Nucryst GMP Report = BUYNovember 8, 2006
Nucryst Pharmaceuticals Inc.
BUY
NCS $7.00; NCST-Nasdaq US$6.23 Target: US$12.50
Q3/06 results in line with our estimates
• Nucryst’s reported a net loss of $0.12 per share in line with our estimate of $0.11 per share. Revenue of $7.3 mm was higher than our estimate of $5.7 mm
• Management announced its decision to terminate the clinical program for atopic dermatitis. As a result, we expect R&D expenses to decline as lead drug candidate NPI32101 is now in preclinical studies
• We believe that Smith & Nephew’s commitment to commercialize Nucryst’s products worldwide will continue to drive growth in the long-term
• Maintaining our BUY rating and US$12.50 target price
WE BELIEVE THAT WOUND CARE BUSINESS WILL CONTINUE TO DRIVE THE COMPANY’S VALUATION
Nucryst reported financial results for Q3/2006. The company’s net loss of $2.1 mm or $0.12/share was in line with our estimate of $0.11/share. Total revenue was $7.3mm, which was higher than our estimate of $5.7 mm. The increase in revenue was mainly due to higher manufacturing cost reimbursement from its partner Smith & Nephew related to build up in inventory in the quarter.
Smith & Nephew commercializes Acticoat products based on Nucryst’s nanocrystalline silver coating technology dubbed SILCRYST for the treatment of chronic wounds, burns and inflammatory diseases. Since 2001, Nucryst has benefited from a high-value partnership with Smith & Nephew, one of the global leaders in wound care management, to develop and commercialize Nucryst’s SILCRYST products. Under the terms of the license and development agreement with Smith & Nephew, Nucryst receives royalties based on Smith & Nephew sales of SILCRYST products. Nucryst also receivespayments upon the achievement of milestones relating to Smith & Nephew’s sales of SILCRYST products and certain regulatory matters. Under the supply agreement, Smith & Nephew pays Nucryst the fully allocated cost of goods sold including equipment depreciation plus a royalty based on sales of these products by Smith & Nephew.
In the conference call, management indicated that it does not expect to receive any milestone payments from Smith & Nephew this year. Based on this, we have moved our estimated $5 mm milestone payment from F2006 to F2007. As a result, we have revised downward our revenue forecast for F2006. We now expect Nucryst to generate total revenue of $25.5 mm this year (previous estimate was $28.9 mm). Gross margins for Q3/06 were 31.8% compared to 43.8% for the same period last year. This sharp decline was due to difference in timing of when the wound products were shipped to Smith & Nephew and when Smith & Nephew actually sold it to its customers. Going forward, we expect margins to continue to vary due to the timing difference between shipping and final sale of the product.
We believe that Nucryst and its partner will continue to expand their wound care franchise worldwide and expect this business to drive Nucryst’s valuation higher over the next two years. Smith & Nephew’s sales of ActicoatTM were flat in the quarter, but they have increased 11% over the first nine months of 2006.
Although pricing and competitive pressures in the European wound care market remain as challenges, especially in Germany and U.K., we believe that sales growth in the U.S. market will become the main driver. With the growing number of cases of diabetes and the increase in the elderly population in the U.S., we believe that the demand for wound care products such as ActicoatTM will significantly expand. We forecast Nucryst’s product revenue of $30.3 million in F2007.
Research and Development expenses are expected to decline next year Research and development (R&D) costs of $3 mm in Q2/06 were higher than our estimate of $4 mm. The decrease was primarily due to the completion of the Phase II clinical trial on the use of NPI32101 for the treatment of atopic dermatitis. We forecast R&D expenses of $13.8 mm and $11 mm in R&D expenses in F2006 and F2007. The decline next year will be due to lower costs related to preclinical studies with NPI32101. At present, Nucryst does not plan to initiate any late stage human clinical trials in 2007. General and administrative (G&A) expenses in the quarter were $1.6 mm compared to our forecast of $1.8 mm. We estimate G&A of $6.5 mm this year and $7.1 mm next year as the company continues to build its infrastructure. Lead drug NPI 32101 is currently undergoing testing in animal models – Human clinical trials to start next year
Besides the wound care business, Nucryst is developing nanocrystalline silver as a pharmaceutical for the treatment of inflammatory conditions. NPI 32101, a nanocrystalline silver-based pharmaceutical with anti- microbial and anti-inflammatory properties, is the lead drug in the company’s portfolio. In the quarter, Nucryst reported negative results from a Phase II clinical trial on the use of NPI32101 for the treatment of atopic dermatitis, an inflammatory disease of the skin. The trial did not meet its primary efficacy end point. Management has decided to terminate this program, but mentioned on the conference call that it plans to pursue other dermatological diseases with NPI32101 topical cream. The type of diseases were not disclosed, but given the inflammatory nature of psoriasis, we speculate that this illness could be potentially targeted by the drug.
Nucryst is currently testing NPI32101 in animal models of ulcerative colitis, an inflammatory disease of the gastrointestinal tract. The preclinical results are encouraging thus far and the company plans to commence human clinical trials by the end of 2007 or early 2008.
Although we agree with Nucryst’s management that NPI 32101 could be a potential treatment for other inflammatory conditions such as ulcerative colitis, we are not assuming any revenue from these programs at present. This conservative approach stems from the analysis of the results of the atopic dermatitis Phase II
clinical trials. We will revise our view on this program once “proof-of-principle” results from human clinical trials in other indications become available in 2008.
Maintaining our BUY recommendation
We have reduced our revenue estimates for the year to reflect zero milestone payments from Smith & Nephew. For F2006, we now forecast total revenue of $25.5 mm (previous estimate $28.9mm) and a net
loss of $0.64/share (previous estimate of $0.41). Our estimates from 2007 and beyond remain intact. We expect Nucryst to earn $0.31 next year. The changes do not significantly affect our valuation model. We therefore maintain our $12.50 per share target price. Our target is based on a DCF calculation using a 15% discount rate to reflect clinical and financial risks. In our view, the current share price does not fully reflect the commitment of partner Smith & Nephew to expand and grow the wound care franchise. We therefore maintain our BUY rating on the stock.