Since charting a course to reinvent its business model two years ago, Oculus Innovative Sciences (NASDAQ: OCLS) hasn’t pulled any punches about how it expects to achieve success. Front and center in the plan has been the U.S. dermatology market. In order to capture as much of this market as possible, Oculus needed more control, which meant ending existing relationships and bringing its sales force in-house. Management made it clear that it intended to leverage non-core operations, which primarily were made up of ex-U.S. derm and animal care product sales, to reach a cash flow positive position with its U.S. derm business.
If a company is measured by its promises, then Oculus is standing tall in its turnaround effort, as it has yet to deliver an unimpressive quarterly report with respect to meeting its goals.
Keeping the pace of introducing one new product to the market about every quarter, Oculus now 15 clearances from the U.S. Food and Drug Administration to commercialize products based upon its core Microcyn® Technology or selective technology in-licensed from partners. New product launches are on the horizon, including treatments for skin descaling and, post-Mohs procedure and atopic dermatitis (eczema).
The graph below (sourced from the current Oculus Fact Sheet) lends some color to the growth curve resulting from market penetration and product launches. These data are underscored by a seasoned sales team – now 22 members strong – capturing more than 550 heavy-prescription-writing dermatologists that has led to over 58,000 prescriptions being filled in the past two years. All told, more five million patients globally have been treated with Oculus products. Helping to get the Oculus products in the hands of patients are some of the biggest wholesalers in the business, including McKesson, Cardinal and AmerisourceBergen.
Q2 Fiscal 2017: Seeing the Vision Take Shape
Oculus recently released the results from its second quarter of fiscal year 2017, ended September 30, 2016. The results mirrored growth from each quarter since the re-build started two years, driven by the main objective of growth in U.S. dermatology.
During the quarter, total revenue rose to $4.11 million, up from $4.05 million in the year prior quarter. While the headline increase was only about 1.5 percent, the improvement was the result of increased U.S. sales offsetting declining international revenue. Product revenue in the U.S. totaled $1.7 million, representing an increase of 43 percent from Q2 fiscal 2016.
Product revenue from Latin America, which used to be the largest sales region for Oculus, was hurt by persistent weakness in the Mexican peso. Revenue declined 6 percent to $1.2 million, as a 9 percent increase in local currency revenue wasn’t enough to outweigh a 15 percent year-over-year decline in the value of the peso. Revenue from Europe and the rest of the world during the quarter eked lower by 3 percent to $920,000.
Oculus reported gross profit of $2.1 million, of 51% of revenue, for the second quarter, essentially matching gross profit (52%) from the year earlier quarter. The tepid reduction was attributed to Oculus progressively eliminating licensing fees and royalty revenue. While they come with higher margins, they also come with restricted control of product sales, which is one component Oculus was aiming to minimize as part of the business restructuring.
Adjusted net loss for the quarter, which doesn’t include non-cash expenses, was $1.5 million, up $171,000 from the year prior quarter.
For the first six months of fiscal 2017, total revenue was up $185,000 to $7.9 million. Aligned with the overall plan, product revenue in the U.S. was the horse pulling the cart, gaining $1.1 million, or 56 percent, from the comparable period in fiscal 2016. Sales from Europe and rest of world chipped in with 29 percent growth, while Latin American sales fell 19 percent mostly due to an 18 percent drop in the value of the Mexican peso.
Enough Cash to Reach Breakeven
In the turnaround strategy, the first major milestone is reaching breakeven in the U.S. derm business. This is no small feat, considering that Oculus adopted a plan that essentially stripped this sales channel to zilch before launching eight new products into the medical dermatology market through a direct sales force. Moreover, even a highly experienced salesperson takes time to cover their own costs. Oculus has articulated that it takes about nine months to reach breakeven on a sales force investment.
Now about 24 months into the turnaround, Oculus is reaching a key tipping point. In order to get there, Oculus management demonstrated its commitment to the U.S. markets as the value driver and future of the company by selling its Latin American business to Invekra S.A.P.I. de C.V. of Mexico in October for $19.5 million in cash plus royalties on certain net sales for the next 10 years.
In the deal, Oculus sold to Invekra all of its assets related to its Microdacyn®-based products sold throughout Latin America and the Caribbean, while maintaining rights to sales of dermatology products in Brazil, the second largest derm market in the world outside the U.S.
Oculus collected $18.0 million upfront with another $1.5 million put in escrow to be transferred upon Oculus delivering certain equipment to Invekra, expected in February 2017. Further, Oculus will collect a 3 percent royalty on all Latin American revenue outside of Mexico for the next decade. The royalty payment has a floor of $250,000 annually, payable each quarter to Oculus in Mexican pesos, adding a minimum of another $2.5 million to the price of the divestiture. Privately-held Invekra is part of the Mexican pharma giant Grupo Invekra, which also operates Oculus distribution partner Laboratorios Sanfer S.A. de C.V. Overall, Invekra has nearly 3,000 employees working in 10 different Latin American countries, meaning that there is an opportunity for royalties to exceed the $250,000 annually going forward.
While the cash didn’t make it to the books for the September quarter, it does mean that Oculus entered November with about $21 million in unrestricted cash and cash equivalents with another $1.5 million expected early in 2017. In the conference call discussing the latest quarter, Oculus CEO Jim Schutz conveyed that the cash is “more than three times the amount of money we need to achieve commercial breakeven and operating profitability company-wide.” Mr. Schutz also noted that in Oculus is already breakeven in all of its non-core businesses (hospital sales, animal health sales, contract lab sales and international sales).
Technical Traders Note New Uptrend Since August
Despite some spikes here and there, the market has been slow to reward Oculus with a market valuation that is typical for the industry, which generally runs at 3x-6x revenue. In fact, with a market capitalization of $19.75 million as on Friday’s close, Oculus is valued beneath its cash value, considering it has essentially no debt.
The technical chart for OCLS is giving hints that Wall Street is taking notice of the fundamental developments. The area of $3.90 is an established area of support and since dipping to $3.57 in August, the chart is making a pattern of higher highs and higher lows.
This movement since August puts the OCLS chart in a position to try and break a downtrend going back to August 2015. A key resistance level is $5.00, with a move through and hold above resistance at $5.50 a pretty strong technical sign that the downtrend has ended and a new uptrend is underway.
Now More Than Ever: Emphasis on U.S.
The convergence of fundamentals and technicals can be a powerful phenomenon in the stock market. Oculus certainly is pointed that direction with the aforementioned data complemented by facts such as 60% average quarter-over-quarter demand dollar growth in the past four quarters and U.S. product sales growing 121% in the full year fiscal 2016 compared to fiscal 2015.
Divesting the Latin American assets puts Oculus in the exact position it wanted when it set out late in 2014 to rebuild. The company has new products on the market and a strong pipeline on schedule for commercialization. They also have plenty of cash on hand to cover expenses related to R&D and adding, as indicated in the conference call, five more sales representatives to the staff “as fast as possible.”
The company is conceding the future revenue from Latin America with the sale, but it was low margin revenue that has been constantly challenged by the struggling peso. The royalty agreement and interest from the cash collected will help offset the top-line difference. More importantly, the value of the cash as to what it means to expedite market capture in the higher margin U.S. derm market business without diluting shareholders is intangible as it can return many multiples that will only be determined by Oculus continuing to deliver going forward.
The takeaway from the most recent conference call is that not only did management meet their guidance yet again, but actually greatly outperformed by putting the company in its best financial position ever and aligning for corporate breakeven sooner than most should have expected.