CPHR: Product Sales Picked Up Steam in Second Quarter of 2015

By Grant Zeng, CFA

NASDAQ:CPHR

On Aug 14, 2015, Cipher Pharmaceuticals (CPHR) reported strong financial results for the fiscal second quarter of 2015 ending March 31, 2015. This is the first quarter the company reported its financials in the US dollar. All numbers in previous quarters (in Canadian dollar) were converted into US dollar.

Total revenue for the second quarter of 2015 was $8.8 million, compared to $8.0 million for the second quarter of 2014, an increase of 10%. Total revenue for 2Q15 also increased 19.4% from $7.4 million for the first quarter of 2015.

Revenue growth in second quarter of 2015 was mainly driven by strong growth in product sales, which was up 451% compared to that for second quarter of 2014. The high growth in product sales was offset by decline in licensing revenue in the second quarter of 2015, which was down 16%.

Product revenue growth was primarily a result of the acquisition of Innocutis completed in April 2015, which added 7 commercial products marketed in the US. Innocutis products contributed $1.8 million, composed primarily of Sitavig^® at $0.5 million, Nuvail^® at $0.5 million and Bionect^® at $0.4 million.

Canadian product sales of Epuris and Vaniqa also contributed $0.7 million to the total product revenue growth. Prescription market share of Epuris® increased to 19% in June 2015 from 17.6% at the end of March 2015.

At the front of licensing/royalty revenue stream, total licensing revenue decreased 16% to $6.3 million from $7.6 million in Q2 2014, largely due to the decreased revenue from Lipofen, which dropped to $0.9 million in 2Q15 from $1.8 million in 2Q14, a decline of 50%. In the company’s quarterly report, management explained that an authorized generic version of Lipofen was launched by Cipher’s US marketing partner in 2Q14, which resulted in the increase in 2Q14 related to launch quantities being shipped to distributors. The product continues to perform well despite the fact that Cipher’s partner, Kowa, has reduced their marketing efforts.

Absorica® revenue was $5.1 million in 2Q15, compared with $5.3 million in Q2 2014, a slight decline of 3.8%. This slight decline was primarily driven by a jump in the company’s 30 mg strength due to a competitor’s stock out in 2Q14. Market share of Absorica continues to hold in the 19% to 20% range in the last three quarters, as compared to 20.3% for 2Q14 according to IMS Health. We continue to believe Absorica will perform well and will be the largest licensing revenue contributor in the coming quarters.

We see Absorica revenues growing to $25.6 million in 2015, providing strong positive cash flow to Cipher that is allowing management to branch-out and fund all the recent acquisitions, as well as take on debt at favorable terms. Sunpharma has made it clear that dermatology is a core focus for the new Sun-Ranbaxy combined company, and Absorica is the flagship brand. Sales of Absorica in 2014 were around $240 million. We believe peak sales are $300 million, still leaving good room for growth in royalties to Cipher.

ConZip^®/Durela^® revenue in 2Q15 was $0.3 million compared with $0.5 million in Q2 2014.

R&D expenses in 2Q15 were $0.5 million, compared to $0.3 million in 2Q14. R&D expenses relate to the company’s drug development activities.

SG&A expenses in 2Q15 were $5.9 million, compared to $2.1 million in 2Q14. The increase of SG&A expenses in 2Q15 was primarily driven by the Innocutis acquisition.

GAAP net loss was $0.6 million ($0.02 per share) for 2Q15, compared to GAAP income of $4.1 million ($0.16 per share). Non-GAAP net loss was $0.2 million ($0.01 per share), compared to non-GAAP net income of $4.1 million ($0.16 per share).

Cipher reported adjusted EBITDA of $2.1 million in 2Q15, compared to adjusted EBITDA of $5.9 million in 2Q14. The decrease of $3.8 million was primarily due to the negative EBITDA in 2Q15 from Innocutis of $1.8 million as well as transaction costs and expenses related to the Innocutis acquisition. The adjusted EBITDA number adds back non-cash items to the net income, including $1.2 million in depreciation and amortization expense.

Strong Balance Sheet

Cipher exited the second quarter 2015 with $29.7 million in cash.

In April, 2015, Cipher closed on a private offering of $100 million in aggregate principal amount of Senior Secured Notes due 2020, provided by investment funds managed by Athyrium Capital Management. Cipher received an initial drawdown of $40 million, which was used to fund the majority of the upfront purchase of INNOCUTIS. The remaining balance of the Senior Secured Notes will be made available to finance future acquisitions and is subject to certain conditions. The five year fixed rate 10.25% Notes are payable on the last day of each quarter. The Notes are interest-only and are secured by assets of Cipher and its subsidiaries, subject to certain exceptions.

Valuation and Recommendation

We continue to rate Cipher shares a Buy and raise our price target to $17 from previous $16 per share.

Our model is consistent with management’s guidance that the INNOCUTIS deal will become accretive in two years. We model product revenue will reach $18.7 million in 2015, and grow to $135 million in 2018, an impressive compound annual growth rate (CAGR) of 93%, driven by both existing products and new approvals.

With respect to the valuation, we believe Cipher shares are undervalued at current market price. Currently, Cipher shares are traded at about $6.30 per share, which values the company at about $160 million in terms of market cap. This is deeply discounted compared to its peers. We believe Cipher shares are fair-valued at $16 per share. The specialty pharmaceutical industry trades at an average P/E ratio of 15x. According to our financial model, Cipher’s EPS will grow from $0.31 in 2015 to $1.94 in 2018, another impressive CAGR of 85%. Applying the 15 x P/E multiple and the $1.94 EPS in 2018, discounted at 20% for three years, we come up with the fair value of $17 per share.

We think if Cipher can demonstrate that they can execute and drive meaningful revenue and earnings growth over the next several quarters, the stock will be an excellent buy at this level. Finally, we see the end-game for Cipher shareholders as an acquisition, and inversion, by a larger U.S. pharmaceutical player.

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