. In addition it may be difficult or not possible to buy, sell or obtain accurate information about the value of securities mentioned in this report. Past performance is not necessarily a guide to future performance. Forward-looking information or statements in this report contain information that is based on assumptions, forecasts of future results, estimates of amounts not yet determinable, and therefore involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of their subject matter to be materially different from current expectations. For the purpose of the FAA, the content of this report is of a general nature, is intended as a source of general information only and is not intended to constitute a recommendation or opinion in relation to acquiring or disposing (including refraining from acquiring or disposing) of securities. The distribution of this document is not a “personalised service” and, to the extent that it contains any financial advice, is intended only as a “class service” provided by Edison within the meaning of the FAA (ie without taking into account the particular financial situation or goals of any person). As such, it should not be relied upon in making an investment decision. To the maximum extent permitted by law, Edison, its affiliates and contractors, and their respective directors, officers and employees will not be liable for any loss or damage arising as a result of reliance being placed on any of the information contained in this report and do not guarantee the returns on investments in the products discussed in this publication. FTSE International Limited (“FTSE”) © FTSE 2018. “FTSE®” is a trade mark of the London Stock Exchange Group companies and is used by FTSE International Limited under license. All rights in the FTSE indices and/or FTSE ratings vest in FTSE and/or its licensors. Neither FTSE nor its licensors accept any liability for any errors or omissions in the FTSE indices and/or FTSE ratings or underlying data. No further distribution of FTSE Data is permitted without FTSE’s express written consent.

Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

295 Madison Avenue, 18th Floor

10017, New York

US

Sydney +61 (0)2 8249 8342

Level 4, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

295 Madison Avenue, 18th Floor

10017, New York

US

Sydney +61 (0)2 8249 8342

Level 4, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

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