Cash-Strapped Lotus Pharma Explains Capex Decisions

| About: Lotus Pharmaceuticals, (LTUS)

Lotus Pharmaceuticals (OTCPK:LTUS) will be as much as six months late in completing its new Beijing facility, a combination of corporate headquarters, R&D labs, manufacturing, a crucial warehouse – and employee apartments.

There is nothing particularly unusual about the delay of a construction project, even a major one. But Lotus is already on the outs with its shareholders. In 2008, the company allocated $33 million to building a warehouse in Outer Mongolia, some 200 miles from Beijing, then apparently abandoned the project to focus on an inside-Beijing center. After all the initiatives, Lotus ended 2010 with just $1.3 million in cash and two unfinished building projects.

Because of its PR problem, Dr. Xing Shen, VP of corporate development for Lotus, went on a blunt-the-bad-news offensive by adopting an “I’m being honest and delivering worst case predictions” stance, as he simultaneously gave context and rationale for the company’s decisions. Dr. Shen made his comments in a friendly interview with RedChip Companies (see story).

It must be noted that Lotus has very solid fundamentals, despite its current difficulties. The company announced 2010 revenues climbed 29% to $72.7 million. However, because of a $6.7 million impairment loss on its Inner Mongolia land and its halted construction, and also because of a $3.4 million charge for professional fees, the company’s net income fell 12% to $14.4 million -- a still-respectable, though disappointing, profit margin.

In Beijing, before closing its operations in late 2009 to repurpose the site, the company’s Lotus East affiliate had some 50,000 square feet of operational space. It signed up third-party manufacturers until its manufacturing space reopens.

The company makes four branded products and owns a fifth one that is produced by a CMO. All of the products are listed in China’s national medical insurance catalogue. They are:

  • Valsartan, a hypertensive.
  • Brimonidine Tartrate, a treatment for glaucoma.
  • Levofloxacin Lactate, an anti-bacterial.
  • Nicergoline, a drug that promotes blood flow.
  • Yipubishan-Octreotide Acetate Injection Solution, a treatment for diseases of the upper digestive tract.

Lotus breaks down its revenue into wholesale and retail components. In 2010, wholesale revenues were $51.4 million and retail sales were $21.3 million. The retail number includes products that Lotus distributes for other companies along with its own.

Despite its still-healthy sales and revenues, Lotus’s stock price had dropped precipitously since last November, falling from a year-high $2.98 to under $1. It is off an additional 9 cents today on the negative news to $0.89 cents per share, a very low price-earnings ratio of 1.2. The company has a market capitalization of just $25 million. Because its Beijing facility will be delayed, Lotus has called for flat-to-lower results during 2011.

To counteract the negative news, Dr. Shen made the following points:

  • To be competitive in Beijing’s drug distribution network, a company must have a warehouse of at least 5,000 square meters, guaranteeing on-time delivery. That’s why the company abandoned the Outer Mongolia project for one in Beijing. Once Lotus is operational in Beijing, it will be able to increase its wholesale revenues by one-third or about $17 million.
  • Lotus has received a valuation on its Outer Mongolia property of $60-80 million, a tidy paper profit on its $32.6 million investment. The company still anticipates using 10% of the property as a warehouse to China’s northwest provinces at some time in the future. It will develop the rest of the land for use by other companies. Lotus decided not to sell the rest of the property in part because it has already received tax breaks of $11 million from Outer Mongolia.

None of this explains fully why Lotus began the Outer Mongolia project in the first place, if Beijing was its ultimate goal. It may be that the company didn’t think it could get the necessary permits, so Outer Mongolia, about four hours away, was both more feasible and less expensive, even though it was also less desirable.

As a result of its decisions – for whatever reasons they were made – Lotus now finds itself in the position of having to delay its drug development projects to manage cash flow. The company has a number of drugs ready to start clinical trials, but it will put them off until its Beijing construction is finished. The Outer Mongolia project will operate on its own timeline, with money that Lotus receives for the 90% of its land allocated to building a warehouse on the remaining 10%.

Lotus may be a lot more attractive a year from now. With just $1.3 million in cash, it could use an infusion to hurry things along. But its stock is selling for under $1 a share, so the company has to tough it out until investors up their appreciation for this beleaguered pharma.

Disclosure: None.