Interleukin Genetics Inc. (ILIU) reported financial results for the second quarter ending June 30, 2011 on August 12th. The reported numbers were very much in-line with our estimates, with revenue coming in slightly ahead of what we were looking for. The conference call and 10-Q, which also came out this morning, also did not contain any surprises relative to our expectations. The company continues to make good progress with growing revenue of its weight management test and with completing enrollment of the PST (periodontal disease test) study. Our milestone timelines, investment thesis/recommendation, and price target all remain intact.
We have made relatively immaterial adjustments to our 2011 (and later) estimates following the Q2 earnings announcement. We now look for revenue of $3.3 million and EPS of ($0.15), compared to $3.2 million and ($0.15) prior to Q2 results.
We are maintaining our Outperform rating and $1.60 price target on shares of Interleukin. See below for free access to our full 18-page report on ILIU.
Revenue
Q2 revenue of $797k was about 4% better than our $767k estimate and consisted almost entirely of revenue from genetic testing. Revenue grew 39% y-o-y and was up 11% from Q1 2011. We continue to model sequential (as well as y-o-y) quarterly growth from here on out. Approximately 69% of revenue came from sales through Amway, compared to 31% in Q2 2010 and 65% in Q1 2011.
Amway has recently taken steps to more prominently feature Interleukin’s tests including launching a new website for their weight management products with Interleukin’s weight management test displayed on the front page. This, along with more active promotion of the weight management test including new literature, appears to continue to be paying off. Management again indicated that they are seeing additional interest for their weight management test from institutional customers including weight loss clinics.
Gross Margin / Operating Expenses / EPS
Gross margin came in at 45%, a hair better than our 44% estimate. Gross margin was 48% through the first 6 months of 2011, relatively very strong (GM was only 10% in the first 6 months of 2010) and benefitting from cost efficiencies from higher test processing volumes and lower material costs. Management appears to be very diligent in finding ways to trim material and test processing costs which could continue to benefit gross margins.
Operating expenses came in at $1.64 million compared to our $1.58 million estimate. Operating expense control has been excellent throughout 2011 (down 17% from 1H 2010), especially considering the relatively high level of revenue (Amway sales commissions run through here).
Q2 EPS (continuing operations) came in at ($0.04), right on with our estimate.
Cash
Interleukin exited the quarter with $1.71 million in cash and equivalents, compared to $2.84 million at 3/31/2011. Cash used in operations was $1.13 million, almost identical to Q1 2011 ($1.17 million) but substantially improved from the $1.44 million average quarterly burn rate during 2010. Liquidity is also bolstered by $3.3 million borrowing availability (unchanged since 3/31/11) under their revolver with Pyxis.
FINANCIAL OUTLOOK
Our financial outlook for Interleukin is based on some recent trends in revenue, expenses and cash flow and incorporates assumptions relative to the outcome of certain events, including the milestones listed above. There is a significant level of uncertainty as to the eventual outcome of these potentially highly influential events which creates substantial risk that our outlook could differ from reality.
Revenue Outlook
Our model assumes that sequential revenue growth remains flat to modestly higher over the course of 2011, slightly benefitting from some more of the smaller weight loss clinics incorporating the weight loss test into their programs. While we have no insight into if or when publication of the weight management test studies will happen or what, if any, benefit it may have to revenue, we have to make certain assumptions – and publication of these studies is one that could have a potentially very significant impact on sales – both in the near and longer terms. Our assumption is that the studies are published by 1H 2012 which in-turn sparks greater interest from some of the larger weight loss clinics as well as retail customers – which results in a greater rate of revenue growth. We model 2011 revenue of $3.28 million, implying growth of 62% from 2010, which includes 79% growth in Q4 2011. Publication of the data earlier than what we have incorporated into our model and/or greater uptake of the weight management test could prove our 2011 revenue estimates conservative.
Interleukin expects to have data analysis completed from the University of Michigan PST test study during 1H 2012 and hopes to roll out the test with insurance reimbursement later that same year. Again, with no particular insight, it is very difficult to gauge the likelihood of hitting this timeline or the viability of Renaissance Health providing insurance coverage for the PST test. As it is now, we assume a soft launch of the PST happens sometime during the second half of 2012. For 2012 we model revenue of $7.24 million which assumes Interleukin continues to gain traction with sales of its weight management test with only an incremental contribution from the PST test. 2012 could be a real transition year for Interleukin depending on the success of the PST test launch (which is highly dependent on insurance reimbursement). Based on the enormous size of the potential market for the PST test, our revenue estimate for 2012 (and beyond) could prove extremely conservative.
Beginning in 2013 we assume most of Interleukin’s revenue growth is driven by sales of the PST test. Again, depending on the level of insurance reimbursement, these figures could be low.
EPS Outlook
Gross margin showed sequential improvement throughout 2010 and has significantly widened through 1H 2011 as a result of higher test processing volumes and lower material costs. We expect gross margins to remain above 40% from here on out. Operating expenses should also be fairly scalable as the bulk R&D for Interleukin’s current product line-up has already been completed and sales and distribution will continue to be outsourced.
For 2011 we look for EPS of ($0.15), reflecting 64% revenue growth, gross margin of 45% (versus 19% in fiscal 2010) and a 3% reduction in operating expenses.
We model EPS to grow to $0.18 in 2014 on revenue of $47.9 million and benefitting from continued improvement in gross margin as well as operating expenses as a percent of revenue.
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