Derma Sciences Inc. (NASDAQ:DSCI)
Q2 2013 Earnings Call
August 12, 2013 11:00 a.m. ET
Kim Golodetz - IR, Lippert/Heilshorn & Associates
Edward Quilty - President, Chief Executive Officer
John Yetter - Chief Financial Officer, Executive Vice President, Finance
Barry Wolfenson - Group President of Advanced Wound Care and Pharmaceutical Development
David Amsellem - Piper Jaffray
Scott Henry - ROTH Capital
Welcome to the Derma Sciences' Second Quarter 2013 Financial Results Conference Call. At this time, all participants are in a listen-only mode. Following management's prepared remarks, we'll hold a Q&A session. (Operator Instructions) As a reminder, this conference is being recorded today Monday, August 12, 2013.
I would now like to turn the conference over to Kim Golodetz. Please go ahead, ma'am.
Thank you. This is Kim Golodetz with LHA. Thank you all for participating in today's call. Joining me from Derma Sciences are Ed Quilty, President and Chief Executive Officer, and John Yetter, Executive Vice President of Finance and Chief Financial Officer. Barry Wolfenson, the company's Group President of Advanced Wound Care and Pharmaceutical Development and Bob Cole, Group President of Traditional Wound Care and Corporate Accounts will join us for the Q&A portion of the call.
Earlier today, Derma Sciences announced financial results for the second quarter of 2013. If you have not received this news release or if you would like to be added to the company's distribution list, please call LHA, New York, at 212-838-3777, and speak with Carolyn Curran.
Before we begin, I would like to caution that comments made during this conference call by management will contain forward-looking statements regarding the operations and future results of Derma Sciences. I encourage you to review the company's filings with the Securities and Exchange Commission, including without limitation, the company's Forms 10-K and 10-Q, which identify specific factors that may cause actual results or events to differ materially from those described in the forward looking statements. Factors that may affect the company's results include but are not limited to product demand, market acceptance, impact of competitive products and prices, product development, commercialization or technological difficulties, the success or failure of negotiations and trade legal, social and economic risks.
Also, the content of this conference call contains time-sensitive information that is accurate only as of the date of the live call, today, August 12, 2013. The company undertakes no obligation to revise or update any statements to reflect events or circumstances after the date of this conference call.
With that said, I would like to turn the call over to Ed Quilty. Ed?
Thank you, Kim. And many thanks to each of you for joining us this morning. During the second quarter we continued to execute on our financial goals and our strategic initiatives. Overall I am very pleased with our results and our momentum. Our advanced wound care business or AWC as we refer to it is performing on plan and now has grown to represent 44% of our total overall sales. In addition, we had two new private-label customers for our traditional wound business or TWC as we’ll refer to it today, and finally our DSC127 phase 3 clinical trials are well underway.
Everybody at Derma Sciences has worked very hard to bring us to the point which we are at today and I couldn’t be prouder of the team that we have assembled. Before I get into my remarks, I would like turn it over to John Yetter, our CFO who will brief you on our financial results for the quarter and then as I said I will come back and talk about our strategic progress. John?
Thank you, Ed and good morning to our listeners. Before I begin I would just (inaudible) everybody out there that’s wondering why we haven’t filed our 10-Q yet, we will file that this evening. We had a little internal change of schedule to be filed the press release this morning and 8-K that [we tend] will be coming out later today.
I assume most everyone is familiar with the company and has had a chance to review our press release. So I will limit my comments to the highlights of our operating performance and financial conditions. And let’s take a look at the numbers.
I will first begin with Q2 2013 versus Q2 2012. Net sales increased $0.5 million or 3% to 18.1 million in 2013 versus 17.6 million in 2012. Sales in the U.S. grew 1.9 million or 14% led by advanced wound car. Sales in Canada declined 1.5 million or 44% due to traditional wound care business loss in 2012 and a significant reduction in sales associated with our exclusive distributor rebalancing its inventory during the quarter. We expect to recover a portion of these sales by year end as we anticipate our distributor rebuilding portion of this inventory.
Europe, Middle East and Africa sales grew 100,000 or 22% during the quarter. Advanced wound care segment sales increased 2.1 million or 33% organically in line with expectations while traditional wound care sales decreased 1.6 million or 13% due to the aforementioned Canadian sales shortfall.
Gross profit increased $0.5 million or 8% to 6.7 million. The gross profit margin increased 36.8% from 35.2%, principally reflecting a favourable sales mix towards higher margin advanced wound care products. Advanced wound care gross profit increased 800,000 or 26% consistent with the higher sales partially offset by a lower gross profit margin percentage. Traditional wound care gross profit declined 300,000 or 11% due to the lower sales, partially offset by slightly higher gross margin percentage. Favorable sales mix and lower (inaudible) related product costs were responsible for the traditional wound care margin decrease.
Direct expenses consisting of distribution, marketing and sales were up 20% and R&D expenses were up 140% as expected. The direct expense increase is reflective of the annualization impact of our significant 2012 advanced wound care growth initiative and to a lesser extent our more modest 2013 growth initiatives. The R&D increase is reflective of our ongoing DSC127 development initiatives.
G&A expenses were up 14% due to higher legal, equity based compensation, amortization and professional service expenses, partially offset by the absence of MedEfficiency related acquisition expenses in 2013. The 1.8 million non-cash deferred tax benefit associated with the MedEfficiency acquisition in 2012 was also not repeated in 2013. All of the above resulted in net loss for the quarter of 77.3 million or $0.43 per share versus a net loss of 2.8 million or $0.23 per share in 2012. One way of looking at the 4.6 million increase in net loss in Q2 2013 versus 2012 is that the increase is principally attributable to the non-recurrence of the 1.8 million deferred tax benefit, higher R&D expense of 1.7 million, higher [non-core] related G&A expenses of 800,000, incremental equity based comp of 600,000, and incremental intangible amortization expense of 200,000, again partially offset by the absence of the MedEfficiency related acquisition expenses.
Now let’s take a look at the six months 2013 versus ’12, June year to date 2013, net sales increased 4 million or 12% to 36.9 million versus 32.9 million in 2012. Organic growth for the six months for the six months, including TCC sales, for the entire period on an apples-to-apples basis was 8%. Sales in the US grew 5.7 million or 23% led by advanced wound care and traditional wound care US private-label sales. Sales in Canada declined 1.8 million or 28% due to loss business in 2012 and again the significant reduction in second-quarter sales associated with the inventory rebalancing.
Europe, Middle East, Africa sales grew 100,000 or 12%. Advanced wound care segment sales increased 5.1 million or 50%, 32% organically in line with expectations while traditional wound care segment sales decreased 1.1 million or 5% due to the Canadian sales shortfall.
Gross profit increased 2.3 million or 21% to 13.4 million due to higher sales and an improving gross profit margin. The gross profit percentage increased to 36.2% from 33.7 principally due to favorable sales mix towards higher-margin advanced wound car sales. Advanced wound care gross profit increased 2.4 million or 45%, 24% organically, consistent with the higher sales, partially offset by lower gross profit margin percentage. Traditional wound care gross profit was essentially flat as the adverse impact of lower sales were offset by higher gross profit margin.
Direct expenses were up 34% for the six months, 53% in Q1 and 20% in Q2, the overall average of 34%, and R&D expenses were up 137% as expected, in line with our advanced wound care and DSC127 growth and development initiatives respectively.
G&A expenses were up 30% due principally to higher legal, equity based comp, amortization and professional service expenses, partially offset by the MedEfficiency related acquisition expense. Through June we had two lawsuits in progress. Our higher equity-based compensation expenses reflected the overall cost of equity associated with the progressive increase in our stock price over the last few years and a long-term retention incentive award grant in December of 2012.
From a professional services perspective, we are incurring incremental consultant expenses to assist with us with the valuations of sales and the non-US right of DSC127 for diabetic foot ulcers. We are looking into the valuation of DSC127. We have an information technology project in Canada ongoing to bring them on to our corporate system’s architecture, and we have various tax planning I initiatives underway. Again also contributing to the 2013 year-to-date over ‘12 change in operating results was the non-recurrence of the 1.8 million deferred cash – deferred non-cash tax benefit. All of the above resulted in a net loss for the six months of 13.6 million or $0.81 per share versus a net loss of 5.3 million or $0.46 per share in 2012.
Now let’s take a brief look at Q2 versus Q1 to see how our business is trending. Net sales decreased $700,000 or 3% to 18.1 million in Q2, versus 18.8 million in Q1. Advanced wound care sales were up 400,000 or 6% to 7.9 million in line with expectations, while traditional wound care sales declined 1.1 million or 9% to 10.2 million. The TWC sales decline reflects the significant reduction in Canada sales as a result of our exclusive distributor rebalancing its inventory in the second quarter.
Gross profit was essentially flat at 6.7 million quarter to quarter as the benefit of an improving overall gross profit margin percentage due to favorable sales mix was offset by lower sales. Our gross profit margin increased to 36.8% from 35.7% in the first quarter. Direct costs were up 2% due principally to our modest 2013 incremental growth spending, higher equity based compensation expense and timing.
G&A expenses increased $800,000 or 24% to 4.5 million due principally to the higher legal, equity based comp and professional service expense previously mentioned. All of the above resulted in a net loss of 7.3 million in the second quarter versus 6.2 in the first, a 1.1 million increase in net loss in Q2 over Q1 principally attributable to the higher G&A and R&D expenses.
What does this all mean? What someone take away from these results? AWC sales grew 50% or 32% organically in the six months ended June 30 over 2012 in line with expectations. We expect AWC sales to continue to grow in excess of 30% organically on an annual basis in 2013. Traditional wound care sales decreased 5% in the six months ended June. The decrease is principally due to loss of sales in Canada. We expect to recoup some of these sales as previously mentioned. In addition, we expect to be able to cover the sales shortfall by year end as a result of securing some incremental private label business which Ed will talk about later.
Our sales in Canada will continue to represent a challenge for us going forward. We expect TWC sales to be flat to 2% growth in 2013 in line with expectation by year end. Our gross profit percentage is presently at 36.2%, we expect this percentage to improve gradually going forward due principally to the favorable sales mix associated with the strong growth of our higher margin advanced wound care sales. We’ve started to see a trend in the advanced wound care direct expense growth levelling off as the planned incremental resources were put in place over the last couple of years. We believe we now have the infrastructure established to drive sales growth and leverage this investment. In the absence of any change in our advanced wound care growth strategy we look forward to seeing sequential advanced wound care segment sales and product contribution improvement going forward.
We will continue to nurture our traditional wound care business in an effort to sustain it and grow it where possible. We’ve had a gradual increase in the level of quarterly R&D spending to support our phase 3 program. This trend will escalate significantly over the next two years now that the clinical trials have begun. Year-over-year G&A expenses have increased due to the MedEfficiency acquisition last year along with general inflationary increases, higher bonuses, equity based comp, legal board [assurance grant], professional service expenses.
We have expanded our headquarters office space to accommodate our growth. We have expanded our IT capabilities to cost-effectively deal with the increased needs of the growing business and to keep investing in technology. We have filed the patent infringement lawsuit to defend and protect our technology and we’re also defending ourselves in a lawsuit filed against us. This lawsuit was settled in July. We’ve initiated a number of [text] studies to better prepare the company for the future and are working on a refinement of our independent evaluation of DSC127 for diabetic foot ulcers. We have engaged a consultant to assist us with exploring options for out-licensing rights for DSC127 for diabetic foot ulcers outside of the US.
That having been said, we believe that we are effectively managing our G&A expenses, doing an excellent job leveraging our core G&A resources in response to the growth of the business. With the settlement of one of the lawsuits and the completion of various non-core projects, we expect G&A expenses to be stable to diminishing going forward.
Now let’s briefly take a look at liquidity. In the first six months of 2013 we used 6.5 million of cash comprised of 8.7 used in operations, 100,000 for working capital, 300 for capital expenditures, partially offset by 2.7 million provided from the exercise of warrants and options. Keep in mind our 6.2 million of R&D expense is included in the 8.7 million used in operations figure. Keep in mind that the 8.7 million used in operations is net of 4.9 million worth of non-cash charges principally consisting of depreciation, amortization of intangibles and equity based comp. Excluding the 6.2 million spent on R&D we used 2.5 million of cash from operations in the first half of 2013. Our goal is to be cash flow positive on a quarterly basis excluding R&D as soon as possible.
At the end of June 2013 we had 39.4 million of cash and investments on hand and 53.5 million of working capital. Our receivables are in excellent shape, our inventory is properly positioned to support our continued business growth. We expect prepays to come down going forward as the R&D clinical trials gain momentum. There has not been any appreciable change in our other assets and liabilities other than in response to normal changes in our business. Overall we do not anticipate a significant change in our working capital requirements through the balance of the year.
Current projected cost of the R&D program is 45 million to 50 million. Through the second quarter of 2013 we have spent 14.2 million on the program to date. Based on our current financial condition and long-term strategic plan we believe we have sufficient capital to sustain the planned growth of our existing business and the development DSC127 for diabetic foot ulcers without the need for further capital.
At this point I would like to turn the call back to Ed.
Thank you John. Appreciate that update. So as I mentioned we are extremely happy with the growth we are seeing in our growth engine of our business, our advanced wound care portfolio. For the second quarter, AWC turned in a 36% year-over-year sales growth. When you adjust for the half a month of sales associate with the acquisition of MedEfficiency in April of 2012 that organic growth number is 33%, which is a very impressive and within our plan. We expect that this growth rate will continue to look good for the balance of the year, and we are still giving guidance to that 30% to 40% organic growth in the AWC business.
Our MEDIHONEY portfolio of products and our TCC EZ total contact casting system are the AWC anchor products. Sales of these two product lines were up more than 50% each as existing and new customers gained greater understanding of the product benefits for wound healing using these products. We acquired TCC-EZ system early in the second quarter of last year as I mentioned and we're seeing more and more conversions to this product given its 89% healing rate and speed and ease of application if used properly.
Earlier this year in Philadelphia we convened a panel of clinical experts in diabetic foot ulcer management and amputation prevention to discuss the benefits of optimal off-loading and the relative disconnect to its uses in the everyday treatment of these ulcers. One of the outcomes of this panel session is the development of a consensus document currently in progress, which in turn may enable the submission of a new quality initiative regarding the necessity to provide optimal off-loading of foot ulcers. Both of these initiatives should they prove to be successful to provide meaningful increases in the adoption of our total contact casting system.
Additionally, through our corporate account efforts [Fred Eigner] and his team, we’ve continued to build strong relationships with the thousand or so wound centers across the United States. Given the clinical and economic outcomes of proper total contact casting our systems are increasingly becoming favored technologies in this setting. Having said all of that, we are well-positioned to see continued strong growth in our TCC line.
Regarding MEDIHONEY, the demand for MEDIHONEY products have never been stronger. In particular we are seeing dramatic increases in interest for utilization of MEDIHONEY as the facilities’ primary product to assist with the removal of necrotic tissue. This combined with MEDIHONEY’s ability to help promote healing [stalled] in chronic wounds continues to make MEDIHONEY a compelling story for clinicians.
While we don’t make a habit of breaking out revenues and growth rates by rand in our AWC line, I can tell you that MEDIHONEY remains the largest product in the AWC category. It also posted the highest growth rates this year even ahead of our internal projection. With the critical mass afforded to us by our US expansion in sales for our size last year we are confident that MEDIHONEY will continue doing -- continue to exhibit this strong sales growth. As a whole, in the United States our AWC sales increased 36% quarter over quarter and for the full year to date has grown 58%. Again when you adjust for the MedEfficiency acquisition that is a 32% organic growth year to date.
Internationally, AWC sales have been increasing. Sales outside the United States and Canada are up 21% for the quarter. Remember these sales are largely through a network of distributors, so results can vary based on stocking orders. Sales growth is strong in Latin America, the Middle East and some countries in Europe. We continue to see new distributors and as we mentioned earlier this year we added Mario Neto as our vice president of international business development to lead that effort, and we expect under his leadership to add several new distributors by the end of the year. Overall through June sales in the EMEA and rest of the world regions have grown 30% year-over-year and this again is in line with our expectations.
Let me briefly add that we have begun launch activity in certain Latin American countries for our TCC EZ system. The response thus far has been very encouraging and we hope to start shipping product in the late third or early fourth quarter. We also have launch activities lined up in the Middle East for TCC EZ. As we’ve previously stated, we do not expect to see meaningful sales outside the U.S. with this product line until well into 2014 but our initial expectation regarding interest had been validated by these early launch programs.
Our advanced wound care product line is comprised of high margin innovative, specialty products that are protected by strong intellectual property. We’ve mentioned many times before that we take our intellectual property very seriously at Derma Sciences. And as we have demonstrated we are prepared to defend our patents vigorously should the need arise. This year we’ve been involved in two legal disputes both around MEDIHONEY. As MEDIHONEY has become a leading brand it has attracted attention both from potential honey-based dressing companies as well as companies that currently compete for business against us.
The one-time expense of dealing with these issues has increased this year as G&A expense above our analysts’ projections. One of these cases, as John mentioned, was settled in July and the other is ongoing. The proprietary specialty nature of these products affords us pricing power compared with commodity dressing. The AWC segment contribution continues to improve along with the sales growth we are seeing. Should we continue to hit our sales goals this year in October at our planning meetings we will analyze the benefits of incremental investment to further strengthen our AWC business.
Let me turn my attention to traditional wound care, this business continues to be a source of positive cash flow for Derma Sciences. Sales in Canada were impacted by prior year’s loss of business, and we expected that and one of the things I just want to take a minute to say is that Canada has been a shining star for us for the last decade and thanks to our strong sales position up there, we were able to build of the rest of Derma Sciences business in the United States. About a year and a half ago we did lose some business up there. Frankly it was business that we couldn’t afford to keep, Derma Sciences has a significant investment in infrastructure in quality and regulatory well beyond that of some of our competitors in the commodity dressing business.
And if you take a look at our Canada sales as a result of losing that business, we did lose the sales but we actually have increased our overall margin in Canada about losing those sales. So it was a business decision that I think was the right one and we are still proud of our team and our plan and Canada is doing quite well. Our traditional wound care segment has two new private label customers, that Bob Cole and his team have developed this year. We believe that as we implement those contracts in the third and fourth quarter that we will still hit our analyst projections for traditional wound care for 2013.
We have been working on modifying some of our key advanced wound care dressings for the OTC private label market and as you recall earlier this year we staffed to position to manage those private label sales and is starting to pay off as you will see now. We’re very excited that we announced this morning that we will begin shipping private label OTC dressings that are based on our MEDIHONEY and XTRASORB products to a leading nationwide pharmacy chain. The medical honey dressing is based on our MEDIHONEY HCS, which is an ideal dressing for dry to lightly exuding wounds including minor burns, cuts and abrasions. In September this honest based dressing should be on the shelves of more than 4000 stores.
This OTC dressing along with the one based on XTRASORB are expected to add approximately $1.2 million to Derma Sciences’ traditional wound care sales during the second half of 2013. In addition, we are accelerating our efforts to expand development of other honey-based OTC dressing with our manuka honey supply partner Comvita Limited of New Zealand. I recently returned from a trip to New Zealand to meet with Comvita, their shareholders and their Board of Directors and as a result of that meeting we are increasing our efforts to integrate vertically, help can be to vertically integrate the honey production and manufacturing and expand our OTC presence around the world -- in the United States and around the world. Although we continue to expect growth of our TWC products, as I said on projection to be flat to 2% growth. The incremental private label business that our team has put together will make up the shortfall that you see through the second quarter.
Let me move now to DSC127, our drug candidate for diabetic foot ulcer healing. We've made good progress in site initiation, activation and patient enrolment in our phase 3 trials since we began them earlier this year. Based on our target to complete enrolment in 18 months at this point we have projected to roughly have 100 patients enrolled in the trials. Currently we are at about 50 and this is partially due to being a couple of months behind schedule in our activation of sites. We have about 60 of the 85 sites open for enrolment at this point. All the sites have been identified, some contract negotiations and IRB approvals had taken longer than we expected. We expect to be near a 100% of targeted sites open within the next two months, which of course will help the overall enrollment numbers.
Having said that, as is the case with most studies, these early days have provided great insight regarding the sites, the flow of patients and other factors. While the proprietary nature of these insights precludes me from discussing all the specifics with you, suffice it to say that we've put programs in place to take advantage of what we've learned in these first months of the trials. Our expectations remain unchanged for data readout for both these trials in -- late in the second quarter of 2015.
We’ve also strengthened our professional staff responsible for conducting these trials. We’re delighted to announce that we have hired Randi Rutan as vice president of clinical operations. With previous experience in similar clinical operations roles at companies such as Johnson & Johnson and LifeCell, Randi has managed large-scale multinational phase 3 programs in chronic wounds in the past. We’re confident that she will make a substantial contribution to the smooth and efficient running of DSC127 and remember she joins what is already a world-class team of professionals led by Dr. George Omburo, our vice president of pharmaceutical development. So we’ve continued to strengthen our bench so that we can bring this trial in on time for our investors and for our company.
I also like to spend a minute and tell you how pleased we are with the DSC127 pharmacokinetic study, proceeded as expected with no systematic drug detected in blood samples of study subjects. This is, as you know, a very significant event for us. It’s very important for the forward movement in the development process and it adds further validation to what thus far has been a very good safety profile for DSC127. In addition, we were encouraged to see in the safety assessment of the treated ulcers that all 18 subjects who completed the study demonstrated a reduction in total alter area compared with the baseline measurements.
In fact, four subjects or 22% of the total achieved full closure of the treated ulcer within the five week study period. It is important to remember that this was not a study that was designed to examine the effectiveness of DSC127. And the five week assessment timeframe is half the length of the 10-week timeframe in our phase 3 pivotal study. While the PK study did not have wound closure as an endpoint, the data helped affirm our optimism about the prospects for DSC127 and its ability to transform Derma Sciences.
We’ve said repeatedly that DSC127 has the potential to be a $900 million global product with 300 million of that being in the United States. These estimates are based on typical adoption rates of well utilized 510(k) wound dressing since there has never been a small molecule pharmaceutical drug approved for the diabetic foot ulcer. It is possible that utilization rates for such a drug will be even higher than the 510(k) wound dressing especially if the heal rates in our phase 3 studies equate what we saw in our phase 2 study.
Presuming FDA approval we expect that DSC127 will fit seamlessly into our dedicated selling organization here in the United States. Naturally we will add to that number of salespeople as we approach market launch so that we can get full coverage and potential and realize the full potential of the drug.
As we mentioned last quarter we have engaged Plexus Ventures to manage the process of licensing DSC127 outside the United States. We also mentioned that the process will not happen overnight. We expect that this will take 9 to 15 months to complete and that it will culminate in one or more agreements covering specific geographies or countries in Europe, Asia and the emerging markets. We do not expect to have any meaningful updates on the progress of this partnering in the next few quarters.
It was mentioned at our analyst day that we also now are looking at DSC127 as a potential platform drug with application for several different indications. We expect to make a decision regarding preclinical development of DSC127 for scar reduction at our upcoming August 27 board meeting -- August 22 and if we approve that program, it has the potential to be a next investigational new drug application with the FDA at some point during 2014.
Remember that scar formation following surgery is not only a cosmetic concern. It is also a significant clinical problem that can lead to disability and disfigurement. According to the CDC in 2010, there were about 51.4 million in-patient surgical procedures formed in the United States about 1.5 million aesthetic procedures and 1.2 million reconstructive surgical procedures. The market for an effective scar reduction treatment likely towards that of diabetic foot ulcers, the diabetic foot ulcer market and could be as much as $4 billion.
That said, remember we are only at the beginning stages of considering any advanced program for this indication. And as we develop the data we will update you appropriately. As you are aware, a contract for advanced development of a drug to treat skin injuries associated with acute radiation syndrome was awarded by [BERTA] to the US Biotest, our DSC127 development partner, also owned by the inventors of DSC127. The contract was granted in February of 2011 and was valued at 4.5 million for the first 16 months with potential to be extended for up to five years with grants up to $14 million. The funding supports advanced development of DSC127 to help cutaneous tissue heal after being exposed to ionizing radiation, the type of radiation that results from a nuclear blast or contamination from a nuclear power plant.
Based on some early encouraging data we’ve also contemplated initiating a phase 2 clinical program for the treatment of radiation dermatitis. Approximately 85% of patients treated with radiation therapy will experience a moderate to severe skin reaction. There is no FDA approved drug indicated for the treatment of radiation dermatitis. In 2004 approximately 1 million people in the United States underwent radiation therapy, resulting in a potential pool of 850,000 patients with moderate to severe skin reaction. Thus we think this market could be at least as large as the one we’re contemplating for diabetic foot ulcers.
As John mentioned in his remarks, Derma Sciences exited the quarter with cash and equivalents of nearly $40 million, and another 16 million in working capital. We continue to be comfortable that we'll have the funds to complete our diabetic foot ulcers study and submit an NDA to the FDA. Over the course of the trials we expect our AWC segment to contribute additional cash along with the cash we historically are generating from our TWC business.
Of course should we successfully conclude one or more transactions with DSC127 outside of the United States this will bring an additional cash as well, which could be used to help fund other R&D activities or acquisitions of other advanced wound assets. We have been systematically building Derma Sciences into a force to be reckoned with in the advanced wound care space. Our investment in talented staff, research and products have gained the attentions of clinicians and we are becoming a leader in the advanced wound care therapeutic area. We believe we have a bright future ahead of us in the months and years ahead.
With that, I will open it up to questions, operator.
(Operator Instructions) Our first question is from the line of Bill Plovanic with Canaccord.
This is actually Kyle in for Bill. Just had a couple quick questions here, first on the core business side, obviously we expected a step-down due to Canada and also there has been inventory rebalancing going on. Just wanted to see moving forward can we expect – is there more potential weakness on another step-down here or is this a new bottom that we’ve reached to now to grow off of?
I am not sure what you mean by bottom. We have previously said that we lost a contract for some traditional wound care dressings in Canada and we’ve more than picked that up through new private label business in the United States. So our goal for the traditional wound care business remains unchanged. We want to maintain the $50 million or so that we have and try to grow it between 0 to 2%. So nothing has really changed that – pretty typical in that traditional wound care business where you lose a contract to gain another one. I think the key objective is to maintain our guidance and we will do that.
And talk about the two private label products, how should we be modelling for the impact of that 1.2 million over the second half, is that just 50% in the first quarter and then the remaining coming in the quarter – fourth quarter or how should we be thinking about that impact and then also when you look into ’14, how should we be thinking about those two new opportunities?
So the 1.2 million is a one contract in the OTC market and that will all book just in the next couple months, August and maybe a little bit September. There is other business that will help pick up traditional wound care to get back to -- very closely to if not above your projections. So you'll see that as that business starts to roll out in the fourth quarter.
Lastly, obviously 2012 was a year of investment in the AWC with the MedEfficiency and acquiring some of the licenses. Just wanted to see how does that – how does the M&A look right now as far as new or additional tuck-in acquisitions like that?
Well if we saw another MedEfficiency acquisition we’d have made it by now because that one was just spectacular. There are our business development people are looking at many, many things at the moment and some of them will find the right one and we believe we can finance it, we'll make that move, but we’re looking at – Barry is on the line but Barry probably gets 50 things a month to look at and that some of them we pursue and some of them we don’t. I wouldn’t say that there are some things out there, that we’re looking at.
Your next question comes from the line of David Amsellem with Piper Jaffray.
David Amsellem - Piper Jaffray
First on the OTC version MEDIHONEY couple questions there, just maybe elaborate on the rationale for private label OTC product on MEDIHONEY and also should there be any concern that an OTC product could cannibalize MEDIHONEY sales in the institutional setting?
I am going to pass to Barry to tell about the rationalization of the product but I'll answer the second one. We wouldn’t worry about any – being cannibalized in the – from our market, I mean these products are purchased by the consumers for different applications and then what a wound professional using it for, remember there is also issue of getting paid and reimbursement, what you buy in the OTC market is not reimbursed.
Sure. First the rationale, I think that there is increasing trends towards more natural products for use at the retail level. Additionally there's increased chatter around the use of honey-based products for wounds. And as we’ve mentioned this HCS product we believe is ideal in a retail setting, easy to use by the patients, it’s cooling and soothing and it has the healing benefits of this honey and actually went around and started to talk potential partners, this one that we have partnered with, was already aware of honey, the new honey in particular and was very interested in launching a product and to be the first at retail. There is very strong data about use of honey on burns and the vast majority certainly first to be burns at home and can be treated in the home. And we believe that our dressings that will be offered through this retail outlet will be ideal for the treatment and management of these minor burns. As well we are launching similar products in medical market to use post-surgically and as patients are discharged and their wounds become more of the minor kind of maintenance variety we have very specific dressings that will manage those as well.
David Amsellem - Piper Jaffray
Second question is on the trajectory of TCC EZ, maybe I missed this earlier, and to the extent we can break out the specific growth of TCC EZ, how are thinking about the trajectory of that product going forward and maybe if you can size up how you are thinking about peak sales of that product?
From a sales trajectory perspective, as Ed mentioned, I think both MEDIHONEY and TCC are growing at about 50%, we don’t really break down individual sales payment or growth but they are both doing well. I think as we’ve discussed on this before one of the special things with regard to total contact casting is that while like our other products it is truly day-to-day kind of door to door connecting with clinician type of sales approach. Total contact casting has the ability due to the wonderful data that's been generated not naturally on TCC EZ specifically but broadly on the use of total contact casting with multiple randomized controlled studies.
To really move clinician thinking about the use of off-loading, and so we got a couple of programs in place that we think can dramatically increase the trajectory of sales and until we get through the successful completion of the strategy and our comments will be more of the broad nature but suffice it to say that we are working on some things that could dramatically increase the trajectory of total contact casting. But right now it’s perfectly well in line with our forecast and along with MEDIHONEY is leading the way for our advanced wound care products.
David Amsellem - Piper Jaffray
And then one last one if I may just on 127, anything in the PK study that you talked about in terms of tolerability that was not consistent with the larger phase 3 data?
No, there wasn’t.
Your next question will come from the line of Scott Henry with ROTH Capital.
Scott Henry - ROTH Capital
I guess just a couple questions, for starters in traditional wound care, can you quantify the amount of inventory drawdown so we can get a sense of how much inventory impacted 2Q?
Scott Henry - ROTH Capital
And then when I am looking at SG&A, obviously a big jump up in 2Q as you mentioned there were some legal issues, if I am looking at 9.8 million in Q1 and 10.8 million in Q2 how do I think about Q3, is this somewhere between those or do a lot of one time events of Q2 go away?
It will be down slightly in the third and fourth quarter. The biggest part of that legal expenses came in the second quarter. So we are spot on our what I would call our control of G&A or budgeted –
Scott Henry - ROTH Capital
And you probably have some one-time hit in third quarter as well I imagine?
Little bit, I mean we’ve asked the final bill on the lawsuit we settled and we should be getting that in the July numbers, August numbers. So we expect – you can expect it to go down.
Scott Henry - ROTH Capital
And now R&D imagine we should start to expect that to increase at a faster pace third quarter and fourth quarter, should we expect a significant jump from second to third in R&D?
Scott Henry - ROTH Capital
And then I don’t know if you have given this and I just wanted to check, when do you expect to complete enrolment, I guess you did say 18 months from the state, and do you want to put a kind of line in the sand when you would expect to complete enrolment for the two trials or I guess maybe stagger?
If you pick a start date of April, and you go out 18 months, I think it would be pretty close.
Scott Henry - ROTH Capital
Final question, you are adding these private label products to the traditional wound care business, should we start to see some gross margin increase as you add those products, the level of higher margin I imagine it would be, what you would typically do?
Yes. I think the question I think Scott, is that we don’t – we have very limited sales and marketing expenses around those products and one of the reasons that we have in the last six or seven years really bolstered our efforts in the private label is – those are – we couldn’t – we can’t afford to field the sales force, to go out and sell traditional wound care products and private label business is a good way to take to grow your sales and one area that we have done particularly well in is in our bandage business, our bandage business has really performed well the last few years and that’s helping the cash flow of our traditional wound care business.
Your next question will come from the line of [Sai Didoski with DSM].
I am looking at a press release dated June 25th 2008 announcing the FDA clearance to sell MEDIHONEY over the counter, I am wondering if that 2008 press release is the actually beginning of this morning’s announcement, so we have today is actually five years in the making.
We always have believed that MEDIHONEY would translate well into the retail space. And so forward thinking we made sure that all of our 510(k) is included clearance to sell over-the-counter along with by doctors order into the professional market. It wasn't until a few years ago when we started to develop this HCS that we felt that we had final aid product that could be sort of our initial beachhead product to go to market with, that would again translate well to consumers. And we think that we have it with HCS, we went out, we pitched it, and we got a great customer. And we think that it's possible that assuming that we’re successful with this one, that we might be able to hold some other MEDIHONEY based products through to retail as well.
So I wouldn’t say that that was the initial shot and that we are working hard on it for these however many years and it’s been a five year long project but we always knew that it would that sooner or later we’d be in retail and as soon as we started to develop the HCS which is actually half years ago we knew that we had a winner.
When we started the MEDIHONEY program, when Barry and I first went to New Zealand in 2006 and we signed an agreement with Comvita and they were starting these products, and we still take as a very serious medical device that is proven to be very in treating these product non-healing wounds. Over in a period of the last five or six years more and more people have gone to being interested in natural products and this turned out one of the added benefits of MEDIHONEY as it is a natural product, and that’s become quite attractive in the OTC market as well and we think that the products that Barry just mentioned that we developed are ideal for – and we hopefully do very well because patients not only will be helpful but they are also that natural product which has been an added benefit of our MEDIHONEY line.
Yeah, that press release from 2008 has a 2.5 billion market research.com market size, 25% of those (inaudible) from private label brand, how do I set appropriate expectations because these numbers are quite large?
Those numbers are large, we certainly have been dealing with our people, we are working with have gotten some idea of the size of the market that they currently sell dressings, (inaudible) dressings and in my mind it’s an emerging market and we will see how the product does it could be millions and millions of dollars is very successful for Derma Sciences, so we are hoping – we think it’s going to be $2 billion market, now we don’t think it’s going to be that big. We are hoping that it’s in the tens of millions of Derma Sciences that would be very nice.
And if I look at the shelf space at the pharmacy, is there anything currently on the shelf that competes in this current space?
No, not like this obviously and again these are private label products so I am not sure they will get good exposure – the name of our partner on, we will get good exposure. That’s what they are trying to do.
There are no further questions at this time. Please proceed with your presentation or any closing remarks.
Okay, in closing let me express my thanks for all of you for participating today. I also want to mention that I will be presenting at the Canaccord Genuity’s 33rd annual growth conference in Boston which is taking place this week. Should we be presenting there on Thursday at 1 PM and hope to see some of you there and looking forward to spend some time with our friends from the Canaccord. And we’re making a lot of progress at Derma Sciences on all our fronts, we have been very consistent in sharing with the investment community what we expect to do and then going out and doing it. We have given you guidance, we are going to grow our advanced wound care business 30, 40%, we are doing it. We said we are going to be in our pivotal phase 3 trials this year, and get our sites up and running and we are doing that. We said we are going to complete those trials and have the data to you by the end of the second quarter of 2015. We are still on track to do that and we promise the investment community that we would maintain and slightly grow our traditional wound care business and we’ve done that. So again I am very proud of our team. We are one of the companies, one of the few companies in our space that’s growing, growing and prospering and we are quite proud of that. We look forward to continuing to execute on our plan and to come back next quarter and report to you on our progress. With that we will wish you all and have a good day. Thank you, good bye.
Ladies and gentlemen, that concludes your conference call for today. We thank you for your participation and ask that you pleased disconnect your lines.
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