Yahoo Finance Ceapro (CZO.V): New Facility Opens; Topline Takes a Break
By John Vandermosten, CFA Ceapro Third Quarter Results
TSX:CZO.V
On November 23, 2016, Ceapro Inc. (CZO.V) released third quarter 2016 revenues and earnings. On a year over year basis, sales fell by 2%, settling at $3.0 million (all currency is denominated in Canadian dollars). This was below our estimates of $4.3 million and lower than 2Q:16 sales of $4.2 million.
By geography, on a year over year basis, sales increases in the US and Canada were offset by declines in Germany, and other regions. Sequentially, substantial declines in Germany, China, Canada and other geographies, and a slight decline in the US led to a 28% sales contraction overall. Veterinary sales to China were $0 in the quarter, matching the prior year levels. The China segment comprises one buyer who is expected to fill their normal order in the fourth quarter. We note that Ceapro’s distribution partner, Symrise, has sales attributed to Europe but also distributes Ceapro products beyond Europe’s borders. The volatile movement in the topline overall was attributed to timing and unpredictable ordering patters for new customers.
Gross margins increased year over year but fell sequentially to 62.7%. This compares to 3Q:15 levels of 61.2% and 2Q:16 levels of 72.3%. The increase in year over year gross margin was attributable to favorable product mix.
General and administrative expense rose 1% year over year to $528 thousand, as increases in public company costs, travel and insurance were mostly offset by a decline in salary, benefits and board of director compensation. In the prior year, there was a large non-cash share-based payment granted to employees and officers, contributing to higher compensation costs.
Research and development totaled $265 thousand in the quarter up from $142 thousand in the same period during 2015. Higher salaries and other expenses attributable to the avenanthramides and beta glucan clinical programs were behind the increase. Work was also performed on Ceapro’s PGX project, but was offset by grant funding. Expenses related to CeaProve were zero in 3Q:16 compared to $20,000 in 3Q:15 which was related to a patent renewal. In 2016, these expenses will be incurred in the fourth quarter.
Finance costs declined by 4% to $49 thousand due to lower interest expense on long term debt, partially offset by higher accretion expense related to the convertible bonds outstanding. Other operating loss was also lower on a year over year basis by 3% on foreign exchange movements, partially offset by higher plant relocation costs.
Cash levels increased over the prior quarter due to a private equity placement during the period. Cash and equivalents increased by $7.6 million as Ceapro issued equity shares of gross $10 million in the quarter. As of September 30, 2016 cash was $9.2 million. For the first nine months of 2016, Cash generated from operating activities was $4.1 million with the recognition of deferred revenue and an increase in receivables explaining the majority of the difference between this and the $5.1 million in net income earned during the period. Capital expenditures and leasehold improvements were ($4.3) million for the first nine months of 2016 compared to ($2.6) million in the prior year period with the increase attributable to expenditures related to the new bio-processing facility located in Edmonton. Share issuance costs and repayment of long-term debt reduced cash levels year to date by approximately ($1.6) million. Total debt carried on the balance sheet, including convertible debentures, fell sequentially from $4.0 million to $3.8 million.
2016 Estimates
We reduce our forecasts for 4Q:16 due to the slowdown in revenue growth in the third quarter and increased uncertainty in ordering patterns. Ceapro had seen substantial uptake of product sales in China in the first half, but sales to this geography slowed in the third quarter. Year to date, demand for natural products has been increasing as concerns over the impact of chemicals in products has pushed quality conscious consumers towards brands that use Ceapro inputs. Additionally, the increasingly consumer-oriented Asian markets, especially China, are using more health and beauty products, where quality commands a premium. To satisfy this demand growth, Ceapro opened its new bio-processing facility on September 28, and has processed the first commercial batches of oat extracts at the new facility.
The company is required by its agreements with customers to run both the old and new facilities simultaneously for the first six months and we currently expect validation trials to be completed by the end of 1Q:17. We forecast higher levels of utilization and more efficient processing to support year over year improvement in gross margin levels in 2016. When the new facilities are operating at normal capacity, we anticipate higher efficiencies, automation and throughput to support higher gross margin levels over the longer term.
Research and development costs are anticipated to increase slightly in 4Q:16 as clinical trials are launched for beta glucan (cholesterol reduction) and safety and bioavailability studies are conducted. We have forecasted $350,000 of expenses here for the last quarter of the year. General and administrative costs should decline slightly from 4Q:15 levels as the prior year saw relatively large non-cash share based compensation which is not expected to continue into 2016. Sales and marketing expenses are considered to be close to zero in 2016 as the company exclusively uses distributors for selling its product.
Recent Material Events
On September 28, 2016 Ceapro announced the grand opening of its new bio-processing extraction facility in Edmonton, Alberta which will use an ethanol recycling system, further enhancing the company’s “Green” credentials. The new facility will also include a commercial and demonstration area for its PGX technology which was developed at the University of Alberta.
Ceapro was awarded the 2016 BioAlberta Achievement Award for Company of the Year which has provided additional visibility in the Canadian Biotechnology industry.
The company announced that it was awarded a research grant from the German-Canadian Centre for Innovation and Research of $250,000 to commercialize and advance Ceapro’s PGX technology. A. Junghans GmbH and Fraunhofer will research and develop membranes to be used in the PGX process, and further commercialize them beyond their use with Ceapro. PGX also received allowance from the Canadian Patent Office for Canadian Patent Application Serial Number 2,794,960 which enables the technology. The patent title is “Supercritical Fluid Treatment of High Molecular Weight Biopolymers.”
Below, we share some of the key upcoming milestones expected.
- Commence bio-efficacy study with avenanthramides as an anti-inflammatory compound in exercise induced inflammation Q4 2016;
- Complete the development of a prototype for a functional coenzyme Q-10 drink in Q4 2016; and
- Commence patient recruitment for pilot clinical study to develop beta glucan as a cholesterol reducer in Q1 2017.
Update on Avenanthramides Program
Ceapro’s flagship product, avenanthramides (AVA), has applications in the cosmetics and personal care industries, and when taken orally, AVA could be beneficial in inflammatory conditions. These findings supported the research and development of AVA as an active pharmaceutical ingredient (API). Ceapro has initiated a bioavailability study with the University of Minnesota, comparing low-dose vs. high-dose AVA which has now completed. Ceapro expects the study results to be published in a journal, the name of which is yet to be announced. Management believes that this bioavailability study will pave the way for future clinical study protocols, and is currently conducting a bioefficiency study also at the University of Minnesota. The study is examining exercise-induced inflammation and is orally administering the active ingredient in this dose finding effort.
Update on Oat Beta Glucan Program
Beta glucan is known for its cholesterol lowering properties (Othman, et al., 2011), and Ceapro aims to develop beta glucan as a cholesterol reducer. It will conduct studies to assess high purity beta glucan when taken orally and will conduct a pilot clinical trial program on cholesterol reduction beginning 4Q:16. Expenditures in the third quarter related to this program were to develop the protocol and prepare the material for the pharmaceutical development stage. The 200 enrollee, year-long study is expected to begin in 1Q:17 and should provide a topline readout by mid-2018. There is currently a library of research that supports the health beneifts of beta glucan and many regulatory agencies in Canada, the US, Australia, the EU and New Zealand already recognize the benefits of the soluble fiber, which should provide for a low-risk approval following the studies.
Bio-Processing Extraction Facility Currently in Commissioning
Currently in commissioning and conducting validation trials, the new facility will hold a Natural Health Products license from Health Canada. It will allow Ceapro to leverage its bio-processing technique and generate additional revenue from custom bio-processing for third party customers that have their own products and extraction processes. In the legacy facility, Ceapro has the ability to manufacture 3-4 tonnes of product per week (approximately 100-200 tonnes per year) using batch mode processes. Ceapro’s plan is to implement a more efficient process at the new facility, with semi-continuous and continuous manufacturing processes which will allow for the simultaneous production of multiple products, and the production of five to six times more material than the government-owned bio-incubator currently used. The first validation batch trials are in process, and the facility is expected to produce by the fourth quarter. As per customer requirements, Ceapro is required to operate both the old and new facility for six months to ensure steady flow of product and we expect this requirement to be met by then end of 1Q:17.
Summary
Ceapro utilizes a proprietary plant extraction based manufacturing process to supply ingredients that are currently used in multiple household products in the personal care and cosmetics industries. We can find Ceapro ingredients inside well-known branded products like Aveeno, Burts Bees, and Nexxus. Ceapro’s active ingredients are manufactured from proprietary oat varieties and various natural sources grown in many regions around the globe. The company’s flagship product, avenanthramides, and its value driver, beta glucan, are two oat-derived compounds that make up the core of Ceapro’s product line. Ceapro is the only worldwide commercial manufacturer of natural AVA.
Over the last ten years, the main priority of the company has been to provide novel, natural, environmentally friendly ingredients to cosmetic and personal care product manufacturers and developers of human and animal therapeutics. Ceapro extracts are currently used in the cosmeceutical (cosmetics that have medicinal or drug-like effects) market, with the hope for entry into the pharmaceutical and nutraceutical (derived from food sources that purport health benefits such as vitamins, minerals, herbals, and functional foods and beverages) sectors in the relative near term. The company has plans to involve a steady pipeline of innovative products for both the human and animal healthcare industries.
Ceapro has been able to generate strong earnings growth through a combination of accelerating topline and improving margins. We believe there is potential to expand into the functional food/nutraceutical, and possibly the pharmaceutical markets, augmenting the current organic growth the company has achieved through its distributors over the last few years. The PGX technology may be able to cross over into other industries and provide upside potential from licensing revenues. The U.S. patent for PGX technology that was issued earlier this year further strengthens Ceapro’s patent portfolio. We think that Ceapro may have the opportunity to sub-license PGX technology to third parties and/or serve as a contract manufacturer. As per management, several multinational organizations in a variety of different industries have already executed confidentially agreements with Ceapro to assess their material with the proprietary PGX technology.
Although the company does have significant customer concentration, we believe its partnership with Symrise in particular, will assist them in selling the additional manufacturing capacity once the project is completed. We have assumed only modest growth in 2017 and 2018 compared to levels achieved over the last several years despite the completion of the additional manufacturing capacity.
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