DUSA Pharmaceuticals: Small-Cap Biotech With a Healthy Cash Flow

| About: DUSA Pharmaceuticals, (DUSA)

DUSA Pharmaceuticals, Inc. (NASDAQ:DUSA) – based in Wilmington, MA is a dermatology company engaged in the development and commercialization of Levulan photodynamic therapy [PDT]. Utilizing their 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 leverage its technology platform to provide treatment in a safe, efficacious, and reliable manner. 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). DUSA received approval from the FDA and launched its Levulan Kerastick 20% Topical Solution with PDT and the BLU-U in the U.S. in September 2000.

When Levulan® is used and followed with exposure to light to treat a medical condition, it is known as Levulan PDT. 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. Further, in September 2003, DUSA received clearance from the FDA to market the BLU-U without Levulan PDT for the treatment of moderate inflammatory acne vulgaris and general dermatological conditions. While the company has another product, ClindaReach, and other small partnerships and arrangements, DUSA has chosen to focus on domestic sales of its core product, Levulan PDT. While the patent on the Kerasticks runs out in 2013, DUSA received a patent for its BLU-U device through 2019. Due to the significant regulatory hurdles [FDA] and the fact Levulan PDT is approved as a combination product for an in-office procedure, (not a prescription that can be simply dispensed at the pharmacy) this should be sufficient protection for DUSA.

Treatment Mechanism and Background: The product is designed as a targeted therapy; Levulan Kerastick is applied to the affected skin areas and photosensitization occurs through the metabolic conversion of aminolevulinic acid [ALA] to protoporphyrin IX (PpIX), a photosensitizer, which accumulates in the skin. When exposed to light of appropriate wavelength and energy (the BLU-U device provides this), the accumulated photoactive porphyrins produce a photodynamic reaction, resulting in a cytotoxic process dependent upon the simultaneous presence of oxygen. The absorption of light results in an excited state of porphyrin molecules, and following a mechanism only a physical chemist would find interesting, reacts to form superoxide and hydroxyl radicals. This ultimately destroys the AKs andclears the lesions. At 8 weeks...

  • 75% clearance of AK lesions was experienced by 77% of patients treated with Levulan PDT vs 23% of vehicle-treated patients (p<0.001)
    • 83% of the patients treated with Levulan had 75% clearance of face lesions and 60% of the patients had 75% clearance of scalp lesions.
  • 100% clearance of AK lesions was experienced by 66% of patients treated with Levulan PDT vs 13% of vehicle-treated patients (p<0.001)
    • 70% of the patients treated with Levulan had 100% clearance of face lesions and 55% of the patients had 100% clearance of scalp lesions.

Competitive Landscape: Current treatment alternatives to Levulan PDT include topical creams (chemotherapy) and liquid nitrogen cryo treatment. These have significant drawbacks. The liquid nitrogen treatment has poorer reimbursement, must be administered by the doctor, and leaves a white scar, whereas the topical creams leave the patient’s face resembling a “pizza”, which often does not resolve for a few weeks. This has resulted in significant compliance issues for the topical creams. On the other hand, DUSA’s treatment has slightly higher clearance rates with no compliance issues due to the inherent nature of an in-office procedure that can actually be done by a physician extender, saving the dermatologist time. The side effect profile is manageable and consists of a stinging sensation, and patients should avoid direct sunlight for approximately 2 days after receiving treatment. The market opportunity is approximately $700 million (most likely underreported, and growing at ~10% annually), according to DUSA, and with single-digit penetration DUSA has the potential to take significant share from existing treatments. However, cryo treatment will continue to be popular for the treatment of only a few AKs.

Pipeline: DUSA is not currently developing any new products but is focused on enhancing their 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 (with results expected 1H 2012). The aim of this is 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 b) illumination with blue light using the BLU-U® Blue Light Photodynamic Therapy Illuminator. This would greatly increase convenience for both patients and physicians. Because of independent investigator studies in peer-reviewed journals with short incubation times have demonstrated efficacy, this clinical trial has a high chance of success, and given favorable results, will likely form the basis for a subsequent phase 3 study.

Fundamentals and Financials: DUSA uses a razor-razorblade business model (definition here). They make virtually no profit (<5% profit margin) on the sale of the BLU-U device and derive their profits from the Kerastick sales (87% gross margin most recent quarter, > 90% expected in 2011). 4Q 2010 numbers (earnings release) were very positive, and due to the seasonality of quarter over quarter comparisons, annual numbers are more relevant. The Company reached profitability on both a GAAP and non-GAAP basis for full year 2010; as well as, generated positive cash flow for the full year 2010.

As of December 31, 2010, total cash, cash equivalents, and marketable securities were $19.6 million, compared to $16.7 million at December 31, 2009. The Company generated $3.0 million in positive cash flow (change in cash and cash equivalents and marketable securities) during 2010. Over the last 6 years, the compounded annual growth rate has been 29%, with domestic PDT (the current focus) posting 34%, and with gross margins improving from 60% to 87%. While a 7% (5-6% net after discounts for volume) price increase began on January 1st, 2011 most likely brought sales into the 4th quarter, this Q4 price increase is to be expected annually going forward. Continued sales to existing offices and new BLU-U units are strong. 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 and modeling a conservative 20% growth in revenue (est. 2011 of $44.7 million, COGS of $8 million), this leads to an annual increase in cash and non-GAAP earnings of approximately $5 million, or $0.20/share with approximately $1/share in cash. This is a very conservative estimate in my opinion, and a valuation at 4-5x revenue would suggest a value of no less $7 per share (fully diluted share count of 27.5 million shares). Net loss carryforwards of approximately $2-3 milion 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.

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. To quote management, DUSA is focused on “feeding the beast” and improving the product through clinical trials to enhance product labeling (letting the reps “take their gloves off”) while expanding into new dermatology offices.

Due to its advantages in compliance, ease of administration, and efficacy, Levulan PDT has the continued potential to make in-roads and increase market share, benefiting both patients and investors. Risk factors include failure to secure better labeling, an inability to increase market share, and in the short term, possible earnings “misses” and medicare reimbursement issues (which most likely result from the high seasonaIity and variation in Kerastick revenues, which could hurt the share price temporarily). Additionally, Leo Pharma has a candidate in phase 2 trials which may prove to be a more effective product, but data is thin now. For additional upside potential, a larger, more established dermatology player with an established sales force may acquire DUSA and gain access to the near 90% gross margins and rapid growth and potentially eliminate redundancies.

Disclosure: I am long DUSA.