On March 18th, 2020, Crescita Therapeutics 2019 financials were released. It was a transformational year for Crescita. They signed a lucrative contract with Cantabria Labs for sales of Pliaglis in four European countries. In addition, non-prescription sales have continued to grow and Crescita began sales in China.
Crescita’s second half of the year was much slower but when taken as a whole they had a very strong year. The company made a major move by reacquiring the rest of world rights for their drug Pliaglis from Galderma for $1.27 million. CEO Serge Verrault quickly signed a new out-licensing agreement netting the company $2.4 million in up-front payments.
On March 30th I spoke with Executive Chairman Dan Chicoine and Director of Financial Planning and Investor Relations Linda Kisa. I had a few clarifying questions about the year-end results. I will add their comments throughout.
For my initial write up please click HERE.
Crescita’s financials can be viewed HERE.
Disclosure: I own shares of CTX.TO
1.1 Crescita Therapeutics 2019 Financials
1.2 Balance Sheet
In times of economical turmoil, the balance sheet becomes even more important. Crescita has $9.3 million in cash and minimal debt, less than $900,000 in convertible debentures. Crescita repaid $3.5 million to Knight Therapeutics extinguishing all debt obligations with Knight. This should save Crescita over $600,000 a year in interest expense. This seems like an intelligent use of cash to me.
Another point of interest is inventory rose 40%. Mr. Chicoine explained that their inventory number can be lumpy. There is a lot of lead time between manufacturing their products and when it gets to the customer. To support the production of its Alyria product Crescita added raw materials to inventory. Inventory did not appear to be a concern to Mr. Chicoine.
1.3 Income Statement
Overall I think it was an excellent year for Crescita. Revenue was up 34.3% while operating expense was up only 4%.
Operating profit swung from -$37,000 to $5 million.
Gross margin on product sales was 47.2%, a 1.2% improvement over 2018. As the non-prescription business grows in scale I hope to see gross margin improvements continue. This will lead to eventual profitability in their non-prescription line.
Out-licencing royalty revenue really fell off from 2018. From $4.2 million in 2018 to $3.0 million in 2019. This is concerning. Pliaglis royalties are vital to Crescita and their greatest source of margin revenue. The company explains that 2018 may not be an indicator of future recurring royalty revenue as sales were high to fill U.S. distribution channels. Canadian sales of Pliaglis are now online with the three remaining European countries beginning in late 2020. Pliaglis royalties will likely be down from 2019 levels due to market uncertainty but 2021 should restart the growth of royalty revenue.
1.4 EBITDA and Adjusted EBITDA
There are some onetime charges in 2019 that will not reoccur. Crescita uses adjusted EBITDA as their preferred metric to compare year over year results.
I think their adjusted EBITDA metric is fair as it discounts expenses that will change year over year or won’t reoccur at all. Adjusted EBITDA grew 381% compared to 2018.
In 2018 Crescita recognized over $1 million in other income from settlements. In 2019 they paid $1.27 million to Galderma to buy back the rights to Pliaglis. This greatly skews the net income number. Adding these back to adjusted EBITDA does give a better picture of results from continuing operations. In 2020 Crescita will have very little interest expense and still generate some interest income from the $9 million on the balance sheet.
1.5 Cash Flow Statement
Crescita generated a healthy amount of cash flow from operations of $5.3 million. We can see that the guaranteed minimum royalties asset is subtracted out in the contract assets line. I misunderstood this asset in my initial write up which skewed my royalty revenue projections.
Only $215,000 was spent on PP&E.
$257,000 was spent on share buybacks and $3.57 million was spent to retire Knight Therapeutics debt. Even with the debt repayment and share buybacks the company had a positive cash flow of $679,000.
2.1 Crescita Therapeutics 2019 Financials: Further Adjusted EBITDA
The goal of this exercise is to figure out what 2019 cash flow would look like without all of the one-time payments and expenses. That is the question I have heard repeatedly from investors. What do the numbers look like without the one-time milestone and up-front payments?
I used adjusted EBITDA and then subtracted all one time payments realized in 2019. I also subtracted lease payments and PP&E investments since these expenses will continue. That left the company with a negative adjusted EBITDA. Management bonuses are based on adjusted EBITDA so I removed them as well.
I ended up with a negative adjusted EBITDA of $1.99 million in 2019. In 2020 I foresee adjusted EBITDA being negative as well due to the uncertainty around COVID-19 and European Pliaglis sales not coming online until late in 2020.
3.1 Crescita Therapeutics 2019 Financials: MD&A
I highlighted some interesting items from the MD&A. I will also add any comments I received from Mr. Chicoine and Ms. Kisa. Crescita’s MD&A is very detailed and provides lots of information about the company and its strategy. It’s one of the better MD&A’s I’ve read. RIWI’s MD&A is also in that category.
3.2 Page #7
I thought this statement was a little surprising. Based on their recent performance, and the ability to generate new partnerships, I believe the company can grow organically with its current set of assets. They have created partnerships with Tetra Biopharma and Sundial which have yet to produce revenue. The non-RX skincare business is growing 10% a year and Pliaglis has yet to be commercialized in all but a few countries. While 2020 will undoubtedly be a difficult year they have growth initiatives that are progressing. I hope this is a case of management underselling.
3.3 Page #3
Crescita identified its e-commerce partner in China as NetEase Kaola. Alibaba, the Chinese tech giant, acquired Koala in 2019. NetEase Kaola is being integrated into Tmall creating the largest cross border e-commerce platform. The acquisition slowed the launch of additional Dermazulene products into China near the end of 2019.
Currently, Dermazulene has four products in China. NetEase has asked for an additional three products in 2020. It looks like these products are already being advertised on Kaola. After a quick Google search, I see seven products on the Kaola website. One of their products has 99.1% positive reviews for whatever that is worth. Crescita has seen a good pickup in sales and expects modest uptake in 2020.
Crescita creates unique formulations for all of its Dermazulene products. The products are made specifically for Chinese consumers to focus on their preferences. Crescita uses multiple factors when building formulations including skin type and pollution level to get the best results for its consumers.
In 2019 the rest of world sales (ROW is all countries excluding Canda, US, Europe) accounted for only 6% of revenue. Dermazulene is only a very small portion of Crescita’s overall revenue but presents an interesting opportunity if they can continue to build a brand in China.
3.4 Page #9
To date, Pliaglis is only being sold in the U.S., Italy, and Brazil. Canada just came online at the end of 2019 using Crescita’s own sales staff. Spain, Portugal, and France have not had any sales of Pliagils yet.
Mr.Chioine told me that they expect commercialization of Pliaglis late this year or early next year in Spain, Portugal and France. Compared to Italy this seems like a very slow rollout.
The reason for this is that Galderma was already selling Pliaglis in Italy. The process to continue sales is much simpler since Pliaglis was already established. Cantabria is starting from scratch in the three new countries. Much of the work to establish distribution and production has been completed. The current timeline for sales in Spain, Portugal and France is in line with expectations. The timeline of sales in late 2020 may be delayed due to COVID-19.
3.5 Page #19
This was the biggest question mark I had after reading the MD&A. I reached out to the Twitter community if anyone had an opinion on this but got no response. I asked for the companies interpretation of this statement.
Here is the complete answer I received from Ms. Kisa:
“Blair, I can direct you to what we know. Here are some articles that talk about the amendments to drug reimbursement plans where there are limits established on reimbursement of certain products by Express Scripts and CVS Caremark, two of the large pharmacy benefit managers in the U.S. Pliaglis is included under the product name Lidocaine/Tetracaine.
We don’t know yet how this will be enforced exactly and how these limits will affect the sales of Pliaglis. All we know is that it may have an impact. We are working with Taro and, of course, they are trying to mitigate any potential negative impact on sales. Although we do not know all the details and it is too early to determine the potential impact on sales, we believe that it is important to be transparent with our investors.”
Here are two links that were provided with a bit of additional information.
Mr.Chicoine further expanded on this in our conversation. This practice is not uncommon in the United States. It is a complicated calculation to determine “aberrant quantities” and at this time they don’t know what effect, if any, it will have on Pliaglis sales. From the two articles, it looks like CVS is targeting high margin products to save themselves money even though this may be illegal.
The dates on the articles are December 10th and December 18th. The change in policy would have had no effect on U.S. Pliaglis sales in Q4. Even without the impact of these changes, Taro had zero Plaglis sales in Q4. Taro had sufficient inventory to meet commercial demand in Q4.
There will be no additional sales and development milestone payments from Taro as they have all been recognized. Further milestone payments can’t be relied upon in future years to reach profitability. The continued buildout of recurring Pliaglis sales is vital to Crescita’s profitability until the non-prescription brand reaches a greater scale.
For the Cantabria deal, there will be milestone payments related to sales of Pliaglis in Spain, Portugal and France. Hopefully, we see them in 2020.
4.1 Crescita Therapeutics 2019 Financials: Subsequent Events
4.2 MiCal 1 (now CTX-101)
The biggest news came on February 11th when Crescita announced that MiCal 1 (now CTX-101) had positive results from its two Phase III trials. This is good news. It provides Cresicta with some potential future diversification of revenue. Crescita has invested very little into the development of CTX-101. In 2019 Cresita invested approximately $300,000 to help fund the phase III trial. I’m not sure if Crescita is required to contribute further funding to CTX-101. I should have asked management this question in hindsight.
4.3 Distribution Agreement with Laboratories FILLMED
Crescita signed an exclusive distribution agreement with FILLMED to sell a range of injectables and anti-ageing treatment. Crescita anticipates sales to start in late 2020 or early 2021 once approved by Health Canada.
Their new partnership with FILLMED could provide more opportunities in the future. FILLMED has a wide range of anti-ageing products. Their website also says they invest 20% of revenue into R&D every year to improve and develop new products. There is the potential for further agreements on FILLMED products for launch in Canada.
These are types of announcements that I think will continue as Crescita becomes more recognized in the dermatology world. This is also the type of product I assume Crescita was looking to acquire. With the market uncertainty maybe we will see valuations come down and Crescita can put some of the cash on the balance sheet to work in an acquisition.
Crescita is trading at around $0.50 a share and a market cap of $10.37 million and an enterprise value of $1.1 million.
Now without a new royalty contract with up-front payments, Crescita isn’t likely to be profitable in 2020. Crescita announced their facility is being closed due to COVID-19. I assume then that many of Crescita’s 2020 initiatives will be delayed. Even with likely delays in growth initiatives Crescita seems incredibly undervalued at an enterprise value of $1.1 million.
Based on Ben Graham’s Net-Net-Working-Capital formula let’s see what the company is worth?
= $0.35 or $7.1 million
If the share price continues on its current trajectory we might get there. The value from the NNWC does include any of Crescita’s working assets. For an ultra-conservative assumption on what Pliaglis is worth I used the up-front payments and sales milestones paid by Taro and the up-front payment from Cantabria. I get $13.8 million.
So with the NNWC ($7.1 million) and very conservative estimation of Pliaglis’s value, you get $20.9 million or $1 a share. That doesn’t give any value to Pliaglis’s double-digit recurring royalties, their skincare brands (they paid $1.7 million for Alyria in 2017 as an example), their drug delivery technology and CTX-101 and CTX-102.
The company is making progress after spinning off from Nuvo in 2016. CEO Serge Verrault has only been with the company for one and a half years. He has made some shrewd allocation decisions already (reacquiring ROW for Pliaglis, share buyback, Knight debt paydown). This is not a worthless company with worthless assets. The company is worth double it’s share price when adding in a conservative estimate of Pliaglis value.
I will be adding slowly throughout this market panic.
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