Dusa Pharma (Dusa)

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DUSA Pharmaceuticals: Recent Pullback Provides Attractive Entry Point

DUSA Pharmaceuticals, Inc. (DUSA), based in Wilmington, MA., is a dermatology company engaged in the development and commercialization of Levulan photodynamic therapy (PDT). Utilizing its proprietary Kerastick 20% Topical Solution with PDT and the BLU-U brand light source for the treatment of non-hyperkeratotic actinic keratoses (AKs) of the face or scalp, the company aims to continue focusing on growing domestic PDT revenues and generate positive cash flows. AKs are precancerous skin lesions caused by chronic sun exposure that can develop over time into a form of skin cancer called squamous cell carcinoma (approximately 10% will turn cancerous). The Kerastick is a proprietary applicator that delivers Levulan, while the BLU-U is the patented light device, and they are regulated as a combination therapy with unified labeling. While the recent price action of the stock is enough to induce cardiac arrest in even the most calm and collected investors, last Thursday’s (May 5) earnings release and conference call provide multiple reasons for exploiting the recent pullback to initiate or add to current long positions.

Financials and Forecast: DUSA uses a razor-razorblade business model (definition here). The company makes virtually no profit (<5% profit margin) on the sale of the BLU-U device and derives profits from the Kerastick sales. Due to the price increase set to take effect at the beginning of this year, it is likely that many sales ordinarily placed in the 1st quarter were pulled ahead into Q4, thereby “inflating” Q4 2010. Indeed, the 4Q 2010 numbers (earnings release) were impressive. Furthermore, because Q1 2010 did not have a price increase, the year-over-year comparisons (due to the seasonality of the business, year-over-year numbers are more relevant) might have been less favorable than expected. These potential headwinds, along with institutional selling, possibly explains the stock sell off in recently. DUSA put all these fears to rest though with its most recent earnings report. Revenues also increased substantially, with total revenue increasing 27% YoY to $11.1 MM and domestic PDT revenues increasing 33% YoY to $10.7 MM . Furthermore, the gross margin for Kerastick’s ($10.2 MM of the $10.7 total) increased to 89%, an increase over the 4th quarter’s 87%. Management expects to exceed 90% this year. The Kerastick revenue improvement was driven by a 22% increase in sales volumes and an 11% increase in average selling price. The company generated $1.4 MM in positive cash flow (change in cash and cash equivalents and marketable securities) in Q1 2011. While the company reported a net loss, this was mainly due to a non-cash charge for the change in the fair-value of warrants. Management expects to incur no tax expense for the year, as NOLs are expected to cover any profits. The company reported the sale of 64 BLU-U units during the first quarter, as compared with the 77 units sold in the comparable prior year quarter. While disappointing upon first glance, for various reasons related to favorable pricing previously and sales reps, this number does not imply a slowdown in the current growth rate.

To reflect these latest developments, I believe a conservative estimate of 28% growth in revenue for domestic PDT with stable international sales produces revenues of $45 MM and $57 MM for 2011 and 2012. On the liabilities side, 5 sales reps were added and can be expected to increase marketing and sales by $1 million to $14.2 million, and the new clinical trials can be expected to raise R&D costs $2-3 million to approximately $8 million on an annual basis. General and administrative rising slightly to $9.5 million is reasonable. Ultimately, this leads to an annual increase in cash and non-GAAP earnings of approximately $5-6 MM, or $0.20-0.25/share with approximately $1/share in cash at the end of 2011. For 2012, net income could conceivably come in as high as $15-16 MM or ~$0.60/share with nearly $40 MM in cash on hand. Given the single digit market penetration, this is a conservative estimate in my opinion, and a valuation at 4-5x revenue would suggest a value of no less $7 per share by the end of the year (fully diluted share count of 27.5 million shares). Net loss carry forwards of approximately $2-3 MM per year are expected to eliminate tax liability for 2011 and partially in 2012 and years beyond. For DUSA’s very detailed 10k, see the SEC website here.

Pipeline: DUSA is not currently developing any new products but is focused on enhancing the label for Levulan PDT. DUSA is currently designing and finalizing protocols for a phase 2 clinical trial with plans to initiate in Q2 2011 for the broad application of Kerasticks with short (1-3 hour) incubation times. If there is any negative to the current earnings report, it relates to this clinical trial. Management previously expected a trial to start in the 2nd quarter, but has now delayed that as the details continue to be finalized. While slightly disappointing, this does not change the fundamental picture. The fact that DUSA was willing to spend the extra time at the expense of guidance to make sure the trial is sufficiently powered and properly designed is not a bad sign and does not reflect poorly on the company. Globally, the aim of this trial will be to allow DUSA to market to providers a 1 day treatment option rather than the FDA approved method, which is a two stage process involving 1) application of the product to the target lesions with Levulan Kerastick Topical Solution, followed 14 to 18 hours later by 2) illumination with blue light using the BLU-U® Blue Light Photodynamic Therapy Illuminator. While likely that many of the physicians currently execute this 1 day treatment as an “off-label” use, DUSA’s sales reps’ hands are tied and cannot market this short incubation time.

Conclusion and Future Directions: Unlike many small-cap biotech companies focused on developing candidates and securing FDA approval while fighting the cash burn, DUSA is in the ramp-up phase and is generating significant positive cash flow. In the author’s opinion, now that DUSA is approaching its fair value (~7-8$/share), I believe a potential acquirer (e.g. larger dermatology player) may acquire DUSA and gain access to the near 90% gross margins and rapid growth. Furthermore, with the potential to eliminate redundancies (58% of revenues were SG&A + marketing in Q1 2011) and take advantage of significant NOLs, DUSA is an attractive M&A target.

Disclosure: I am long DUSA.

http://seekingalpha.com/article/268997-dusa-pharmaceuticals-recent-pullback-provides-attractive-entry-point?source=yahoo