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Crescita Q2 2020 Financials

On August 11th Crescita Q2 2020 financials were released.

It was a difficult quarter for Crescita. In March Crescita closed its office and manufacturing facility in Quebec. Not only was their facility closed but many of the spas that sell their products were also closed in Canada due to COVID.

Hopefully, this will be the most difficult quarter for the company. Working to return revenue to pre-COVID levels will be difficult and will not happen immediately. Crescita also recorded a non-cash impairment of intangible assets to reflect the decline in revenue.

The big news came after the end of the quarter with the big $5.2 million one-time payment from Taro.

I did my best at trying to value Crescita which you can see here:

Crescita Therapeutics: Trading Below Net-Net

Disclosure: I own shares of CTX.TO. I have been planning on adding more.

Crescita Q2 2020: Balance Sheet

Crescita Therapeutics Q2 2020 Balance Sheet
Crescita Therapeutics Q2 2020 Balance Sheet

This is what I would call a “fortress” balance sheet with $9.3 million in cash. This is after hopefully the roughest quarter they will experience due to coronavirus. The $5.2 million from Taro is not accounted for on the balance sheet since it came after the end of the quarter and will be recognized in Q3.

Inventory & Impairment
Crescita Q2 2020 Inventory
Crescita Therapeutics Inventory

Inventories ended the quarter at $4 million. This is relatively stable compared to prior quarters. In the first half of 2020, $75,000 of finished goods were written down. My gut feeling is that more write-downs will be coming in future quarters based on finished goods that they have to discount to sell. Just a gut feeling. I don’t have any real insight into this.

And speaking of write-downs Crescita recognized an impairment charge of $1.9 million on intangible assets ($1.1 million for commercial skincare and $817,000 for the CDMO business). This is a non-cash charge.

In my previous post, I expressed my concern that the commercial skincare business might not be worth what Crescita paid for it. I discounted the value of the commercial skincare business to 50% of what Crescita paid for Intega and Alyria. Maybe that wasn’t a deep enough discount due to decreased sales because of COVID-19.

Below is a helpful video about asset impairment. It explains both the inventory write-down and intangible asset impairment.

Asset Impairment

Crescita Q2 2020: Income Statement

Crescita Therapeutics Q2 2020 Income Statement
Crescita Therapeutics Q2 2020 Income Statement

Q2 2020 was the worst quarter in revenue Crescita has seen since Q4 2016. The quarter was even bolstered by $413,000 in licensing revenue from guaranteed future royalties. I don’t understand the contract asset accounting method but I do know that it’s not recognized as cash which we will see on the cash flow statement.

The major cause of poor revenue was COVID-19. Spas were closed in Canada and across the world. I believe there is some stickiness to their product sales revenue. Customers who get skin treatments are likely to continue the treatments once they are able to do so. It becomes a part of their healthcare routine. We will see in the back half of 2020 if my assumption is correct. I do worry the stickiness is with the actual spa and not the specific product the spa uses for the treatment.

As for out-licensing revenue, I was hoping there would be some Pliaglis sales in Italy by Cantabria. I am not surprised there are zero U.S. sales after the big $1.4 million sales in Q1.

Repeatable Revenue

I’ve put together a graph to track what I call repeatable revenue. This is revenue from product sales, Pliaglis or other royalties (excluding one-time, upfront, milestone payments) and CDMO revenue. It is worth noting that Crescita started to break out CDMO revenue from product sales in Q1 2020.

Crescita Repeatable Revenue
Crescita Repeatable Revenue

Out-Licensing In Europe

Cantabria Manufacturing Approval

It is good to see some progress on launching Pliaglis in Europe. Chairman Chicoine explained that numerous things needed to be accomplished before Pliaglis could be sold in Spain, Portugal and France. One of them was manufacturing which is now approved.

Crescita Q2 2020: Cash Flow Statement

Crescita Q2 2020 Cash Flow Statement
Crescita Q2 2020 Cash Flow Statement

For a quarter that was as difficult as it was Crescita only had a net change in cash of $69,000. This was bolstered by a collection of accounts receivables. The cash burn in Q2 without the receivables was closer to $1.1 million when adding lease payments and property plant and equipment purchases to cash provided by operating activities before working capital changes.

We can see in orange the $1.9 million in asset impairment that isn’t a cash charge but worrying none the less. Also in orange is the $413,000 in contract asset that is recognized as revenue but isn’t actually received as cash.

The cash-saving measures helped in the quarter. Revenue will need to meaningfully rebound since the manufacturing facility has been reopened and management is back to taking their full compensation.

MD&A Notes

Commercial Skincare Gross Margins
Commercial Skincare Gross Margins

Gross margins were fairly stable in the first half of 2020 at 50.4% but this is actually an improvement over full-year 2019 of 47.2%. Gross margin is important to me with the commercial skincare business. It shows that they can maintain or raise prices and are not heavily discounting to generate sales. Below is a short article on the importance of gross margins.

What Gross Margins Can Tell You About a Company’s Economic Moat

Taro Amendment
Taro Pharmaceuticals Amendment
Taro Pharmaceuticals Amendment

This was the major announcement that was released on July 28th. As a result of royalty adjustments, Crescita is to receive $5.2 million in Q3. On July 27th Crescita had a market cap of $9.5 million with over $9 million in cash. Add $5.2 million to the balance sheet and we have a company trading as a net-net.

At first glance, this was amazing news. The company added $5 million to its balance sheet once collected. I then began to think what are the ramifications of this payment?

Has the relationship with Taro been harmed because of the payment? Will Taro place less emphasis on Pliaglis now that they are paying a higher flat royalty rate? Were the negotiations between Crescita and Taro contentious? I emailed Crescita but they couldn’t provide any additional comment.

Crescita has acknowledged in its Critical Accounting Policies and Use of Estimates section that the complicated process of accounting for royalties creates a risk that revenue could be misstated.

My hope is that Taro miscalculated the royalties due to the tiered royalty agreement and the relationship is still healthy. As a result, they are paying to the remainder of the royalties and Crescita and Taro have agreed on a simpler, higher, flat-rate.

Drug Delivery Technology Royalties

Crescita signed two agreements for use of their MMPE technology. The first was with Tetra Bio-Pharma on February 4, 2019. The second agreement was with Sundial Growers on October 28th, 2019.

Neither Sundial nor Tetra shows up in this quarter’s MD&A. Sundial was listed as a significant partnership in Q1 2020, however, in the Q2 MD&A, it is no longer present.

I did a quick search through both company’s financials to see if there is any mention of the products using MMPE.

Sundial is a mess. They are constantly burning through cash and raising money. They recently lost $15 million on a failed acquisition in the UK. The company is reviewing all strategic options, including mergers and sales of the company. There is no mention of CBD products in their MD&A.

As for Tetra Bio-Pharma, its subsidiary Lumeria is working on commercializing TERPACAN. TERPCAN uses beta-caryophyllene to treat hemorrhoids and muscle pain. Tetra is targetting a Q3 2020 product launch.

Also in the Tetra MD&A current as of July 20th, 2020, Tetra has signed an agreement for manufacturing with DeltaPharma for TERPACAN. From the initial news release, it said Crescita and Tetra were in discussion to have TERPACAN produced by Crescita. Doesn’t look like that is happening.

Conclusion

As expected Q2 was a difficult quarter for Crescita. Revenue was down in all segments. Costs were cut which lessened the cash impact of the poor quarter.

The real question now is how will revenues rebound in the last half of 2020 and into 2021. If rebounds in revenue do not occur but costs return to previous levels the cash outflow in future quarters is going to look scary. Management has proven to be competent since CEO Verrault took over the company so I am optimistic sales will return. The coming quarters will be interesting.


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