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Avid Bioservices, Inc. (NASDAQ:CDMO)
Q1 2019 Earnings Conference Call
Sep. 10, 2018 4:30 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good day, ladies and gentlemen, and welcome to the Avid Bioservices first-quarter 2019 financial results conference call. [Operator instructions] As a reminder, this conference call may be recorded. I would now like to turn the conference over to Tim Brons of Avid's Investor Relations group. Please, go ahead.

Tim Brons -- Investor Relations

Thank you. Good afternoon, and thank you for joining us. On today's call, we have Roger Lias, president and CEO, and Dan Hart, chief financial officer. Today, we will be providing an overview of Avid Bioservices contract development and manufacturing business, including updates on corporate activities and financial results for the quarter ended July 31, 2018. After our prepared remarks, we will welcome your questions.

Before we begin, I'd like to caution that comments made during this conference call today, September 10, 2018, will contain certain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, concerning the current belief of the company, which involves a number of assumptions, risks, and uncertainties. Actual results could differ from these statements and the company undertakes no obligation to revise or update any statement made today. I encourage you to review all of the company's filings with the Securities and Exchange Commission concerning these and other matters. With that, I will turn the call over to Roger Lias, president and CEO.

Roger?

Roger Lias -- President and Chief Executive Officer

Thanks, Tim, and thank you to all of you who have dialed in or are precipitating -- participating, excuse me, via webcast today. It's been only two months since we last reported results, but it's been a very busy and productive eight weeks as we continue to execute the plan. Fiscal 2019 is a transition year for Avid, as we align our organization and operations with our new business model and direction and implement improvements designed to drive growth and probability, to deliver exceptional customer service and to ultimately meet the needs of our clients' patient populations. During the quarter, we advanced the projects of our existing active clients and continue to engage with numerous potential new customers. This increasing activity is driven by our aggressive business-development efforts, our newly client-focused project management team and our enhanced capabilities in process development, all of which position Avid well for growth and the achievement of positive cash flow.

I will provide more details on each of these topics and provide an update on the biologic CDMO market, following a review of our first-quarter 2019 financial results by Avid Bioservices new Chief Financial Officer Dan Hart. Dan officially joined us on August 1 and I'm delighted to be able to report that he's settled in extremely quickly and is already contributing his expertise and experience to our business. I can say without fear of contradiction that Dan is a great asset to our team. So with that, I'll turn it over to him to provide the financial review.

Dan Hart -- Chief Financial Officer

Thanks, Roger. Hello, everyone. I'd like to first say that I'm very happy to join the Avid team at this important time in the company's development, with the transformational period behind us and the transition ongoing during fiscal-year '19. It's exciting to be part of an organization with such promise and growth potential.

I also look forward to building a strong relationship with the investment community that has been so supportive of the company to date. I'll now discuss our financial results from continuing operations for the first quarter ended July 31, 2018, starting with revenue. During the first quarter of 2019, Avid recognized revenue of $12.6 million, a decrease of 54% as compared to $27.1 million in the first quarter of 2018. Excluding the impact of adopting the new revenue standard ASC 606, which is revenues from contracts with customers, revenue decreased 89%.

The decline as compared to the same prior-year period is primarily attributed to a previously disclosed shipping delay, which resulted in $9.9 million of revenue recognized in the first quarter of fiscal year '18 for manufacturing runs completed but not shipped during the fourth quarter of fiscal year '17. Another factor contributing to the decline is the decreased demand from our two lead customers, which we anticipated and have previously disclosed, offset by the adoption of ASC 606, which accelerated revenue recognition for a portion of Avid's projects, enabling revenue for certain products to be recognized over time rather than upon delivery to the customer. Despite the decline, our first quarter 2019 revenues put us on track to meet our annual projected revenue. As stated during our year-end call in July, Avid is projecting revenues between $51 million and $51 million for fiscal-year 2019 under ASC 606 and we maintain this guidance.

As a reminder, we adopted this new standard on a modified-retrospective basis. As a result of our adoption of ASC 606, $10.8 million of revenue that may have been recognized during the 2019 fiscal year under the previous revenue recognition standard ASC 605 has been moved to retained earnings. Our backlog as of July 31, 2018, was $39 million, the majority of which we expect to recognize in fiscal 2019. Excluding the impact of adopting ASC 606, backlog was $60 million, an increase of 3.6% from our fourth-quarter backlog of $58 million.

Gross margins for the first quarter was 9%, a 15% decrease compared to the prior-year period. Excluding the impact of adopting ASC 606, gross margins were a negative 73%. The decrease in gross margin was primarily attributed to the $9.9 million recognized in the first quarter of fiscal '18 due to shipping delay discussed previously, also, a fewer manufacturing runs during the period that contributed to an increase in idle capacity during the quarter, combined with the variability of manufacturing costs from product to product. While we are pleased that projects were successfully onboarding during the quarter, we recognize the importance of building our backlog and our customer base as well as improving our margins by increasing capacity utilization.

During the first quarter, we made important advances to support each of these objectives and Roger will provide more color on those achievements in his comments. Turning now to operating expenses. Total SG&A expenses for the first quarter of fiscal 2019 were $3.2 million, a 17% decrease compared to the $3.9 million for the first quarter of fiscal 2018. The decrease in the quarter was driven primarily by the company's previous efforts to align the cost structure to match the needs of our current CDMO operations by reducing costs and the streamlining of our operations.

For the first quarter of 2019, the company recorded consolidated net loss attributable to common stockholders of $3.4 million or $0.06 per share, compared to a consolidated net loss attributable to common stockholders of $2.6 million or $0.06 per share for the same prior-period quarter. Excluding the impact of adopting ASC 606, diluted EPS from continuing operations was a net loss of $0.11 per share. Cash and cash equivalents as of July 31, 2018, was $37.5 million compared to the $42.3 million at fiscal year ended April 30, 2018. Not reflected on our quarter-end cash balance is the receipt of the third and final upfront payment on September 6 from Oncologie of $2 million for the assignment of the company's legacy R&D assets.

This concludes my financial overview. I will now turn the call back over to Roger to address Avid Bioservices key activities and achievements during the first quarter of fiscal 2019.

Roger Lias -- President and Chief Executive Officer

Thanks, Dan. As I stated in my opening comments, fiscal '19 is a transition year for Avid Bioservices, as we position the company for strong growth and success within the attractive global biomanufacturing marketplace. We continue to make changes and improvements across the organization. Today, I will address the current CDMO market and provide an update on Avid's business development activities and enhancements to our process development service offering. So I'll start with a brief update on the biologic CDMO landscape.

Recent market research conducted by BioPlan Associates, which was published in April, shows that the demand for biologics production remains robust. BioPlan's findings show that the global biopharmaceutical manufacture -- oh excuse me, the global biomanufact --biopharmaceutical market is currently valued at over $250 billion a year, with a market for products that we manufacture at Avid being major contributors to that number. Recombinant proteins now contribute about $150 billion a year and the market for recombinant monoclonal antibodies is now greater than $80 billion. This market continues to grow at a compound annual growth rate of 12% to 15% and drives growth and demand for the services offered by Avid Bioservices.

Future growth is expected to be fueled by increasing R&D spend on biopharmaceuticals and the more than 950 identified biosimilar products currently in development. Given the demand, the availability of appropriate capacity on a product-by-product basis remains a significant hurdle across every stage of bioprocessing, from early-stage clinical work to commercial manufacturing. When considering that worldwide pharmaceutical manufacturing capacity is now estimated at over 16 million liters across all manufacturing platforms, Avid needs only to capture a very small fraction of this demand to be at full utilization. Avid is focused on development and manufacture of products derived from mammalian cell culture.

And as mentioned, this manufacturing platform continues to dominate the biopharmaceutical manufacturing market, driven by highly complex recombinant proteins and monoclonal antibodies and their derivative products. When looking specifically product -- production of products derived from the manufacturing platforms and technologies that we offer at Avid, the figures become increasingly interesting. According to the findings, 54% of biopharmaceutical drug developers are currently outsourcing up to 50% of their production, while 16% are outsourcing over 50% of their production. On this topic, BioPlan Associates concluded that there is a continuing trend toward greater outsourcing of mammalian cell culture, with 72% of users projecting at least some outsourcing by 2023.

Researchers also noted that they believe that continued robust demand will extend to ancillary services also offered by Avid, including analytical development, cell line development, stability studies and so on. A market report from Future Market Insights published just last Thursday estimated that the global biopharmaceutical contract manufacturing market was valued at $5.6 billion at the end of 2017 and is expected to increase to $15.5 billion by the end of 2027, registering a compound annual growth rate of 10.6% over the forecast period. Within these numbers, mammalian cell culture is the largest segment by platform and estimated to represent a 68.6% share of the total market in 2017 and is projected to reach 81% share by the end of 2027, expanding at a compound annual growth rate of 12.5%. The United States is anticipated to remain the dominant market space, although Asia Pacific market, excluding Japan, is growing at a slightly higher rate.

Given this growing demand and current limited capacity, predominant themes in the industry revolve around productivity and cost reduction, continued adoption of single-use technologies, where, incidentally, Avid can be considered a market leader, having been releasing GMP batches from single-use bioreactors for more than a decade and continuous bioprocessing. Avid has an existing expertise in single-use technologies and is actively developing relationships with key vendors and industry experts, positioning the company as an innovator and leader within the biologic CDMO space. With this backdrop, I'd now like to address our expanding business-development activities and achievements. During the first quarter, our highly experienced new Eastern and Western U.S.

business development leads became fully operational and we are currently receiving high-quali -- high-quality request for proposal from both territories. This represents the first time in Avid Bioservices' history that the company has had full CDMO-targeted business development reach across North America. Despite the fact that there is a traditional summer lull in the biologic CDMO space, we're processing requests for proposal at a rate that we've never encountered before at Avid and our team is working diligently to issue high-quality proposals and to meet deadlines. In an effort to support this RFP priceline -- pipeline and continue to expand our customer base and diversify our project mix, our team is executing a broad-reaching targeted marketing and promotion campaign.

With the trade show season now upon us, we have recently exhibited at the Bioprocessing Summit 2018 and the 2018 Bioprocess International Conference & Exhibition, both in Boston. We also plan to exhibit or have other commercial presence at numerous industry events during the fall. These events generate visibility with customers and other stakeholders as we grow the Avid Bioservices brand and increase awareness among emerging and growth biotechnology companies and multinational pharmaceutical companies alike. We consider these conferences and trade events to be key opportunities to reach new clients and to generate future demand. With at least equal importance to onboarding new projects is growth generated from our existing clients.

I'm very pleased to announce that each project governed by the master service agreements executed by Avid in calendar 2018 is now generating revenue. Almost all of our existing relationships have expanded since initial engagement, either by progress against the originally scoped work program or by project expansion and extension. Such growth represents an important contributor to our revenue stream and we look forward to supporting the continued success of the client programs and to accommodating increased demand as these programs progress through clinical development and into global markets. Another area of critical importance for us is enhancement of our process development service capabilities and work in this area has continued during the first quarter of the fiscal year.

As we discussed on prior calls, we believe process development to be a vital component of our success. Process development or PD is typically broken down into three core function, cell line and cell culture development or upstream development, where we persuade cells to express the desired protein and to grow efficiently; purification development, or downstream development, where we isolate the target protein from a vast soup of other proteins, cell debris, growth medium components, and so on; and finally, analytical development, where we develop the analytical methods needed to characterize the manufactured biopharmaceutical and to demonstrate that it is of sufficient quality and purity. Our process development scientists are also critically important for transferring processes and methods that have been developed outside of Avid into our facilities. These functions, which typ -- typically contribute around one-third of revenue for biologic CDMOs are vital for onboarding new programs and securing a pipeline of manufacturing opportunities. Prior to establishing Avid Bioservices as a dedicated CDMO, I think it's fair to say that the company's process development function was underserved.

And we are now investing in the enhancement of these capabilities in order to continue to support our existing clients and to attract new customers. Today, our process development group is contributing immediate and meaningful revenues and for the first time, operating as a stand-alone unit. Process development will support both revenue growth and profitability during the fiscal '19 and beyond. We've made progress in recent months for the previously announced laboratory expansion and improvement project.

We've taken great care to phase this work so as not to disrupt any ongoing processing and planning is further evolved to reflect business needs. As part of this expansion, our first refurbished laboratory, which is for purification development, has been completed and is now fully operational. In addition, we've commenced work on a major new upstream development laboratory and are continuing refurbishment work within our existing buildings. These new and/or updated laboratories are being outfitted with state-of-the-art equipment to facilitate the development of robust, scalable and cost-effective manufacturing processes and we're working closely with our vendors and collaborators to pioneer and optimize innovative processing approaches.

I would now like to touch briefly on the importance of the efforts of our human resources team as they continue to support our organizational realignment and positioning for growth. The fast-growing and extremely complex biopharmaceutical manufacturing field is highly reliant on qualified and trained workforce, and critical shortages are emerging in some areas. 20% -- 28%, excuse me, of respondents in the recent BioPlan Associates industry survey identified the inability to hire new experienced technical and production staff as a factor likely to create biopharmaceutical production capacity constraints by 2023. And it is known that companies in some biomanufacturing hubs are already being impacted by staff shortages.

As we complete transition to our CDMO model and contemplate significant growth, it is critically important that we maintain access to a qualified workforce and continue to focus on hiring, training, and retention. In summary then, during the first quarter of fiscal 2019, Avid continued to successfully execute the plan we outlined during our year-end earnings call in July. As a result, we are reaffirming our revenue guidance for fiscal 2019 of $51 million to $55 million. Our confidence in achieving this target is driven by the expected recognition of a significant portion of our confirmed backlog of $39 million during the remainder of fiscal 2019, combined with the anticipated extension and expansion of projects underway with existing clients and additional revenue expected from the numerous new client proposals that are currently in progress. To support this effort, we have built an exceptional business-development team, with a cumulative 60-plus years of successful and direct industry experience.

We're aggressively pursuing new opportunities and successfully building awareness for the business within the industry. We have high visibility on customer orders for the balance of the fiscal year and are actively and successfully onboarding recently awarded projects. We are significantly enhancing our process development capabilities to best serve the growing demands of our customers. The master service agreements that we've executed in calendar 2018 are all now contributing to revenue and our process development service is generating meaningful revenue also.

While there is some business to secure to achieve our top-line guidance, hitting our revenue targets for fiscal 2019 will largely be about operational execution. Much work remains to be done during this transition year, but the advances made during the first quarter place us on track to achieve each of our primary goals: To grow and stabilize revenues through an expanded customer base, to improve margins through increased capacity utilization and to position the company to achieve positive cash flow. With that in place and the vitally important business operations and process development, CDMO functions now established and properly functioning for the first time in the company's history, we're onboarding new revenue-generating programs and expanding and extending existing projects. Focus will now shift toward operations during the remainder of the fiscal year, as we work toward efficient conversion of backlog into revenue. This concludes my prepared remarks for today.

And I will now open the call up for questions. Operator?

Questions and Answers:

Operator

Thank you. [Operator instructions] First question is coming from Joe Pantginis from H.C. Wainwright. Your line is open.

Joe Pantginis -- H.C. Wainwright -- Analyst

Hey, guys. Good afternoon. Thanks for taking the question. Roger, first -- my first question is two-pronged.

First, is there a potential why your backlog number could be potentially conservative? And you know, with that in mind, can you discuss, I guess, maybe some general numbers as to the level of RFPs and proposals that you look like -- that you look at a, say, a weekly or monthly basis?

Roger Lias -- President and Chief Executive Officer

Sure. Thanks, Joe. I appreciate the question. I think it's fair to say that our backlog is a conservative number.

We -- this is, you know, business that is basically irrevocably contractually committed at this point. We have, as we've discussed actually on some previous calls, what I would describe as a trailing backlog, which is work which is very highly likely to come in, and this is work -- continuing work on existing projects. But until that work is actually contractually committed, we don't add it to the backlog. So in addition to the hard -- what I consider, the hard backlog, we do have a very good window and runway of visibility to future opportunities from existing projects and we continue to execute those sort of in real time as we're going along and as the projects expand.

So the projects expand both -- we get contractual commitments to current projects and then we also see growth within scopes almost inevitably or, I would say, at least nine times out of 10 once we sign a scope of work initially. It grows over time as we realize that the technical nuances of the project and additional work needs to be doing. And then of course, it's a very sticky business. So should a client meet perhaps one of its clinical milestones, if they're successful, they -- very, very low chance that they will go anywhere else for the next phase of work.

So we tend to extend those projects as well. So I would say that, yes, backlog in general is conservative. With respect to proposals, we don't give out too much information. I think we can say, couple of weeks ago, we had -- I think we're not struggling, but working to get out seven proposals in parallel, to give you an idea of the magnitude of the work involved.

We really are starting to generate a lot of request for proposals now. But it's not sheer numbers, it's really, more important to me, is the quality of those request for proposals. Obviously, we like to work with more established companies. We like realistic goals for the projects.

But we have a very broad mix of opportunities right now.

Joe Pantginis -- H.C. Wainwright -- Analyst

No, that's great. Thank you. And then my second question has to do with gross margin. I appreciate the added details with regard to the first quarter impact on gross margin.

So I guess, first, I guess, as the company matures, what is your ultimate goal with regard to gross margins? Obviously, there's a lot of variability in it. And then the second part of that is, near-term to moderate-term impacts on gross margins based on your expansion needs and plans. Thanks.

Dan Hart -- Chief Financial Officer

Hey, Joe. This is Dan. Pleasure to meet you on the phone here.

Joe Pantginis -- H.C. Wainwright -- Analyst

You too, Dan.

Dan Hart -- Chief Financial Officer

Your question is about gross margin. Currently, we have a growing product mix is what I'll say. And as we grow through our existing customers and move on to new customers, with some follow-on work in signing some of these proposals, our gross margin will increase over time. But right now, we have a little bit of a fluctuating gross margin based on the product mix and filling up the pipeline.

So I think if you look at kind of our trajectory, as we start to fill that idle capacity, our margins will continue to improve over the rest of the year.

Roger Lias -- President and Chief Executive Officer

Yep. I think I'll just add, Joe. If you look at some industry comparators out there and unfortunately, they're few and far between, because obviously, a lot of private companies out there. Certainly, we've seen in situations where manufacturing facilities are extremely full or are full, basically, we've seen, certainly, gross margins in excess of 40%.

But I must stress that it's really an occupancy business. So we have some ways to go before we get to those levels of facility occupancy right now.

Joe Pantginis -- H.C. Wainwright -- Analyst

Got it. Very helpful. Thanks a lot, guys.

Operator

Next question is coming from Steve Schwartz from First Analysis. Your line is open.

Steve Schwartz -- First Analysis -- Analyst

Well, good afternoon, everyone.

Roger Lias -- President and Chief Executive Officer

Hey, Steve.

Steve Schwartz -- First Analysis -- Analyst

Hey. So I guess the first question is just with respect to the development revenue. Is there a way to parse that out? I mean, I know what you just list revenue as contract manufacturing. But you know, Roger, the way you described the kind of the three categories of development work, there's revenue and there's project work that doesn't necessarily hit your production floor per se, right?

Roger Lias -- President and Chief Executive Officer

Yes. It's a complicated question to answer, Steve, because everything we do is custom. So we do everything from -- we can bring in a DNA sequence on a piece of paper and start with cell line development. But we can bring in partially developed processes or we can transfer in, essentially, fully developed processes.

Even in that case, we do some -- typically do some process development work to amend analytical techniques to our own equipment, and things like this. So I can understand that it's a difficult one to get a head around. So similarly, on the same stage, well, not all process developments are created equally from the point of view of revenue, timing also comes into it. We only take on projects at the moment which are means to an end.

Every project we bring in, in process development, the end goal is to be in manufacturing of some sort. Now there's plenty of stand-alone process development as well out there, but right now, based on available resources, we don't consider those projects. So you could have a process development project take six months before it generates -- or starts to generate manufacturing revenue. You have a process development project that takes 24 months before you start to generate meaningful manufacturing revenue.

So it's a difficult question to answer, because it quite simply isn't the one-size-fits-all. And I realize that's probably not helping you much, but that's the fact of the matter.

Steve Schwartz -- First Analysis -- Analyst

Yeah. Yeah. OK. Well, you understand the nature of the question, and certainly, it's on my mind, and I'm sure it's on others'.

So if you could just keep that in mind as you talk about the business.

Roger Lias -- President and Chief Executive Officer

Yes, certainly. We're trying very hard. This is new to, certainly, our company, if you like, to be dedicated in reporting stand-alone contract development and manufacturing results. So we're working hard on how we can make things more granular going forward.

It's a very inexact science. As soon as you put out an example of one project and apply it to a model, immediately, that model is, in essence, incorrect, because of the inherent variability in all these projects. But we are working very hard to make things as granular and transparent as we can going forward.

Steve Schwartz -- First Analysis -- Analyst

Yeah. And along those lines of just your revenue development, with the new process development labs coming online, was there a backlog, if you will, of projects waiting for that facility? So in other words, is there going to be like a secular step-up, if you will, in revenue with that? Or are you going to have build revenue into the newly available operations?

Roger Lias -- President and Chief Executive Officer

To answer it another way, at the moment, as soon as we have more space, equipment, people available, they are revenue-generating and busy. So we are -- I won't say we're struggling to keep up by any means, but it's a balance at the moment between new business coming in and available resources to execute those projects.

Steve Schwartz -- First Analysis -- Analyst

OK. And then my last question, and perhaps this one is for Dan, is on the ASC 606. I think you mentioned in your prepared remarks that it basically was a benefit to revenue in the first fiscal quarter. And if that's the case, if we try to understand the flow of revenue, does that essentially mean that on a percentage of a completion basis, you took more revenue from the second quarter of FY '19 than you would have gained from 4Q '18 under percentage of completion? How did you run that calculation on this first quarter? And does -- how can we read that information with respect to revenue through the year?

Dan Hart -- Chief Financial Officer

Steve, thanks for the question. And I can understand that the complexity of moving from a point-in-time to an over-time type model from 605 to 606. Essentially, the revenues for 606 contributed to increasing revenues in the first quarter, because it's not based on the delivery of the product. Where the delivery of the product will happen during Q2 or Q3 sometime during fiscal '19, we set forth effort during the first quarter of which we can recognize revenue on a percentage of completion.

Steve Schwartz -- First Analysis -- Analyst

Yeah. Yeah. And so it was a net benefit? And when you...

Dan Hart -- Chief Financial Officer

Correct.

Steve Schwartz -- First Analysis -- Analyst

When you do the numbers behind that statement, a net benefit, you're also factoring in revenue booked on order shipment versus percentage of completion for the fourth quarter of '18 too, right?

Dan Hart -- Chief Financial Officer

Anything that was delivered in the fourth quarter of '18 and/or worked on during the fourth quarter of '18 is essentially either was recorded in '18 or was booked to the beginning balance retained earnings, which was included in that $10.8 million of revenue shifted back.

Steve Schwartz -- First Analysis -- Analyst

Right. RIght.

Dan Hart -- Chief Financial Officer

So we started at a clean line in the sand on May 5 going forward.

Steve Schwartz -- First Analysis -- Analyst

Got it. OK, that's helpful. Thank you.

Dan Hart -- Chief Financial Officer

You bet.

Roger Lias -- President and Chief Executive Officer

Thanks, Steve.

Operator

Thank you, ladies and gentlemen. At this time, I would like to turn the call back to Roger Lias for closing remarks.

Roger Lias -- President and Chief Executive Officer

Thank you, Lisa. Thank you for your time today, everybody, and your interest in Avid Bioservices. I wish, in closing, to thank our board, our employees and our investors for your continued support of the company as we pursue our goals for growth and value creation. We look forward to the next quarter call.

And with that, we'll conclude this one. And thank you, and have a great afternoon.

Operator

[Operator signoff]

Duration: 32 minutes

Call Participants:

Tim Brons -- Investor Relations

Roger Lias -- President and Chief Executive Officer

Dan Hart -- Chief Financial Officer

Joe Pantginis -- H.C. Wainwright -- Analyst

Steve Schwartz -- First Analysis -- Analyst

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