Aequus Pharmaceuticals: Reaping The Rewards Of An Adapted Business Strategy

Summary

• New record revenue of 535k CAD in Q4/2019 with a strong +44% growth compared to previous quarter Q3/2019 (370k CAD).
• Positive manufacturing audit at Medicom, submission for approval with Health Canada (30 days review, OTC) for Evolve product line once audit certificate is available; market entry expected in August 2020.
• Positive dispensing formulary decision in Q4/2019 for British Columbia for Aequus' Tacrolimus product to be the mandatory product for organ rejection patients requiring Tacrolimus.
• Awaiting reimbursement decision for Vistitan in Quebec and British Columbia, covering 36% of the 55Mio CAD bimatoprost market in Canada.
• Aequus and Medicom to jointly expand to large US ophthalmology market, starting in 2020 with Evolve.

Aequus Pharmaceuticals (OTCQB:AQSZF) is a growing specialty pharmaceutical company with an increasing pipeline of commercial products in ophthalmology and transplant, and a development stage pipeline in neurology and psychiatry. In today's article I will follow-up on my latest article from 29th August 2019 and will summarize the progress in order to verify the investment opportunity.

Recap of Investment Opportunity

My thesis of the investment opportunity is based on projected revenue growth coming from already marketed products and new in-licensed products, creating an opportunity to reach breakeven in 2020. Considering the very small market-cap of currently around 10Mio CAD, it generates a significant upside opportunity for the share price if events and revenue materialize as projected. At the same time, I'd like to stress the point that we are talking about a penny stock in the nano-cap range. There are significant risks associated with investments into such companies and standard investors may not be willing to accept this level of risk.

Pipeline - Source: Aequus webpage

In August 2019, the breakeven projection for 2020 faced some question marks due to products not progressing as anticipated by the company (Topiramate XR, Zepto, Evolve). Meanwhile, more information around the lack of progress has been shared and Aequus adapted their business strategy. The share price has not taken these facts well and showed an all-time low of 0.065 CAD during the global market's COVID-19 crash on 20th Mar 2020.

On the other hand, during the past months Aequus also communicated some very positive surprises that will and partly already have been driving some promising revenue growth. In my opinion, Aequus has taken some good decisions regarding their business strategy and there are promising facts that give me confidence of seeing a breakeven in 2020 for real.

I will discuss all the outlined points in more detail in my article.

Despite a stellar Q4/2019 and my confidence for a breakeven in 2020, I keep the rating on "Bullish" for this time, also due to some remaining uncertainties (see Risk Update chapter). If the Q1/2020 figures, to be published until end of May 2020, confirm the progress of the actual path to breakeven, I will raise the rating to "Very Bullish".

Events September 2019 - April 2020

Business Strategy Adaptations

The original business strategy was built around the in-licensing of products for the Canadian market. Products that are too small in terms of revenue for bigger companies but generate just the right revenue for a small company like Aequus. Based on this revenue stream, the company intended to drive "bigger fish" like Topiramate XR (also known under the US product name Trokendi XR) and AQS1303 through clinical studies, taking the company to the big money.

If I had to take a guess, it was likely a mixture between bad luck with events outside of the company's control (e.g. Zepto), some too optimistic judgments on the clinical paths of the pipeline (Topiramate XR, AQS1303) plus a newly rising opportunity with Medicom Healthcare that led Doug Janzen and the management team to adjust their business strategy.

With the limited revenue available in 2019 and Zepto being put on hold, it probably did not seem acceptable to have the company's short-term fate depending on products like Topiramate XR or their own AQS-130x pipeline. These products still require a significant amount of time and money for clinical trials. While the company did not want to exit on the foundational business approach of marketing & distribution of in-licensed products, a less time & resource intense way had to be found to get to breakeven. In short, look for products with a short path to market and no clinical trials required.

Aequus got themselves well-established in the Canadian ophthalmology market during the past few years. At the end of 2019, the company grew to an impressive 8% of market share in the highly competitive Canadian 55Mio CAD glaucoma market (bimatoprost based products, e.g. Vistitan). Medicom has a strong ophthalmology portfolio, including the Evolve dry eye products, and was looking for a partner to commercialize the products in additional countries. A partnership between Aequus and Medicom for Canada made a lot of sense. Furthermore, based on the press release of 13th Dec 2019, a joint venture is planned for 2020 to take the partnership to the next level and to enter the lucrative US market.

Zepto (cataract surgery)

In August 2019 we were wondering about the lack of revenue for Zepto. Since then, the reason has been communicated, see the Q3/2019 MD&A. There were issues with the handpiece of the Zepto device and the manufacturer Mynosys has to do some modifications. Aequus paused the promotion of Zepto in Canada in Q3/2019. In the latest news release of 29th April 2020, the company announced the permanent discontinuation of Zepto.

Topiramate XR / Trokendi XR (epilepsy and prophylactic migraine)

There has not been any visible progress on Topiramate XR and I consider it unlikely that it will ever go to the Canadian market with Aequus. Basis for my conclusion is on one hand the adapted business strategy and on the other hand the fact that Aequus would be facing significant milestone payments of ~5.1Mio CAD (3.6Mio USD) to Supernus (SUPN) upon regulatory approval of both Supernus products Topiramate XR and Oxtellar XR. Aequus is at this stage simply not in the position to handle such milestone payments without either going through some massive equity financing or generating substantial debts. The annual 2019 MD&A still lists the "Initiation of Trokendi clinical study" with some funds assigned but I doubt that this will happen accordingly, especially considering the notorious lack of cash.

Topiramate XR is not without value for Aequus, however, as it is considered a 20Mio CAD annual peak revenue product for Canada. It is just the wrong product at the wrong time for the adapted business strategy. My assumption is that Aequus might partner or out-license the product instead, thus either seeing a one-time upfront payment or some royalties at a later stage.

Medicom Products (dry eye products, ophthalmic medication)

Quick recap: In the press release of 27th August 2019 Aequus provided additional details on the Medicom agreement which shall cover "the Evolve® line of preservative free dry eye products which contains 5 commercial products and 2 products in development, an undisclosed preservative free ophthalmic medication, and the diagnostic eye drop Fluosine within Canada.". The estimated annual peak revenue is around 10 Mio CAD according to the press release of 29th July 2019.

The first step was to seek approval from Health Canada for the Evolve products which was originally anticipated to happen before end of 2019. Unfortunately, in January 2019 a new audit standard with the MDSAP (Medical Device Single Audit Program) was established by Health Canada. The new standard is targeting every manufacturer who is distributing products in Canada, including the already marketed products. As a result, this generated a huge demand for audits across the industry and led to significant delays. Medicom's request to get their Evolve manufacturing site audited, was queued and delayed for several months.

Finally, on 21st April 2020, Aequus announced the positive audit result for Medicom. Unfortunately, it will take another two or three months until Medicom receives the formal audit certificate. The documents required for Evolve to file for approval with Health Canada are ready and can be submitted as soon as the audit certificate has been received. Within 30 days after submission, Aequus will get the response from Health Canada. Evolve is an OTC product already marketed in many countries, so I consider the risk of rejection minimal. With the already established distribution channels it is reasonable to expect first revenue for Evolve towards the end of August 2020.

Commercial Product Update - Source: MD&A for 2019 annual report

The "undisclosed preservative free ophthalmic medication" is expected to support the continuous revenue growth with a 3-5Mio CAD annual peak revenue, once hitting the market. Looking at the graph above, market entry is not expected before 2021. With the successfully completed manufacturing audit, however, any additional submissions with Health Canada for Medicom OTC products should be a fast process, once all regulatory data is available.

Furthermore, the plans of Aequus and Medicom go beyond Canada. On 13th December 2019, Aequus surprised us with the announcement of a term sheet for a joint venture with Medicom to bring the Medicom products to the US market during 2020 already. The CEOs of both companies mentioned that there are "no upfront requirements or commitments on spend" and that their "initial commercial strategy will be to work with Insurers, Pharmacy Benefit Managers and Business to Business relationships to begin generating US revenues in 2020 without building a large infrastructure.".

With the US ophthalmology market being roughly 5-10 times bigger than the Canadian market, the joint venture would open a sizable revenue stream for both companies and may become a transformational event for both companies. On a personal note, I am not convinced yet that revenue coming from this joint venture will already materialize in 2020. Entering the US market may take time even for OTC products and I have not yet seen any statements about the regulatory path to be applied. Does Evolve conform to an existing monograph or does it need to be reviewed through an NDA process? Time to market directly depends on that answer and may vary from "a few weeks" to "more than a year". Once they pass the regulatory requirements, however, the revenue is anticipated to be very rewarding.

Vistitan (glaucoma)

In the past, Vistitan (bimatoprost 0.03%) has been the main driver for revenue growth. On 18th October 2019, Aequus communicated a reference to a study indicating Vistitan as the most effective treatment for glaucoma. This study will certainly help with the company's efforts for continued revenue growth.

On 10th January 2020 Aequus announced their effort to advance the filings for reimbursement for British Columbia and Quebec. These two provinces are covering around 36% of the 55Mio CAD bimatoprost market in Canada. A positive outcome, expected "shortly" for British Columbia and "later this year" for Quebec, is anticipated to further push Vistitan revenue.

A welcomed side-effect of such a push in Vistitan sales would be the prospect of earning an increased revenue share from their partner Sandoz. The revenue share figures have not been disclosed but Aequus shareholders experienced the effects of a revenue share decrease from Sandoz in Q1/2019 when the company's revenue dropped significantly from 507k CAD in Q4/2018 to 329k CAD in Q1/2019 (-35%). The opposite effect would certainly boost future revenue.

Tacrolimus (organ rejection)

It was a big surprise for many shareholders when Aequus announced exciting news on 16th January 2020. The health authority in British Columbia changed their dispensing formulary for tacrolimus. They mandated that the Aequus / Sandoz tacrolimus product is to be dispensed for all patients requiring tacrolimus for the treatment of organ rejection in the province of British Columbia, replacing the current standard product Prograf. The reason is simple: Aequus' Tacrolimus is significantly cheaper than Prograf so health systems save a lot of money. Prograf had an annual volume of around 20Mio CAD in British Columbia.

With the lack of official figures, it takes some guesswork to assess the revenue impact for Aequus. Assuming a price less than half of Prograf and a revenue share of around 15% for Aequus, you'll end up with an additional 150-250k CAD per quarter. This is a significant step towards breakeven for this small company. Even better, the decision in British Columbia may trigger health authorities in other provinces to revisit their formulary to save money.

Medical Cannabis / AQS1304:

After having announced some news coming "soon" for nearly a year, the topic of medical cannabis seems dormant although AQS1304 is still part of the official pipeline and has some funds assigned in the annual 2019 MD&A. I can only speculate whether maybe the cannabis hype was over and Aequus didn't consider it meaningful anymore, or it was a victim of the business strategy adaptation. I do not expect any further activities or news on his topic anytime soon.

AQS1303 (pyridoxine/doxylamine, anti-nausea patch)

AQS1303 was the company's hope of a kind of mid-term blockbuster. The daily transdermal patch would have a significant safety and usage advantage compared to the currently available 4-times-a-day equivalent Diclegis. Diclegis reached an annual sales volume of around 200Mio USD in the USA alone.

On 21st June 2018, Aequus announced the partnership with Corium (CORI) to develop the transdermal patch. Corium was to finalize the formulation for AQS at no cost in exchange of the right to be the exclusive clinical and commercial manufacturer for the product.

Development Product Update - Source: MD&A for 2019 annual report

No relevant updates have been communicated within the last around 12 months and the annual 2019 MD&A still shows the standard statement: "Aequus continues to pursue development collaborators and marketing partners for its internal programs in markets outside of Canada, particularly for AQS1303 and Topiramate XR".

While I consider it unlikely at this stage for Aequus to drive this product to market, with global rights available it may still generate some relevant revenue through out-licensing for different countries / regions.

Impact of COVID-19 on Aequus

Many penny stocks like Aequus struggle to live through the COVID-19 pandemic. In this case, however, the company is doing a remarkable job in adjusting to the new circumstances. It looks to me like Aequus might be one of the few that come out of the pandemic stronger than ever.

On one hand, the current business is not directly impacted by the pandemic. Organ transplant patients still require tacrolimus and glaucoma treatment with Vistitan has to continue as well. On the other hand, Aequus has taken the opportunity to "integrate existing retail structures with more wide-reaching virtual channels", as Anne Stevens (COO) mentioned a few days ago. This is not only an adjustment for the pandemic but will allow for cost effective operations in the future.

In the past, Aequus required 1.0-1.2 Mio CAD per quarter for breakeven, i.e. 4-5Mio CAD per year. Official numbers have not been communicated recently but anticipating the cost reduction triggered during the pandemic, my estimation would see around 3Mio CAD per year to be enough for operational breakeven in 2020, i.e. ~750-800k CAD per quarter.

Balance Sheet and Cash Flow

Please find the annual 2019 Financial Report and MD&A at SEDAR.

Source: Annual Financial Report - page 5

The annual revenue 2019 shows an increase of 16% to 1.63Mio CAD from 1.41Mio CAD in 2018. Continuous growth of revenue is the way to go for Aequus. The absolute figure of 1.63Mio CAD, however, is a bit disappointing and origins from the revenue drop in Q1/2019 due to the revised profit share split with Sandoz, impacting all subsequent quarters as well, of course. The failure to decrease the net loss of 3.1Mio CAD origins in the same revenue drop.

2020 is expected to show vastly different figures. Taking 550k CAD of quarterly revenue as the basis for a yearly projection, not considering any revenue growth, the yearly revenue would show at ~2.2Mio CAD. Considering my estimate of around 3Mio CAD required for breakeven, the net loss in 2020 should stay around or below 1Mio CAD. Projecting some continuous growth for Vistitan and Tacrolimus, plus some good news around Evolve (market entry in Q3/2020) and Vistitan (reimbursement in two provinces) potentially takes the company to breakeven before the end of 2020.

It is remarkable that the company recovered from the drop to 329k CAD in Q1/2019 and achieved a new record quarter with 535k CAD in Q4/2019:

Source: MD&A for 2019 annual report - page 14

Balance sheet:

Source: Annual Financial Report - page 4

With a mere 484k CAD of cash and cash equivalents on 31st December 2019, you may wonder why we have not seen any financing yet. On one hand, it tells us that Aequus managed to survive 4 months with minimal cash, supporting the projection of reduced cost and increasing revenue in Q1/2020. On the other hand, it means that we can expect some financing activities any day now.

Should we be afraid of a massive dilution coming up? I don't think so. The company should not require a large amount of cash for 2020, considering our projections. By going for, let's say, 1Mio CAD at 0.10 CAD per share, plus warrants, the dilution would likely comprise around 15Mio shares. With the fully diluted amount of shares being around 96Mio (already considering the potential conversion of the convertible debenture issued in 2019, 16Mio shares), the dilution with some additional 15Mio shares would not necessarily be pleasant but, in my opinion, acceptable to guide the company to operational breakeven in 2020.

More important for 2020, from my point of view, would be to succeed with good news to push the share price above 0.32 CAD, which would allow Aequus to force the conversion of the convertible debenture units and to get rid of the interest payments of ~200k CAD per year.

Investment Opportunity and Risks Update

I'd like to point out - as in every article - that we are looking at an unprofitable penny stock in a high-risk sector. It should be obvious that this stock is not for risk averse investors. If you invest in a company like Aequus, you need to be in the position to handle the full loss of your investment in worst case.

Aequus had some tough times in the 2nd half of 2019. Zepto was put on hold, the Evolve manufacturing audit got delayed and Trokendi XR did not move at all. The company had to start from a low 329k CAD of revenue in Q1/2019 due to the revised profit share split and thus did not get a fair chance to reduce the yearly loss.

Combined with the over-optimistic communication around these products, the company simply failed to meet the investor's expectations in 2019. The share price has been sent down to the uncomfortable one-digit cents.

Why do I still believe in Aequus?

• The company did a remarkable job in working its way back to a new record quarter in Q4/2019 with 535k CAD and took some good decisions to adapt their business strategy
• Aequus communicated some positive news within the past 5 months that should allow for continuous revenue growth in 2020:
  • dispensing formulary decision for tacrolimus in British Columbia (adding ~150-250k CAD to the quarterly revenue baseline over time without any increase of operational expenses)
  • positive study on Vistitan in Q4/2019, plus expected decision on reimbursement in two provinces that should trigger further revenue growth
  • Evolve market entry expected in Q3/2020, low risk for failure for this OTC product after positive audit result (annual peak revenue of ~5Mio CAD)
  • Joint Venture with Medicom to enter US market
• The company manages the COVID-19 pandemic well and streamlines operations with virtual channels to adapt to a new world and to reduce cost in a sustainable way

Still, there are some risks that investors should observe:

• The agreement with Sandoz for Tacrolimus expires on 31st Dec 2020 and a renewal has not been announced yet. Aequus cannot afford to lose the revenue of this product before they entered the US market together with Medicom
• The amount of additional revenue resulting from the tacrolimus formulary decision is unclear. If Q1/2020 revenue goes beyond 600k CAD I consider it a hint that my projection of "adding 150-250k CAD per quarter" is valid. If revenue stays below 550k CAD we need to assume that the additional revenue staying with Aequus may be at ~100k CAD per quarter only
• Cash is expected to be close to zero at the time of writing. Financing activities of any kind should be expected by investors any day. For penny stocks, however, a successful financing under these circumstances may also become a catalyst for the share price. On the other hand, it will not be easy for Aequus to find venture investors these days

Analyst’s Disclosure: I am/we are long AQSZF. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.