Neos Therapeutics Valuation Appears Low Should They Report Operating Profits In 2020
Feb. 18, 2020 2:45 PM ET|6 comments | About: Neos Therapeutics, Inc. (NEOS)
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Summary
Average weekly prescriptions grew ~15% Q4 2019 versus Q3 2019 (excl. holiday weeks) and NEOS has more than tripled its NEOSRxConnect network within the last 4 months.
Goldman Sachs and Sphera Funds Management both recently filed 13G's reflecting recent investments in NEOS that take both over 5% shareholders.
Q42018 restructuring working well. NEOS's continues to significantly grow revenues on much lower expenses successfully pivoting from 2018 operating losses of ~$10mm/quarter to almost break-even in Q32019.
NEOS's enterprise valuation versus forward looking are less than half that of peers suggesting material gains are likely should dilution concerns pass. 1 new product in development.
NEOS as a whole continued to burn cash into Q32019 (but much less than before). Investors should consider risk of dilution.
NOTE: All tables, graphs, charts and inserts below were prepared by the author based on company filing's (unless otherwise noted).
Our analysis concludes NEOS Therapeutics (ticker symbol "NEOS") share price is materially undervalued because:
NEOS trades at much lower forward looking revenue multiples than peer commercial biotechs (by a factor of almost 3 times) while at the same time simple analytics suggest NEOS's FY2020 consensus growth estimate (per Seeking Alpha) of ~25% is understated, primarily because FY2020 consensus revenue estimates are unchanged after a 13% price increase for 1 of its 2 primary products announced 1/1/2020 and:
We know via Symphony data NEOS product prescriptions continue to grow rapidly up to the date of this report in 2020 and:
NEOS has grown its prescriber centric NEOSRxConnect program by more than 200% in the last 3 months and:
NEOS implemented a restructuring 1 year ago to focus on becoming profitable and have reduced operating expenses and quarterly losses for 5 quarters in a row. NEOS reported an operating loss of ~$400K in Q3 2019 versus consistent ~$10MM+ operating losses per quarter pre-Q32018 and:
NEOS secured a new working capital line of credit of up to $25MM on eligible accounts receivable that mitigates the apparent risk of an imminent dilution and:
NEOS should attract new investor attention should NEOS's report positive clinical data from its Phase I trial of a new Sialorrhea (excessive drooling) therapy (named NT0502 on NEOS's investor presentation). Per biopharmcatalyst top line PK data from the NEOS trial is due Q12020.
At $1.50 per share, NEOS trades at an enterprise valuation of ~$100MM which is only 1.2X consensus FY2020 revenue estimates of $83.2MM that should produce ~70% gross manufacturing margins. Anecdotally, NEOS's revenues, revenue growth and gross margin profile are similar to Osiris Therapeutics (previously ticker symbol OSIR) that had roughly the same gross margin profile at scale but was growing revenues more slowly. OSIR was acquired 1 year ago for roughly 4X forward looking revenues and 5X TTM revenues. Considering the growth in NASDAQ & Biotech averages in the last year, it is likely multiples would only be higher in such an acquisition today. NEOS peers as identified by Seeking Alpha that have more or less the same forward looking revenue growth profile and revenue dollar profile trade at multiples much higher than NEOS as noted below:
NEOS Valuation Analysis
NEOS trades at 1.2X consensus FY2020 revenue estimates where the average peer (with similar growth profiles) trades at 3.3X FY2020 consensus revenues. Peers that are forecast to grow faster than NEOS (as demonstrated above to the right side) trade at 6.8X consensus FY2020 revenues. Should NEOS growth accelerate due to its new initiatives then its multiple could be even higher.
While interpreting any data set is always debatable, it is commercially reasonable to conclude that NEOS, when compared to companies with more or less the similar profile as noted above, appears materially undervalued. Our analysis also concludes that imminent dilution risk is also overblown because NEOS has more than enough cash on hand to service debt for the next 18 months and just secured a line of credit for up to $25MM on accounts receivables (discussed below). Readers should also consider continued growth in prescriptions into FY2020 (shown below). Our analysis concludes that NEOS's risk/reward profile is as compelling as any like stock in the space (i.e. with such a low revenue multiple and valuation it appears the stock could not fall much lower).
In Q4 2019 NEOS's 2 primary products (~90% of revenues) experienced weekly prescription growth of about 15% from Q3 2019 weekly averages (one product grew ~ 20%+ and the other ~12%+) when excluding holiday weeks. More important, NEOS has more than tripled its NEOSRxConnect network since 9/30/2019. In spite of these respectable growth related data points NEOS’s share price continues trade within a small range the last 6 months and at much lower revenue multiples than peers. Using Microsoft Excel trend regression and analysis of NEOS prescription data since last June 2019 (provided below) demonstrates NEOS is trending to end 2020 with significantly higher prescriptions per week than today also suggesting 2021 revenues will be higher than analysts predict. We also admire NEOS’s ability to execute its business plan including a laser sharp focus on controlling expenses. NEOS has now lowered operating expenses and dramatically reduced operating and net losses for 5 quarters in a row now (as noted the most recent quarter reporting a very small operating loss of ~$450K on $17MM in revenues) as shown below:
NEOS 5 Quarters
SOURCES: NEOS Q32018 10Q, FY2019 10K, Q12019 10Q, Q22019 10Q and Q32019 10Q
Below is a schedule like the above but to reflect only net losses. The author would caution investors to be certain it is understood that in Q32019 NEOS continued to report net losses...albeit lower losses for 5 quarters in a row...even when considering non-cash expenses (and not considering working capital requirements, CAPEX, principal debt service and other potential uses of cash):
NEOS Net Losses Last 5 Quarters
SOURCES: NEOS Q32018 10Q, FY2019 10K, Q12019 10Q, Q22019 10Q and Q32019 10Q
Again, as evidenced above, NEOS has demonstrated a commitment to reducing expenses and becoming profitable. It is perhaps most important to consider that although NEOS reported a ~$400,000 operating loss in Q32019, this operating loss was net of ~$1,500,000 in noncash expenses (stock compensation, depreciation & amortization). Simply put, NEOS operations did not "burn" cash in Q32019 (but to be clear excluding CAPEX, debt service and working capital considerations...it is important the investor understands NEOS as a whole continued to burn cash in Q32019). Should the trend in operations continue to improve, as the prescription growth into Q42019 and FY2020 suggest, NEOS could generate cash from "operations" in Q42019 (again excluding CAPEX, debt service and working capital considerations). It appears NEOS CAPEX requirements are now minimal ($750,000 YTD 9/30/2019 per NEOS's Q32019 10Q). Again and for the third time it is important investors remember we are only referring to NEOS operations by adding back non-cash expenses to NEOS's Q32019 ~$400K operating loss that excludes working capital considerations, CAPEX and debt service requirements. Below we will show that while NEOS's Q3 2019 operating loss was $433,000, NEOS Q32019 statement of cash flows reflect approximately $4MM cash used in operations in Q3 2019 (primarily from a large increase in accounts receivables). While the author applauds NEOS's Q32019 operating performance, it is important the investor understands total cash requirements on NEOS's business.
By way of background NEOS was founded in the year 1994 and recorded its first commercial product shipment in 2014. NEOS sells products that treat attention deficit hyperactivity disorder (“ADHD”) for children and adults. NEOS also sells a product used somewhat seasonally to treat allergies or a cold (roughly 10% of sales). Product sales have essentially doubled every year since NEOS became a commercial enterprise starting with $3.8MM in 2015 revenues, $9.2MM in 2016, $25MM in 2017 to almost exactly $50MM in 2018. Products sales are only growing roughly 40% in 2019 because in late Q42018 NEOS reorganized their entire commercial infrastructure which included layoffs and sales territory re-alignments to about 75 territories today. The ultimate purpose of their reorganization was to optimize commercial operations and "accelerate their roadmap to profitability" (aka focus on high prescribers and increase their WAC/ASP). As evidenced by the ~$400,000 Q32019 operating loss noted above (from almost $10MM/quarter the year before), the plan is definitely working. As a side note NEOS increased their pricing for one of their two primary products by 13% effecting 1/1/2020 (SOURCE: MarketWatch). Hence it appears NEOS's plan is, at a minimum, working if not exceeding expectations as evidenced by comparing NEOS’s income statement for the years FY 2016 – 2018 versus annualizing their Q3 2019 income statement as follows:
NEOS Q32019 versus prior years
The ADHD market within which NEOS competes is in the billions. NEOS sells 2 products that use the same basic "ingredients" as other popular ADHD treatments but NEOS's products offer extended release formulations. This is the primary competitive advantage of NEOS's 2 primary products. NEOS sells its ADHD medicines through pharmacy chains. NEOS records revenues based on shipments to these pharmacies and not based on the number of end user prescriptions in any given quarter. This is why it is not possible to take the number of prescriptions written in a fiscal quarter as reported by IVQIA or Symphony and multiply by the product's WAC/ASP to determine quarterly revenues. As a practical matter, it is obviously more important to track prescription totals by week per Symphony or IVQIA to track how well NEOS's products are doing in the market.
To first provide a perspective on NEOS sales year to date, here is a summary of NEOS revenues by product and pricing and volume data as reported by quarter in FY2019:
NEOS YTD2019 Revenues
The author would note that NEOS expected prescription volumes to fall after its re-organization plan was implemented in Q42018. The author can confirm that, per Symphony, prescriptions are now growing considerably again in Q42019 and into FY2020 as they had for years before the restructuring (graph provided below).
NOTE: The author uses the term ASP (average selling price) where NEOS refers to "net revenue per pack" in its investor related materials. We will generally use the term ASP in this article. The author would note that on the Q3 2019 conference call NEOS guided investors to again expect slightly lower ASP, as is customary, in Q4 2019. The author noted ASP for both products was $108 in Q3 2018 then fell to $97 & $95 in Q4 2019. We will assume similar decreases for modeling Q42019. NEOS then guided investors to expect increases to ASP moving forward beginning 1/1/2020. Again, NEOS was specifically identified in the press as implementing one of the higher price increases in the industry by MarketWatch.
NEOS's 2 primary products represent ~90% of their revenues. The first product is called Adzenys-XR which is, in simple layman's terms because it is more complex, an extended release version of Adderall (the standard of care amphetamine used to treat ADHD) except targeted at adults with ADHD which is the fastest growing market per NEOS. Adzenys-XR was roughly 50% of NEOS's Q32019 YTD revenues. NEOS's second primary product is called Cotempla-XR, representing 40% of YTD revenues but growing more quickly, that is an extended release of methylphenidate (another popular way to treat ADHD) targeted at kids aged 8 to 17. The following are UNOFFICIAL graphs of Adzenys & Cotempla precsriptions by week using Symphony data since the beginning of Q2 2019 that include trendlines generated by excel to extrapolate what prescriptions per week should look like at the end of 2020:
NEOS Adzenys prescription data
NEOS Cotempla prescription data
These graphs are provided so it is clear that NEOS continued to experience growth in prescriptions in Q4 2019 and into 2020 (from Q32019). In our opinion it is better to start the trending in early July because there was disruption due to the re-organization in 1H2019. It appears NEOS has worked out the disruption related kinks. The analysis also helps you understand where NEOS is headed towards the end of 2020 to not only help estimate average FY2020 prescriptions and revenues but what NEOS may look like going into FY2021. The author would remind readers that NEOS implemented a 13% price increase on Cotempla effective 1/1/2020. While the author was unable to identify Adzenys specific price increases for FY2020, it is reasonable to assume NEOS implemented a price increase as well. The author can only confirm it was less than 9.9% because increases over 9.9% are reported by mainstream media. For modeling purposes we will assume only 7%.
Investors should also consider that it is customary in the biotechnology & pharmaceutical businesses to see drops in prescription volumes in Q1 of any year as deductibles under virtually all health insurance plans reset.
As part of NEOS's new commercialization plan implemented in late 2018, NEOS created NEOSRxConnect ("NRxC") at participating pharmacies that was launched in January 2019. NRxC is a NEOS service that keeps co-pays consistent and seeks to eliminates hassles for the prescribing physician. For example, if a patient using a like medicine has a financial related issue refilling a prescription (from say a higher co-pay) it creates patient dissatisfaction & requires additional attention of the prescribing physician & his/her office staff. NRxC seeks to eliminate these kind of "headaches" to the prescribing physician and, per NEOS, has been a success to date noting it has "fundamentally changed practices." As of 9/30/2019 NEOS had roughly 150 pharmacies participating in NRxC. NEOS signed a "large regional grocery store chain" to NRxC to take participating pharmacies to 450 by 11/30/2019....a 200% increase. Per NEOS's January 2020 Investor Presentation the number of participating pharmacies stood at 500 at 12/31/2019. This is important because the prescription data noted above, and trending exercise to 12/31/2020, does not necessarily consider these gains in NRxC participating pharmacies. Per NEOS, approximately 20% of prescriptions were filled YTD through NRxC participating pharmacies. The author does not believe consensus estimates considered this tripling of NEOS's NRxC network because consensus FY2020 revenue estimates per Seeking Alpha are more or less unchanged from 3 months ago (incidentally consensus revenue estimates have also not been changed to reflect a 13% price increase...however to be clear we do not know what analysts modeled as a price increase in 2020). NEOS did not announce the contracting with a large pharmacy chain that tripled this network until 11/8/2019 (still less than 90 days ago when this article was first prepared).
When considering appropriate revenue multiples, the author should advise investors to expect a generic versions of Adzenys-XR to be introduced by Actavis on 9/1/2025 and a generic version of Cotempla-XR to be introduced by TEVA on 7/1/2026.
Balance Sheet
The following is an overview of NEOS's 9/30/2019 & 12/31/2018 balance sheets:
NEOS Therapeutics Balance Sheet
Our analysis concludes NEOS's appears to have managed its balance sheet as well as NEOS has controlled expenses. While NEOS accrued expenses appear high, the author would note they are consistently in this range and are made up of accrued savings offers, coupons and customer & wholesaler fees that generally increase as sales increase. Hence accrued expenses does not appear to be an overwhelming burden on working capital. The author can confirm traditional accrued expenses (i.e. payroll, benefits & other) were roughly $7MM at the end of each period.
NEOS does have a long-term debt facility of $45MM as of 9/30/2019. The balance was $52.5MM as of 12/31/2018 but NEOS made a $7.5MM payment as required via cash in May 2019. The facility is complex but essentially requires $15MM principal payments due in May of every year for the next 3 years (the $16,108,000 in current maturities of long term debt includes $1,108,000 principal due under certain capitalized leases). Relatively minor amounts of the facility may be paid in stock. The lender may also convert the debt to equity but not to exceed 3.8MM shares. As a practical matter investors should assume NEOS must pay off the remaining $45MM facility (that accrues interest at 13%) via cash.
RISK OF DILUTION
NEOS's balance sheet suggests that the risk of a dilutive event is high because of negative shareholder equity and a $2.05MM net loss in Q32019. The author would remind investors should be sure they understand the difference between operating income/loss versus net income/loss. Investors need to be aware that while in Q32019 NEOS reported its 5th straight quarter of reduced operating losses ($433,000 operating loss in Q32019), NEOS continued to burn cash as a whole as "operating" losses exclude working capital considerations (like it may take 60 days to collect cash from a sale), CAPEX and debt service.
Below is a schedule that reflects NEOS's statement of cash flows by quarter year to date. Remember statements of cash flows (for any company) are always reported year to date and not for the given quarter specifically except for Q1. NEOS's statement of cash flow in 3 month increments year to date are as follows:
NEOS Therapeutics Cash Flow by Quarter
Again and only to be crystal clear, net cash used in Q32019 operations totaled $4MM (primarily because of increases in accounts receivables) and excluded CAPEX and debt service requirements.
That being said the author would first remind investors that NEOS reported a $433,000 operating loss in Q32019 (the 5th straight reduction in losses per quarter) that included approximately $1.5MM in noncash expenses. Again if one adds back these non-cash expenses to Q32019's $433,000 operating loss NEOS operations (by itself) did not "burn" cash (again to be clear we are excluding working capital considerations, CAPEX and interest/debt service). YTD CAPEX was only $750K. Moving forward we noted it appears NEOS prescription growth in Q42019 on likely lower ASP should keep NEOS more or less revenue neutral for Q42019 all other things being equal from an operations perspective. NEOS will continue to have to pay $2MM interest per quarter and has a $15MM payment due their lender in 5/2020. Our analysis concludes that the $15MM payment, by itself, will not materially affect NEOS's ability to grow revenues as the $23MM cash on hand at 9/30/2019 and the new A/R line of credit for up to $25MM provide more than enough working capital for the immediate future. This could especially be the case should revenues continue to grow and expenses decrease. The small yet real overlooked bonus of making the $15MM payment is annual savings on interest expense will total just under $2MM/year. Simply put if NEOS continued to grow revenues and lower expenses it appears NEOS would not burn any cash in Q42019 from traditional operations (again excluding working capital considerations, CAPEX & debt service) nor going into FY2020 (unless they opted to invest more aggressively in growth or the Sialorrhea therapy discussed below). The author would also remind investors that it appears the high accrued expense balance is consistent within the industry and hence do not appear to be a material strain on working capital. Of course there are macro type risks that could adversely impact NEOS's ability to grow its business.
Obviously investors need to monitor NEOS performance and consider the risk of a dilutive event (especially should the share price rise materially). It is the author's opinion that one reason NEOS trades at such lower multiples than peers is because the market has "priced in" a dilutive event. Hence should NEOS tell investors not to expect a dilution in the near future on the next conference call it could propel the share price higher.
CLINICAL PIPELINE
NEOS has initiated a Phase I trial for a new product, for now called NT0502, that will manage Sialorrhea symptoms (aka excessive drooling). There are roughly 1.4MM people in the United States who suffer from Sialorrhea including those with Parkinson's Disease, Cerebral Palsy and people who have suffered a stroke. This is a particularly attractive space because, per NEOS, physicians reserve Sialorrhea treatment for only the most severely affected patients due to the side effects and complex dosing regimens from current therapies. Without going into great detail, patients not only suffer social stigma associated with drooling but, untreated, can lead to higher risks of choking and/or pneumonia.
Consistent with the compelling competitive advantages of NEOS's ADHD products, it appears NEOS will ensure dosing is oral only and limited to once or twice per day. While NEOS has yet to quantify NT0502's total addressable market (or "TAM"), it appears quite reasonable to conclude TAM would consider 1.4MM patients at a cost of $100/month or $1,200/year from a Sialorrhea therapy. This would translate into roughly a $1.7B market. To be clear this is a directional estimate per the author for modeling purposes. Considering there are currently very limited treatment options, revenues could be materially higher. Hence a 10-15% NEOS share of this market could easily be $150MM to $200MM/year. NEOS's CEO appeared quite confident when he noted NT0502's pre-clinical work and specifically referred to it as "transformative" when guiding to expectations around moving the clinical process forward quickly.
As noted top line PK data is due in Q12020 per biopharmcatalyst. It is the author's opinion the market could reward positive NT0502 top line data with a rewarding valuation gain.
Q42019 & FY2020 NEOS REVENUE FORECASTS
While the author noted average Q4 2019 prescriptions per week, excluding holiday weeks, grew significantly from Q3 2019, there were significant holiday weeks in Q4 2019 (customary for the entire industry). Q42019 includes Thanksgiving, Christmas and New Years. Unofficial Symphony prescription totals show a 6.2% increase in Adzenys prescriptions and a 11.5% increase in Cotempla prescriptions Q42019 v Q32019. Forecasting revenue is also somewhat risky because as noted NEOS records revenues based on shipments to pharmacies. To provide perspective, the following is a reconciliation of Adzenys-XR & Cotempla-XR reported revenues versus the number of prescriptions written multiplied by ASP:
NEOS Revenues versus Prescription Data
SOURCE: Q42017 Earnings Press Release, Q12018 Earnings Press Release, Q22018 Earnings Press Release, Q32018 Earnings Press Release, Q42018 Earnings Press Release, Q12019 Earnings Press Release, Q22019 Earnings Press Release, Q32019 Earnings Press Release
It is the author's conclusion that the growth in prescriptions in Q42019 versus Q32019 are likely offset by reductions in ASP. It is therefore the author's conclusion that Q42019 revenues will not increase dramatically from Q32019 from simply "restocking the shelves." Again because NEOS records revenues based on shipments to pharmacies we do not know for sure. NEOS Q42018 revenues were $15.4MM up from $12.5MM in Q32018 (up 23% quarter over quarter) with a similar prescription volume/ASP change profile. It is just as possible revenues will surge in Q42019 because NEOS doubled its NRxC partners. The good news is we do know NEOS prescriptions are growing rapidly and can model revenue changes consistent with Symphony prescription data. Lastly, the author would also note that NEOS's Tussionex (10% of sales) prescriptions doubled Q42019 v Q32019. NEOS's Tussionex revenues also more than doubled Q4 2018 v Q3 2018. It therefore appears reasonable to assume revenues will probably grow in the $0.6MM to $1.2MM range in Q42019 from Q3 2019. Our directional estimate of Q42019 & FY2020 NEOS revenues, using unofficial prescription data, are as follows (official consensus revenue forecasts noted as well):
NEOS Therapeutics FY2020 revenue forecast
To demonstrate what NEOS has done, the schedule below shows FY2017 & FY2018 actual income statements, Q1/Q2/Q32019 actual income statements and an estimated Q42019 and FY2020 income statement should the FY2020 revenue forecast above be more or less accurate. The "WHAT IF" FY2020 assumes modeled revenues above and annualized Q32019 actual expenses to demonstrate NEOS is well on the way to material operating profits in FY2020 should it chose not to re-invest in incremental R&D and/or M&S programs. It also reflects lower interest expenses after NEOS makes the $15MM repayment in May 2020. To be crystal clear the author does not believe this to represent NEOS's FY2020 forecast or budget, it only demonstrates the possible business model after reducing expenses quarter after quarter. NEOS core business is that close to being cash flow positive. NEOS management has said it will scale up certain investments in new programs in FY2020 which suggests they anticipate the same.
NEOS potential 2020 operating forecast
Before we conclude, the following are NEOS valuation metrics (revenue multiples) versus all peers as identified by Seeking Alpha (actual peers and other companies that "were mentioned in like articles). The following also includes the like companies mentioned above. This data is for the investor to consider. We did not perform a detailed review of the peers on the bottom on the schedule below:
NEOS Valuation Versus All Peers
SOURCE: Seeking Alpha data
Below we provide a history of NEOS trading the last 6 months. The author would note NEOS at times has an unusual trading pattern. For example, NEOS average trading volume is only ~240,000 shares per day. A review of the schedule below reflecting NEOS's share price and trading volume by day the last 6 months shows there are times trading volumes are less than 150,000 shares. One day in late January NEOS traded as high as $1.95 on over 1,000,000 shares traded. The author's expertise is in analysis and valuation and not trading strategies per se. Nonetheless, our analysis of NEOS's trading patterns suggest NEOS's share price should continue to surge when there is higher volume...especially on good news. The following is a schedule of NEOS trading over the last 6 months.
NEOS Share price history
SOURCE: Yahoo Finance download
OTHER CONSIDERATIONS
On January 31, 2020 Goldman Sachs filed a 13G reporting it had increased its investment in NEOS to just over 5%. Because this is the first time Goldman Sachs had filed such a 13G we do not know their previous holdings. However, investors should consider Goldman Sachs' aggressive investment in NEOS, at a minimum, compelling to at best an endorsement that NEOS's business model is working. On February 10, 2019 Sphera Funds Management filed a 13G reflecting a 7.1% ownership (like Goldman it appears this is the first time Sphera has filed such a 13G...at least in the last 2 years).
When reviewing NEOS trading history, the author noted that on the last 2 earnings calls, NEOS's share price rose rather dramatically. As a specific example, on August 6, 2019 NEOS's share price closed at $1.20. On August 8, 2019 NEOS released its Q22019 financial results and NEOS's stock surged 50%+ to $1.82 on August 9, 2019. We see the same phenomenon for NEOS's Q32019 earnings release where NEOS traded at $1.50 before earnings were released, then closed at $1.72 after earnings were released. Obviously this does not mean we will see the same phenomenon again. However, investors are encouraged to review NEOS trading data for themselves.
https://seekingalpha.com/article/4324976-neos-therapeutics-valuation-appears-low-should-report-operating-profits-in-2020
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