Accelerate Diagnostics' (AXDX) CEO Lawrence Mehren on Q3 2017 Results - Earnings Call Transcript

Accelerate Diagnostics, Inc. (NASDAQ:AXDX) Q3 2017 Earnings Conference Call November 2, 2017 4:15 PM ET

Executives

Laura Pierson - IR

Lawrence Mehren - CEO, President and Director

Steve Reichling - CFO, CAO and Secretary

Analysts

William Quirk - Piper Jaffray Companies

Steven Reiman - JPMorgan Chase & Co.

Brian Weinstein - William Blair & Company

Operator

Good day, and welcome to the Accelerate Diagnostics, Inc. 2017 Q3 Results Conference Call. [Operator Instructions]. Please note this event is being recorded. I would now like to turn the conference over to Laura Pierson of Accelerate Diagnostics. Please go ahead.

Laura Pierson

Before we begin, I would like to advise you that information presented during this conference call may contain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Forward-looking statements include statements about our future and statements that are not historical facts. These statements may contain expectations regarding revenues, earnings, operations and other results and may include statements of future performance, plans and objectives.

Forward-looking statements include statements pertaining to, among other things, the commercial launch and demand for the Accelerate Pheno system and Accelerate PhenoTest BC kit for positive blood cultures; the potential benefits of the Accelerate Pheno system and Accelerate PhenoTest BC kit, including accelerated identification and susceptibility results and estimates of time reduction to results; expectations on placements, sales and product profitability; the potential of our technology generally; our belief that our expanded manufacturing capability will allow us to meet demand; our expectation of our 2017 and 2018 performance and our future development plans and growth strategy, including with respect to research and development as well as product expansion. These statements represent only our belief regarding future events, many of which are inherently uncertain.

You are cautioned that any such forward-looking statements are not guarantees of future performance and involve risk and uncertainty, and that actual results may differ materially from those projected in the forward-looking statements as a result of various factors. Information regarding important factors, including specific risk factors that could cause actual results to differ, perhaps materially, from those in our forward-looking statements are contained in reports we file with the SEC. You should read and interpret any forward-looking statement together with the reports we file with the SEC. I will now turn the conference call over to Mr. Lawrence Mehren, President and CEO of Accelerate. Larry?

Lawrence Mehren

Thank you, Laura, and good afternoon, everyone. I'm happy to have you with us for our Q3 2017 conference call. We'll begin this call, as usual, with an update on global commercial progress. During the section, I will also discuss our sales funnel, some of our model assumptions and a forecast for the rest of the year and into 2018. I will then hand it over to Steve Reichling, our CFO, to review preliminary Q3 financial results. I will then cover our product development progress and conclude with Q&A. This quarter's commercial progress was very exciting. Year-to-date, we are meeting or exceeding the majority of our expected commercial metrics and funnel assumptions, while dissecting time-consuming elements of the hospitals' acquisition process and refining our sales approach. At the top of the funnel, overall interest continues to build for the Accelerate Pheno system in the U.S. and the EU.

Market awareness is growing, inquiries increasing and our funnel of interested qualified prospects that we plan to move to evaluation contracts is large and expanding. For example, in North America alone, this group of qualified prospects now totals over 600 accounts, representing approximately 1,800 instruments. Further, these qualified prospects are turning into active customers. Although not yet reflected in our reported revenues, we are enjoying a strong commercial launch of the Pheno system, as measured by new accounts acquired. Today, we have signed agreements for 295 instruments, of these 239 are under evaluation contracts and 56 are placements. For review, we define evaluation contracts as an agreement, which allows a customer to evaluate the system with the intent of purchasing, if performance meets expectations.

We define placements as installed, validated revenue-generating instruments whose contracts have converted from evaluations to commercial agreements and for which we can record revenue. And while we would prefer the rate of these conversions to be faster, we believe the significant majority will convert to placements. Currently, evaluation contract conversion to placements is above our expectations, remaining close to 100%. For example, in all of North America, we have lost only one evaluation. In this particular account, our analytical performance was excellent. However, a major staff reorganization in lab resulted in a shift in acquisition priorities.

We also believe our support is broad-based with qualified prospects, evaluation contracts and placements coming from across all market segments, from large centralized labs to small regional hospitals. We believe that this is an affirmation that the Pheno platform is highly attractive across the potential spectrum of labs we expect for full penetration of the market. Moreover, we believe this market is also larger than we originally estimated. Having now prospected a large segment of the potential customers in the U.S., collecting data as we went along, we now believe that the sepsis market is 20% larger than we originally calculated with the total opportunity of approximately $2.3 million tests. We think this, combined with our panels for respiratory and other indications such as urinary tract infections and intraabdominal infections, makes our market opportunity appreciably larger and quite attractive. Pricing is solid for both instruments and reagents. For example, in both the U.S. and the EU, reagent pricing on average remains above $200 for all our clinical customers.

Globally, instrument mix is also favorable to our model with more than 50% of deals closed this year for capital. Reagent pull-through or annuity per box is also something we're tracking closely. And while it is early, what we are seeing with our first customers is encouraging. Not only are these customers exceeding our expectations for the total number of kits they are purchasing, they are also purchasing more instruments than we expected. So, while annuity per instrument is in line with our expectations, annuity per customer is exceeding our expectations. For example, our contract with one of our new customers calls for them to purchase 120 kits per month. They could have consumed these kits running twice a day on 2 instruments, but instead of choosing to purchase a third instrument to ensure constant availability for patient cases. We believe this is a positive development and one we're seeing with other customers as well. And while still very early, this is resulting in annuity per box ranging from 0.34 to 1.71 kits per instrument per day.

Finally, we believe clinical performance has been outstanding with numerous papers moving towards publication or already having been accepted. Most notably, our data from the U.S. clinical trial has been submitted and accepted by the Journal of Clinical Microbiology. In addition to the support publication, our investigators have so far, this year published 3 papers submitted another 4 that are awaiting decision, with 4 more in process. We believe that this, combined with 28 poster presentations highlighting the significant benefits of the Pheno system, are helping to drive the high degree of interest we are seeing in platform.

More importantly, the number of significant clinical interventions our customers are reporting is exciting, and we believe, speak to the significant clinical utility of the system. For example, a customer in the U.K. found that of their last 105 patients run on the Pheno, 85 of those runs resulted in meaningful interventions, including among others, escalation, de-escalation and isolation. We believe that results like this spread by word-of-mouth and in papers and posters will continue to drive broad-based adoption of the platform, reason for optimism for sure. However, as mentioned in our Q2 call, the acquisition process for a new diagnostic device has never been more complicated nor time consuming, extending the sales cycle. We highlighted in the last call that the period to complete the verification, signing the contract and moving to a placement, originally estimated at 3 to 4 months could extend an additional 3 months as our customers take longer to work through the contracting process. With more contracts under our belt, we believe that most of the evaluation contracts in the funnel for a 2017 close will take this amount of time to convert to placements.

In addition, as we move to placements in more sites, we are seeing an additional time period post-contract signing as sites build a unique LIS interface into our system. This is typically an internal effort by the hospital's IT group coordinating with an outside LIS vendor. Our current experience suggests that this is adding an additional 3 months post-contract signing until we begin to generate meaningful reagent revenue. We've been all over these unexpected increases to our sales cycle dissecting the acquisition process step-by-step and refining our approach. We have now developed mitigations for both of these time increases and believe these will have a meaningful impact. For example, simply increasing the number of instruments used in the verification can significantly decrease the time to completion at little cost to Accelerate. Changes like these, we believe, will decrease the time to reagent revenue for 2018, bringing it back more in line with our expectations. However, for 2017, we expect this to reduce reagent sales.

In summary, 8 months into our launch, we have met or exceeded our expectations on most of our key parameters, including the number of qualified prospects, the number of evaluation contracts, conversion percentage, pricing for tests and instruments, capital mix and annuity per customer. However, we underestimated the time it would take for a customer to convert from an evaluation contract to a placement and to meaningful reagent revenue. We believe this will result in lower sales in the short-term due to a decrease in reagent revenue for the year. In addition, we currently have 40 contracts for placements under review with an expected close in 2017. However, there is risk that some of these could get pushed into Q1 2018. Given this, we expect to finish the year with revenues in the range of $5 million to $8 million. We expect the success we've achieved in signing evaluation agreements and converting them to placements will show up in reported revenues in 2018. Hence, we expect to show strong growth in 2018 with revenue growth between 5 and 7x 2017. And with that, I will turn it over to Steve Reichling to review our Q3 preliminary results. Steve?

Steve Reichling

Thank you, Larry, and good afternoon. Revenue for the third quarter was $828,000 and $2.1 million year-to-date compared with $24,000 and $207,000 for the same period in the prior year. These increases were driven by sales of the Accelerate Pheno system and Accelerate PhenoTest BC kit across the U.S., Europe and now the Middle East. The cost of goods for the quarter were $191,000 and $352,000 year-to-date, resulting in gross margins of 77% and 83%, respectively. These gross margins are inflated due to instrument inventory sold in the past few quarters that were previously recorded to research and development expense. Selling, general and administrative expenses for Q3 2017 were $11.6 million and $33.6 million year-to-date, compared with $9.6 million and $26.7 million for the same period of 2016.

These year-over-year increases were driven by higher personnel and evaluation-related costs in the U.S. and Europe. Research and development costs for the quarter were $6.4 million and $16.2 million year-to-date compared to $7.9 million and $24 million from the same period in the prior year. These year-over-year decreases were due to clinical trial and prelaunch inventory costs incurred in 2016 that did not repeat in the current year. Our net loss for the third quarter was $17 million and $47.7 million year-to-date, resulting in a net loss per share of $0.31 and $0.89 on weighted average basic shares outstanding of $55.3 million and $53.6 million, respectively. These net losses contained $3.5 million and $11 million year-to-date in noncash stock-based compensation expense. Net cash used for the quarter was $13.9 million and $40.2 million year-to-date. The company ended the quarter with cash and investments of $121.3 million. We anticipate filing the 10-Q for the quarter ended September 30, 2017, on November 7, 2017. I will now hand it back to Larry to review our R&D progress.

Lawrence Mehren

Thank you, Steve. So, this quarter the team achieved several milestones across a number of development initiatives that are focused on 3 key strategies. First, unlocking future test volumes through new kits and expanded claims. Second, improving existing product performance and the experience of our customers. And third, inventing new technologies that make life-saving decisions easier for clinicians and safer for patients facing serious infections.

Let's start with respiratory. This week marked the completion of assay development activities for our kit targeting severe pneumonia. Over the coming weeks we plan to kick off verification and the performance evaluation study to achieve a CE mark before the end of the year or just after the holidays. For the U.S. clinical trial for respiratory, we plan on including a clinical arm to demonstrate the clinical and health economic benefits of the device. Further we plan on expanding the indication to include severe community-acquired bacterial pneumonia, for which we will add 2 additional probes and a novel sample prep device. We plan to begin site recruitment in the next few weeks and plan to begin the trial in Q2 2018.

Our focus is on respiratory, the team also completed market assessments and collected customer requirements for the next kit aimed at sample types for acute urinary tract infections and intraabdominal infections. We believe these can be developed concurrently and are in the process of building out the teams behind them. Urinary tract infections are a great target for us. More than 7.5 million emergency department visits are associated with UTIs. Of patients admitted, more than 500,000 inpatients principal diagnosis is the urinary tract infection, meaning the primary reason for their hospital stay is due to UTI. On average, these patients are in the hospital for 4 days and the cost for serious urinary tract infections is over $13 billion annually in United States alone. Often these organisms are multidrug resistant and may lead to urosepsis, a potentially fatal condition. We believe rapid susceptibility testing will aid treating physicians on optimal therapy choices.

Intraabdominal infections also represent a high acuity target for the Pheno solutions. More than 200,000 inpatients are diagnosed with an intraabdominal infection each year. These patients are often quite sick, in the hospital for nearly 7 days. These infections are difficult to diagnose given the polymicrobic nature of the sample and are often associated with drug-resistant organisms where empiric therapy may fail. Again, we believe rapid identification and susceptibility testing will aid treating physicians on optimal therapy choices. For blood culture, we completed development of 2 new antibiotics for Europe, amoxicillin/clavulanic acid and cefuroxime. These drugs are both key to de-escalation or limiting exposure to unnecessary antibiotics for the EU. In addition, based on customer feedback, we've expanded the organism coverage of 3 existing antibiotics in the blood culture kit, adding 22 new assays. We plan to achieve a CE mark for these additions before end of year.

In addition to menu expansion for Europe, efforts to reduce signal noise and other updates have improved reportability for identification to around 98%, consistent with best-in-class molecular diagnostics.

Finally, we completed feasibility for a new method to improve sample cleaning and concentration, which we've mentioned previously. Based on early data, we believe this new method will reduce supply risk, improve logistics by likely eliminating cold shipments and offer a margin benefit for the current and future kits. At this time, we will turn it over to the operator for questions.

Question-and-Answer Session

Operator

[Operator Instructions]. And the first question comes from Bill Quirk with Piper Jaffray.

William Quirk

First question Larry, just help us a little bit about what - how the reps are spending their time? Are you seeing any shift here in the third quarter from prospecting to working with their validation placements to try to get them across the finish line? Just trying to understand kind of what the mix is there?

Lawrence Mehren

Yes, bill. Thanks for the question. It is seasonal and at the end of the year you're going to see our reps do a lot more work, converting the evaluations that they already have put in place to placements, and that's what you're seeing in the latter part of the third and in the fourth quarter.

William Quirk

Okay. Got it. And then just thinking about the 2017 guidance, obviously, it suggests pretty nice step up here in the fourth quarter. Does that mean, and I suppose someone in conjunction with your previous answer, that you are pretty optimistic about nearing the finish line on a number of these validation placements?

Lawrence Mehren

That's correct, though. We have, as we mentioned, 40 contracts right now that are marked for close in Q4 2017, and we feel optimistic about those. So, we think it looks really good.

William Quirk

Okay, excellent. And then last one for me is the comment about you're seeing faster validations when you have additional units on site. And so, can you just elaborate on that a little bit? Are you suggesting that Accelerate is placing some additional units at no cost? Are you're giving them loaner unit, or you are encouraging them to take more Phenos? I am just trying to kind of understand some of the dynamics around that?

Lawrence Mehren

Sure, Bill. The context for that was a mitigation to increase or rather decrease the time for validation. And yes, the validation is a fix number of sample. So, the more units, more instruments you have, the faster that goes. And so, for those that have a 4, 5, 6 Phenos the validation can go quite quickly, for those that have 2 it's slower. In the future, we will loan those customers extra units to complete their validation much more quickly.

Operator

Our next question comes from Tycho Peterson with JPMorgan.

Steven Reiman

Steven Reiman for Tycho. Larry, may we start - can you talk a little bit more about how the evaluation contracts are structured? Are there set time lines within the contracts, which the customer has to validate the system within a certain time period? And then if the system hits all the performance targets, are customers contractually obligated to purchase the system or they still have an opportunity to decide whether or not they want to take it on?

Lawrence Mehren

So first there is time period in the contracts, Steve, typically 120 days and in terms of whether the contract is binding, I would say in general, the contract does require them to purchase. But we expect to go through second contracting process and go through a lot of Ps and Cs before it turns into a placement.

Steven Reiman

Got it. And then recognizing it's really early, but can you give any color on what you are seeing in terms of the use, in case of the Pheno in the field. Are you seeing it used primarily in gram-negative, pediatrics or just kind of across-the-board in all sepsis cases?

Lawrence Mehren

Yes, for current live customers we haven't seen a bias towards gram-positive, gram-negatives. We've heard from some lab directors that they might consider focusing their Pheno volume on gram-negatives for cost reasons. But as we've said before, bifurcating the workflow between gram-positive and gram-negative bacteria to us doesn't make sense. While there be a small savings in direct costs, the overall operational challenges posed by that makes it unlikely for most customers. Further, our Chief Scientific Officer reminded me recently that the situation for gram-positives is evolving rapidly. And then it's not just a question of MRSA versus MSSA any longer. There is a number of bad bugs out there, and phenotypic analysis is required to address these emerging challenges. For example, our first customers are really running everything that they have on the Pheno.

Steven Reiman

Got it, and I appreciate all the color on the LIS component post install. Is there anything, any enhancements you can make to the system to streamline that process, be it through a system upgrade or software upgrade to kind of shorten up that time period it takes to make the LIS upgrade on hospital end?

Lawrence Mehren

So, Steve, the answer is yes. After we have covered interfaces for all the major LIS vendors, the speed at which we can accomplish that increases significantly. Further, right now we do the LIS interface concurrent - excuse me, consecutively post the site going live. We believe that we can make this a concurrent process, while they are in their verification phase, which should allow us to decrease the time even further.

Steven Reiman

Got it, and lastly, and apologies if I missed this, but would you be able to give the split between U.S. and OUS for the customer evaluations, just how many of those are Europe versus U.S.?

Lawrence Mehren

Yes. So, of the evaluation contracts, 139 of those are in the U.S. and 100 are in the EU.

Operator

[Operator Instructions]. Our next question comes from Brian Weinstein with William Blair.

Brian Weinstein

So, I'll start kind of on the front-end of the process here, in getting an evaluation started. Last quarter, I think you guys hit 220 evaluations, now you're saying that you have, I think, 239 is the number there. So, you increased it by 19. Maybe [indiscernible] could be a little bit stronger. So are there additional headwinds towards getting an eval started at this point, I think we spent more of the time on the call talking about - once an eval is going, getting that placement into revenue. But can you talk about kind of on the front-end what's going on? And may be slowing down the pace of initial, just evals kicking off?

Lawrence Mehren

Yes. Sure Brian. So, I think mathematically what you said is correct. I would say, however, that delta is not as significant as the numbers would suggest because some customers have decided to go directly to acquisition, skipping the evaluation process entirely. For example, I know that at least four customers, I think it's around 13 instruments who are proceeding directly to acquisition. So, I think this is a positive trend. Further, as I mentioned to Bill earlier, there is some seasonality to PVP and conversion to placement. And so, we expect to see more PVPs in the first half of the year than the second half.

Brian Weinstein

Okay. And then you talked about, I want to make sure I heard these numbers correct, that you had qualified prospects of over 600. If, let's say, you had not signed up another qualified prospect, if that stopped right now today, when would those 600 - how long would it take those 600 to work themselves completely through the funnel to the point that you think that they will be revenue generating on the commercial side?

Lawrence Mehren

So, Brian, let me walk you through the sales cycle, I think that might be helpful. So, let's begin with establishing of a qualified account. So, as we mentioned, we have over 600 of these currently in the funnel and while it's variable, some, I would say, some qualified accounts move directly to evaluations, others take a bit longer. And so, for example, I would say we expect about one in four to move directly to an evaluation. And once an evaluation has been requested, we begin the contracting and installation process. This typically takes between 1 and 3 months. Once that's completed, once installed, the evaluation typically takes between 3 and 4 months to complete. And then post the successful completion of the evaluation contracts conversion to placement is taking an additional 3 months, as we mentioned in the call.

And then finally, upon execution of the placement contract, hospital - the hospital IT staff builds an LIS interface to the Pheno and the site becomes what we call active. And this is taking about 2 to 3 months. And I'd also say again, while this represents our current experience, we have already undertaken a number of programs to significantly reduce the cycle time at each of these key steps. For example, as we mentioned in our remarks, we believe simply increasing the number of mods instruments used for accounts - used for an accounts evaluation will decrease the time significantly by increasing throughput.

Brian Weinstein

Okay. That was helpful to dig into that. Last one for me, is there anything in terms of large tenders that are taking place outside the U.S. that you guys are competing for and how meaningful can those be? Can you give us an update if there are any tenders that are going on about the timing for those?

Lawrence Mehren

Yes, sure Brain, there's a number of tenders ongoing in the EU, some of them are meaningful, particularly in France. And I can't tell you exactly what the timing for those is today. I would also say that there are number of meaningful accounts that we're working in the U.S., which beyond the 40 contracts that we talked about in Q4 of 2017 could hit in the early part of 2018.

Operator

This concludes our question-and-answer session. I would like to turn the conference back over to Mr. Lawrence Mehren for any closing remarks.

Lawrence Mehren

So, thank you, and in closing, I would like to say thanks to all the accelerators out there. Your inventive minds, open hearts and steel wills are an inspiration to all. And then to our shareholders, without you none of this would be possible. Thank you very much. Together we're changing the practice of medicine. And this quarter confirmed that we got it nearly all right. We have the right product, generating high demand at good prices. And while the sales cycle is longer than we expected, we are confident that we are addressing this. And this confidence, I will tell you, is not hubris, rather it comes from working with the team that has faced much more significant roadblocks and has always knocked them down. We expect this to continue. Thanks.

Operator

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.