Cogstate Limited (CGS) Earnings Call Transcript & Summary

Hello, everyone. Welcome to the presentation of the 2021 financial results for Cogstate. My name is Brad O'Connor. It's been my pleasure to be the CEO of Cogstate for more than 15 years, and I can tell you at no stage over that time have I been more excited about the future of Cogstate than I am right now. Joining me today is our CFO, Darren Watson. Darren joined Cogstate about 6 months ago after more than 24 years at IBM. His most recent role is, Darren held the position of Chief Operating Officer for IBM in Australia and New Zealand, which is a $3 billion company with more than 5,000 employees. He's been a great addition to our team, and so as we go through the presentation today, I think you'll find his fingerprints over the improved financial reporting that we'll take you through. Today's presentation includes forward-looking statements and, therefore, I note our disclaimer stating that this presentation is general in nature and encourage all investors to consider your own investment objectives and also to review in detail the annual report that was lodged with the Australian Stock Exchange this morning. Following our presentation, we'll take questions. If you do have a question, you have 2 ways in which to ask that. Firstly, you can type your question into the control panel and it will be read by a moderator. Or if you prefer, you can raise your hand by selecting the button that is highlighted with the arrow to have your line unmuted and you can ask your question yourself. Finally, I note that the slides are available under the Handouts tab of the recording, and a recording of this presentation will be available later in the day. So to get started, Cogstate was found more than 20 years ago with a vision that we could develop technology that will allow assessment of brain health anywhere and for any purpose. Importantly, with an aging population and increasing incidence of Alzheimer's disease and other dementias, Cogstate's goal was to make assessment of cognition as simple and as informative as taking a temperature. Our technology solutions are based on excellent science with over 500 peer-reviewed publications supporting the validity of our tests. To our proprietary technology, we've then added scientific and operational expertise. I note that Cogstate reports in U.S. dollars and all of the numbers we take you through today are in U.S. dollars. Cogstate has 2 revenue streams. Our Clinical Trials business generated more than $28.7 million of revenue in fiscal '21. This is a project revenue model that provides us with really good forward visibility and predictability of our revenue. The length of clinical trials provides a great tail of revenue from which to build on year-on-year. And later on in today's presentation, Darren will be talking to you about that forward visibility and predictability that we have of our revenue. Our health care model, which is the use of the Cogstate technology to measure brain health in the community, is our next horizon. Following the execution of the global license agreement with Eisai in October of 2020 and then the accelerated approval by the FDA of the first-ever disease-modifying treatment of Alzheimer's disease in June of 2021, the Healthcare segment is now delivering positive earnings contribution with the prospect of significant software revenue in the coming years from that section of the business. Today, Cogstate is really well positioned. Our technology solutions are well validated. We have excellent relationships with large pharmaceutical company customers with strong balance sheet, and we are profitable and cash flow positive, and we're benefiting from external factors such as the release of the first-ever Alzheimer's disease therapy and a push towards more virtual and telehealth solutions in clinical trials. And we'll talk about both of those tailwinds as we go through the presentation. Cogstate began to gather momentum in fiscal year '20 with the execution of our Japan agreement with Eisai early in that year and then finishing the year with a record level of clinical trial sales contracts. That momentum continued into financial year '21. In our Clinical Trials business, we set a new record for clinical trial sales contracts, resulting in a new record for revenue backlog to be recognized in future periods. In our Healthcare business, we executed the global license agreement with Eisai, generating an upfront payment of $15 million that was received in December of 2020. There were also external factors that had a positive impact on our momentum, and we'll discuss those next. Finally -- financially, we've generated 44% revenue increase, but just as important as that is we've shown financial leverage that our investors have been waiting to see. We recorded a profit before tax, we were cash flow positive with a strong balance sheet at the end of the financial year, and we've begun financial year '22 with really strong momentum continuing from that prior year. During 2021 financial year, there were 3 significant changes that fundamentally impacted the commercial opportunity for Cogstate. In June of 2020, Eisai and their development partner, Biogen, announced that the FDA had given accelerated approval to the first-ever disease-modifying therapy for Alzheimer's disease. The FDA then followed up that approval by providing 2 other investigational therapies, being Lilly's donanemab and Eisai's lecanemab with breakthrough therapy designation. We believe that these decisions will positively impact Cogstate's business in 2 ways. Firstly, we expect our Clinical Trials business will benefit from increased R&D spend in the area of Alzheimer's disease. And then secondly, our Healthcare business will benefit from diagnosis and monitoring that are expected to be an important part of patient management following the approval of one or more therapies. The second significant change was the announcement in October 2020 of our global license agreement with Eisai. Eisai are a world-class partner and a great partner for Cogstate. The global agreement provides us the opportunity to realize our initial vision of cognitive assessment forming an important part of a regular health checkup for everyone. Finally, and perhaps just as significantly, we saw the pandemic cause a real increase in the adoption of remote assessment in clinical trials. Known as decentralized clinical trials or virtual trials, the at-home testing nature of such trials means that digital assessments have a real advantage when designing those trials. Cogstate expects to benefit from an increased adoption of decentralized trial design in the incumbent periods. Continuing on that theme of growth momentum driven by an increase in R&D spend in Alzheimer's disease and the adoption of decentralized clinical trials, yesterday, we announced a record start to fiscal '22 with $35.4 million of clinical trials contracts executed since 1 July. Included in that total is one large Phase III clinical trial in Alzheimer's disease that is being designed to incorporate home-based assessment as a key feature of that trial design. Cogstate will deliver our computerized assessments and will also provide telehealth assessments of other cognitive measures in that Phase III trial. That trial alone will generate approximately $6 million of revenue in this current fiscal '22 year and $8 million of revenue in each of fiscal '23, '24 and '25. I'm now going to hand over to Darren Watson, our CFO, and he's going to talk you through the 2021 financial results.

Thank you, Brad. So look, I'm very pleased to report a very strong financial performance for the financial year 2021, with the second half, in particular, a very strong performance for us. We delivered a record new contract signings here in clinical trials of $47.3 million, up 15% year-to-year on top of what was a record year in 2020. Alzheimer's continues to be a key source of that growth and represented 65% of our contract signings in 2021. The record signings, combined with additional years 6 to 10 minimum royalties from the Eisai license agreement, which is now a contractual obligation following the FDA approval of ADUHELM, takes the future contracted revenue above $100 million to $101.5 million, a growth of 151 point -- 151% from a year ago and is a record for Cogstate for future revenue under contract. The consecutive years of record contract signings in clinical trials and the recognition of revenue from the Eisai agreement has resulted in revenue of $32.7 million, which is a year-to-year growth of 44%, again, a record for Cogstate. Within the second -- within that, the second half was $18.8 million compared to the first half of $13.9 million, illustrating the momentum within the business. Importantly, the revenue -- the growth in revenue has allowed us to better utilize the capacity across our business and, as a result, we have transitioned to a positive profit before tax. The profit before tax was $5.8 million and is marginally ahead of the top end of the range that we gave back in July, which was $5.2 million to $5.7 million. Again, it's important to highlight the strong second half with the second half profit of $6.2 million compared to the loss that was reported for the first half of $0.4 million. Included in that profit before tax is a one-off gain and the forgiveness of the U.S. PPP loan of $2.4 million, which is a U.S. government's support for COVID impact in 2020. Excluding this one-off gain, together with the first half one-off impact from advisory costs associated with the negotiation of the Eisai global licensing agreement, the underlying profit before tax was $3.9 million. Again, the second half, where we've been able to return to improved utilization levels of our existing capacity, has delivered $3.8 million compared to the first half of $0.1 million. As we turn to Page 10, it's important to point out the improvement in margins across the business, particularly the second half margins. Total gross contribution margin for the second half was almost 60 points, up significantly from the first half, taking the overall gross contribution margin for the year to almost 55 points. This is an improvement of more than 13 percentage points year-to-year and reflects the discipline we have applied to managing capacity, utilization and managing costs. The strong contribution margins are also reflected in the EBITDA margin, where for the second half we were above 26 points, and for the EBIT margin, [ where we had ] 20 points. For both of these, the margin improvement year-to-year is in excess of 20 points. As I previously mentioned, we do benefit from a one-off gain from the forgiveness of our U.S. PPP loan to the tune of $2.4 million. This is not included in EBITDA or EBIT but does form part of the net profit before tax. We've provided an underlying profit before tax, which excludes this benefit. Chart 11 here details the reported results of underlying results after adjusting for the 2 nonrecurring items of the PPP loan and the one-off adviser charges of the Eisai agreement. Turning now to the segments and starting with clinical trials. This is where the benefit of strong new contract signings over recent years and the improved utilization of our capacity, particularly in the second half that resulted in strong results for the year. Revenue growth of 36% and a growth in the gross contribution by almost 75% with gross margins being almost 55 points in the second half. As I mentioned, improved utilization of our capacity and a strong software license contribution in the mix has resulted in particularly strong margin performance for the second half. Not only was the revenue and profit strong, but the record new contract signings performance was strong, contributing to revenue growth within the year but also creating growth to the future contracted revenue. As you can see from the graph in the bottom right hand corner, we now have 8 consecutive quarters of new contract signings exceeding revenue. And with a strong start to the first quarter of 2022, we expect it will be 9 quarters as we exit this first quarter. Moving to the Healthcare segment. Strong revenue and gross contribution are largely attributable to the Eisai licensing agreement. As a reminder, for the Eisai global agreement, the $45 million is being amortized over a 11-year period, being 10 years of licensing agreement and 1 year in which to reach the first commercial sale. This has resulted in $2.9 million of revenue recognized in 2021, with the remaining $42 million in the future contracted revenue. Contributions were strong across the year as we build up the team to both manage and support the commercial relationship that we have with Eisai. As we look at future contracted revenue, as of 1 July, we now have over $100 million of future revenue under contract for the first time. Obviously, we have now added that following the strong start to FY '22. In Clinical Trials, the future revenue was $58 million at 1 July. Again, this has now improved following the more than $35 million of net sales contracts executed in the first few weeks of the first quarter of the financial year 2022. In Healthcare, an additional $43 million of contracted revenue represents the contracted minimum revenue from the Eisai agreements. In terms of the runoff of the backlog, we had almost $29 million revenue under contract for the current financial year of 2022 at the start of this financial year. As we announced yesterday, the contracts executed at the start of this year have added approximately $6 million of contracted revenue to that starting position, taking our revenue under contract for this financial year to approximately $35 million at this time. Just as important, as we look forward towards financial year 2023, we already had over $25 million of revenue under contract at the start of financial year 2022 compared to just $5 million this time a year ago. With the new contracts that we've executed so far this year, financial year '23 contracted revenue now exceeds over $30 million. As we look at what this means, to the right is a representation of how backlog revenue reflects in our actual revenue performance for a year. In 2021, for example, the backlog revenue at the start of the year was 54% of our full year revenue, meaning that we were able to add over $15 million from our new contract signings during the year. This backlog coverage has ranged between 49% and 54% over the last 5 years with the exception of 2019, which was impacted by a number of trial terminations. It is important to note that as the business continues to grow, we would expect this backlog coverage to increase. In other words, in the future, a greater percentage of revenue will come from the amount contracted at the beginning of the year. Turning to cash flow. The strong revenue and profit performance, together with the signing of the Eisai global agreement in the first half of 2021, has resulted in a strong cash flow performance. Net cash operating -- net operating cash flow was $16.1 million for the year, which included the upfront receipt of the Eisai $13.8 million on the signing of the global licensing agreement. Adjusting for pass-through charges, which is purely a timing difference for us, the net operating cash flows are a little stronger at $16.8 million. We also finished the year with $23.6 million of cash or $22.4 million of net cash, if I take into account the cash held on behalf of customers for future pass-through charges. So as we sit here today, we have a very strong cash position to fund those going forward. Back to you, Brad.

Thanks, Darren. So we're going to turn away now from the financial statements to have a look in some more depth at some of these other factors that are impacting our business going forward. The first of those is the release of the first-ever disease-modifying therapy for Alzheimer's disease. As we mentioned earlier in the presentation just a few months ago in June, Eisai and their development partner, Biogen, announced that the first -- that the FDA had given accelerated approval to the first-ever disease-modifying therapy. The FDA then followed that up with -- by providing 2 other investigational therapies with breakthrough therapy designation that essentially means that it clears the way or that it makes it a little bit easier for them to interact with the FDA as they're seeking to get their drug approved. We believe that these decisions will positively impact on Cogstate's business in the coming years. And in fact, it's possible within the next 2 to 3 years, there might be a number of treatment options available for those who are suffering from Alzheimer's disease. And I think everyone understands this inherently that Alzheimer's disease is a serious condition. Early subtle signs of that occur in 10 or even 20 years before some of the more obvious effects. It's currently the 6th leading cause of death in the United States and expected to take more and more lives over the coming years. So this is a big problem, yes, and it's a problem that is worth solving. What we've seen in other indications following the approval of the first therapy is that it actually results in an increase in R&D spend, and we expect that to continue in Alzheimer's disease. The graph here shows what happened in multiple sclerosis following the approval of the first interferon beta treatments in 1993, which set in motion a cycle of innovation that resulted in more than 20 different treatments being approved over subsequent years. And our expectation is that's the level of R&D spend we will see going forward in Alzheimer's disease. Our agreement with pharmaceutical company, Eisai, is critically important to our commercial plans. We believe that our technology can play a really vital role as a low-cost, easy-to-access, scientifically valid assessment of cognition. Those easy-to-use test can really facilitate home-based self-assessment or physician assessment and screening. It can provide a diagnostic support tool for physicians and can be helpful in monitoring response to therapy. Eisai has a really long and proud history in Alzheimer's disease dating back to the launch of the first symptomatic treatment called Aricept in 1997 with their financial interest in the approved treatment for ADUHELM as well as their considerable exposure to potential new treatment through their strong R&D pipeline in Alzheimer's disease. They have significant financial interest in the identification of the very first cognitive changes that might be associated with Alzheimer's disease. So we think we've got a good partner. The target market for our technology is not limited to those suffering from Alzheimer's disease. In fact, our target market is everyone who is worried about their memory [ as they age ], and that's a really large market. Over 320 million people are over the age of 65 in just the 4 key markets that are identified in the agreement executed by Cogstate and Eisai. So this is a really significant opportunity that we hope will generate significant revenue in coming years. We do need to be realistic about time frames in terms of that revenue opportunity with product only expected to come onto market in the United States in the coming months. And so the -- our revenue expectations in relation to fiscal '22 are quite realistic and quite sensible. And I think the opportunity is for those whose substantial revenue comes a bit later in fiscals '23, '24, '25. I want to talk now a little bit about decentralized clinical trials, which is a term that is probably new to a lot of people. Since the beginning of the pandemic, the clinical trials industry has seen an increase in demand for remote assessment. Decentralized clinical trials, also known as distributed or home-based or siteless trials, provide a means of conducting a trial in the patient's home as compared to requiring the patient to come to a major clinical facility. Now this was a trend that was occurring pre-pandemic, but like much technology option that has occurred as a result of the pandemic, this has gathered speed. And I want to be clear, we expect to see clinical trial sites continue as a really important part of the clinical trial of the industry, but it is our expectation that more and more trial designed will incorporate aspects of remote assessment because of the advantages that exist for both the pharma or biotech companies, but also the advantages for the patient, allowing trial designs that incorporate technology and, therefore, allowing the industry as a whole to bring new potential treatments to patients regardless of geography and other factors such as ethnicity and language spoken, which we see as major impediments to participation in clinical trials. Cogstate's computerized assessments are perfectly placed to benefit from the adoption of the decentralized trial design, and we expect, going forward, for this to be another catalyst for Cogstate's ability to increase our market share. I'm going to turn now to the outlook for financial year '22, and we've provided this year some quite detailed guidance in respect to the financial year '22 results. So in our Clinical Trials business, following the strong -- the announcement of the strong start to the '22 year, we now have $30.5 million of contracted revenue that we expect to be recognized in the '22 financial year. This is just in clinical trials. And to try and give you a sense of the -- of our revenue expectations beyond that contracted amount, I'd note that in the last financial year, from contracts executed through quarters 2 to 4 inclusive, Cogstate was able to generate an additional $12 million of revenue from that which was already contracted at 30 September. We expect that for fiscal '22, our clinical trials margin to remain constant with financial year '21 at approximately 54%. In our Healthcare business, we expect to recognize $4.2 million of revenue from the Eisai agreement and for that to contribute $2.5 million to $3 million. We expect our operating cost to be in the range of 31% to 33% of revenue, which is an improvement of 5 to 7 points on fiscal '21, thereby resulting in EBIT margins of 15% to 18% of revenue. In terms of cash flow, we expect operating cash flow to be in the order of 30% to 35% of EBITDA, allowing for the amortization of the Eisai revenue that was received upfront as well as the amortization amount of capitalized software development. So to summarize, Cogstate is in a really strong position going into financial year '22. Given our strong contracted revenue position and our strong start to the year, with a record level of clinical trials contracts executed in just the first few weeks of the year, we can state that we'll continue to grow revenue from the record that we set last year. And that -- like last year, the revenue growth will result in earnings growth and growth in our already strong cash position. Cogstate's scientifically validated technology is addressing a large market opportunity, and we have significant external factors positively impacting on the business through the release of new treatment options for Alzheimer's disease and the adoption of decentralized clinical trials, both of which are positive for the Cogstate's business going forward. Over the coming years, we expect to continue to grow our Clinical Trials business, which is now becoming a substantial business in its own right. Through our partnership with Eisai, we've established a foundation, which could potentially grow a significant opportunity in the Healthcare market. The opportunity in Healthcare is expected to take a little time to establish significant revenue beyond those contracted minimums, but we are confident we have partnered well, and we're looking forward to product launch in the U.S.A. over the coming months. Overall, we're really well placed to grow Cogstate into a leading technology company that has potential to disrupt both the research and general practice medicine through technology solutions that make brain health assessment as simple as measuring blood pressure. With that, I'm going to conclude our prepared remarks, and we'll take some questions. [Operator Instructions]

[Operator Instructions] So the first hand raised here is [ Dennis Hill ]. [Operator Instructions]

If I can jump in, we've just had some success now. You mentioned that in the clinical trials business in FY '22, you expect the contribution margin to be 54%, in line with the current year. And -- instead of 58%, which is what you achieved in the second half. You mentioned that that's partly due to some technology investments. Can you just talk a little about those technology investments? Will they be ongoing? For how long will they be impacting margins?

Yes. So I think, Dennis, I think the right way to look at this is we expect to be able to grow gross margin in the Clinical Trials business into future years. What the decision we've made in respect to fiscal '22 is you'll appreciate the size and scale of this business is expanding rapidly. And what we want to do is ensure that we have the technical infrastructure, the operating processes that support a much larger business. We think that we can make those investments while maintaining margins and delivering good earnings growth and bottom line growth in fiscal '22. And so we're committing to make those adjustments. The benefit for shareholders for us making those investments now is we get to higher margins at a faster rate as we look forward to fiscal '23, 24, '25.

So will those investments be largely completed in FY '22? Or will they be ongoing into FY '23, et cetera?

Look, I think it's one of those things that you continue to improve and continue to invest in. But I think by and large, the margin impact will be fiscal '22, which is not to say that we won't be continuing to invest in our business in '23 and '24. But I think the financial impact of that in terms of margins will be much lower as we push forward.

So we'll move on to questions submitted to the questions panel. The first one is, thanks to the Cogstate team for their hard work and very good results. Where are you looking at Cogstate in the next 5 to 10 years?

It's an excellent question. So look, I think we're in a position now whereby we see significant growth opportunities in our clinical trials business. We expect to record very strong growth in bookings in fiscal '22 that will deliver really strong revenue growth, and we see that continuing over the course of the next 5 years. Our belief is that R&D spend in Alzheimer's disease will be strong over that period of time. There will be increased adoption of digital assessments, digital native assessments, and we're really well positioned to benefit from that. So 5 years from now, we expect to have a very strong and very profitable clinical trials business. Over the top of that, we layer the health care opportunity. And that's -- we need to be some constrained by reality in terms of what is that opportunity. And we think that, that has the potential to be enormous, but there's a lot of rubber yet to hit the road in respect of that opportunity. We think we have a good technology solution. We think we have an excellent partner. We think that there's an enormous market opportunity that's currently unmet. So we think we have the infrastructure in place to execute on that opportunity. But 12 months from now, we'll have a much better sense of how that opportunity is playing out. So I think that's the big unknown. We're -- in terms of our dreams, our beliefs, where our passion is driving us in terms of this business 5 years from now is that we have a really strong software business with software-style margins in that health care part of the business that essentially layers on top of a very strong CRO clinical services-style business in a growing niche opportunity, which is our Clinical Trials business.

Great. Thank you, Brad. So based on yesterday's update, the large Phase III trial is worth USD 30 million, i.e., September quarter today, the company already executed the same amount of contracts as the whole of September '20 quarter. Is it fair to say that this momentum of Alzheimer's trial initiation is still ramping up?

Yes. So as I interpret that question, what we're saying is, if we exclude the large Phase III, there's a significant amount of work in the September quarter to date. And I think that's a fair assessment. The -- we are seeing a lot of activity. We don't talk to sales pipeline, and we don't do that deliberately because I think that can get a little misleading for investors. But our pipeline of opportunities is strong. I think in terms of the R&D space, specifically, what I can say is we are seeing pharmaceutical and biotech companies, one who have not been active in Alzheimer's disease, initiate activity in Alzheimer's disease. We are seeing smaller biotech companies who are focused on Alzheimer's disease be able to raise new capital and raise that at good valuations. All of these things are really positive in terms of increased R&D activity.