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CPHR: Cipher Pharma Offers Solid Execution and GARP Valuation

By Jason Napodano, CFA & Nisha Hirani, MD

NASDAQ:CPHR

Over the past several quarters, Cipher Pharmaceuticals (CPHR) has demonstrated solid execution in terms of both growing the existing business and expanding operations into new areas. We believe Cipher offers an attractive valuation and is the ideal Growth At a Reasonable Price ("GARP") investment for those looking to own a small specialty pharmaceutical company. Our target is $16 per share.

First Quarter Results

On May 13, 2015, Cipher reported financial results for the first quarter ending March 31, 2015. Total revenues in the quarter were $9.2 million, up 17% from the $7.9 million reported in the first quarter 2014 and handily beating our estimate of $8.7 million. Revenues were driven by strong growth across the royalty and collaborative products, including $6.3 million in revenues associated with Absorica, $1.6 million associated with Lipofen, and $0.5 million associated with ConZip/Durela. Sales of Epuris in Canada totaled $0.8 million, up 139% from the first quarter 2014 sales of $0.3 million and right in-line with our expectations. Below is a breakdown of the key revenue drivers and pipeline assets for Cipher during the first quarter 2015:

Total net Absorica revenues in the first quarter 2015 were $6.3 million, up 5% year-over-year and handily beating our expectations for total revenues of $5.7 million. Backing out the amortization of licensing fees of around $0.3 million, and Absorica royalties were up 11%. Sales are being driven by Sunpharma (formerly Ranbaxy USA), with Absorica in the primary detail position for 50 full-time sales representatives targeting approximately 3,500 prescribing dermatologists in the U.S. Cipher reported that Absorica held roughly ~19.2% new prescription market share at the end of March 2015. This is flat over the last six months.

Epuris sales in the first quarter 2015 totaled $0.8 million, up 139% and right in-line with our expectations. Prescription market share at the end of the quarter was 17.6% and the trajectory is strong. Prescriptions were up 162% year-over-year. The graph below shows the new prescription market share for both Absorica and Epuris over the life of the products.

We see Absorica revenues growing to $25.6 million in 2015, providing strong positive cash flow to Cipher that is allowing management to branch-out and fund all the recent acquisitions, as well as take on debt at favorable terms. Sunpharma has made it clear that dermatology is a core focus for the new Sun-Ranbaxy combined company, and Absorica is the flagship brand. Sales of Absorica in 2014 were around $240 million. We believe peak sales are $300 million, still leaving good room for growth in royalties to Cipher. We believe sales of Epuris in Canada will total $3.6 million in 2015, growing to $5.0 million in 2017.

Product gross margin for Epuris in the quarter was 71.3%, up from 70.6% in the first quarter 2014. Operating expense in the first quarter totaled $4.7 million, consisting of $0.4 million in research and development, $0.6 million in sales and marketing, $3.5 million in general and administrative, and $0.2 million in amortization of intangible assets. Net income for the quarter totaled $3.1 million, or $0.12 per share. Net income included $1.3 million in non-cash deferred income taxes during the quarter.

The company reported an adjusted EBITDA number of $5.1 million in the first quarter 2015. The adjusted EBITDA number adds back non-cash items to the net income, including $0.2 million in amortization expense, $0.5 million in stock-based compensation, and $1.3 million in deferred taxes. The $5.1 million adjusted EBITDA number equates to a 55% EBITDA margin on the $9.2 million in reported revenues. This is in-line with the specialty pharmaceutical peer-group. However, we note included in that adjusted EBITDA number is $1.1 million in deal-related expenses during the first quarter 2015. As a reminder, Cipher closed on four business development deals during the first quarter 2015, including the out-right acquisitions of Melanovus Oncology and Astion Pharma. The other two deals were product licensings, including the Canadian rights to Ozenoxacin from Ferrer and CF101 from CanFite Bio. Backing out these deal-related costs and the pro forma adjusted EBITDA number is $6.2 million. That’s an incredible EBITDA margin of 67%.

Deals, Deals, and More Deals!

The Cipher Pharmaceutical (CPHR) story continues to become more interesting as the management executes on its plan to become a leading dermatology-focused specialty pharmaceutical company. Since the onset of 2015, Cipher has completed the following six transactions:

Cipher began the year with the acquisition of the Canadian licensing rights to Ozenoxacin, a topical antibiotic for the treatment of adult and pediatric impetigo, from privately-held Ferrer of Spain. We expect Phase 3 data will be available in May or June 2015.

Later in January 2015, Cipher completed the acquisition of Melanovus Oncology Inc., with access to seven pre-clinical assets for melanoma and other cancers for only $0.5 million.

In February 2015, Cipher completed the acquisition of Astion Pharma, which provided two late-stage inflammatory products and a mid-stage candidate for lupus.

In March 2015, Cipher licensed the Canadian rights to Can-Fite s CF101 for moderate to severe plaque psoriasis.

On April 13, 2015, Cipher completed the acquisition of INNOCUTIS with seven marketed dermatology products including a potential breakthrough treatment for herpes labialis (cold sores).

Finally, on May 6, 2015, Cipher acquired the Canadian rights toVaniqa and Actikerall from Spanish pharmaceutical company, Almirall S.A.

Deal-1: Licensed Rights to Ozenoxacin

In January 2015, Cipher licensed the Canadian rights to ozenoxacin, a topical antibiotic for the treatment of adult and pediatric impetigo, from privately-held Ferrer of Spain. Ferrer obtained exclusive worldwide rights (except China, Japan, Korea and Taiwan) to ozenoxacin from Toyama. Ferrer licensed the U.S. rights to Medimetriks in 2014. Under the terms of the agreement, Ferrer received an upfront payment and is eligible for development milestones and revenues from product sales in Canada. Ferrer will manufacture ozenoxacin and deliver the finished product to Cipher. The product is being formulated as a 1% topical cream for the treatment of impetigo, and is the subject of a number of granted and pending patent applications.

Ozenoxacin is a next-generation non-fluorinated quinolone being developed to combat resistance of certain bacteria to earlier-generation quinolone and fluoroquinolone antibiotics such as moxifloxacin, ciprofloxacin, and levofloxacin. Quinolones and fluoroquinolone are generally broad-spectrum antibiotics active against both gram-negative and gram-positive infections.

Ozenoxacin is designed to be used twice daily for five days compared to three times daily application for 7 to 10 days like most competitors. The drug also shows no light sensitivity, unlike other currently available quinolone products. This would be a big advantage for the drug, especially in this topical formulation for an indication such as impetigo. Pre-clinical and clinical data on the use of ozenoxacin demonstrates excellent antibacterial activity against methicillin-resistant Staphylococcus aureus (MRSA) strains and clinical isolates of organisms with emerging resistance to quinolones and other topical antibiotics.

In June 2013, Ferrer successfully completed a Phase 3 clinical trial of ozenoxacin in adult and pediatric patients aged two years and older with impetigo. The study demonstrated the superiority of ozenoxacin 1% cream versus a placebo, applied topically twice daily for five days, on both the clinical and bacteriological endpoints by end of therapy visit (day 6-7). Ozenoxacin 1% cream demonstrated a superior bacteriological cure compared to placebo as early as visit two (day 3-4). The trial also demonstrated that ozenoxacin 1% cream was safe and very well tolerated in the adult and pediatric population, which confirms the results of an absorption, tolerance and safety study in juveniles aged two months and above announced previously. The trial, conducted at 27 centers in the U.S., South Africa, Germany, Romania and Ukraine, involved 465 adult and pediatric patients aged two years and older with a clinical diagnosis of bullous or non-bullous impetigo.

Ferrer commenced a second Phase 3 trial with ozenoxacin in June 2014. The multicenter, randomized, double-blinded, clinical study is comparing ozenoxacin 1% cream versus placebo in 412 adult and pediatric patients aged two months and older with a clinical diagnosis of non-bullous or bullous impetigo. The trial is being conducted at 36 centers in the U.S., South Africa, Germany, Spain, Romania, Russia and Puerto Rico. Ferrer anticipates that this second Phase 3 study will be completed by the end of March 2015. We expect data in May or June 2015. We believe it will take Cipher several months to prepare and file the NDS to Health Canada – likely to take place in the fourth quarter 2015. Once approved, we believe ozenoxacin has peak sales potential in the $10 million range. We expect that Cipher will need to expand its current dermatology-focused sales force to include pediatrics and infectious disease doctors to truly take full advantage of the ozenoxacin market opportunity, but we suspect the initial prescriber overlap to Epuris and Beteflam Patch is close to 50%. If successfully developed, ozenoxacin has peak sales potential in the $10 million range.

Deal-2: Melanovus Preclinical Oncology

In January 2015, Cipher acquired the assets of Melanovus OncologyInc., a Pennsylvania-based life sciences company for $0.5 million. The assets include seven pre-clinical compounds for the treatment of melanoma and other cancers licenses from the Penn State Research Foundation. The compounds originate from work done by Dr. Gavin Robertson, professor of pharmacology, pathology, dermatology and surgery at Penn State University, and director of the Penn State Hershey Melanoma Center. The lead product candidate, Nanolipolee-007, is a liposomal formulation of a plant-derived compound that is a first-in-class cholesterol-transport inhibitor which has demonstrated anti-proliferative activity against certain melanoma cell lines (including B-raf resistant strains) in vitro as well as in early in vivo mouse studies.

Cipher will pursue pre-clinical studies with the goal of filing an IND with the U.S. FDA and Health Canada, among other health authorities in 2016. Management has allocated an R&D budget in 2015 of $1.5 million to complete the pre-IND enabling work. The plan for the development of the remaining compounds in the portfolio has not yet been established.

Deal-3: Acquisition of Astion Pharma

On February 26, 2015, Cipher announced it had acquired the worldwide rights to three products from Astion Pharma, a Denmark-based specialty pharmaceutical company. The three products are focused on inflammatory dermatological diseases. We highlight these products below.

- Dermadexin is a patent-protected topical barrier-repair cream currently approved in the EU for the treatment of seborrheic dermatitis, an inflammatory skin disorder affecting the scalp, face, and torso (below). Dermadexin has a unique "dual action" mechanism designed to offer rapid onset of action, high responder rate, and an excellent safety profile. The dual mechanism comes from Astion's anti-neuro-inflammation technology that targets both the pathogenesis targeting inflammatory cells, like infiltrating leukocytes, as well as primary afferent sensory neuron peripheral endings.

Dermadexin also offers a Micro Lipid Crystallization technology that enables a physical restoration of the disrupted skin barrier, which plays an essential role in the pathophysiology of dermatitis. The active ingredient in Dermadexin is P3GCM, which has been shown in clinical and preclinical studies to inhibit Fatty Acid Amide Hydrolase (FAAH) and Nuclear Factor Kappa B (NFkB). FAAH is responsible for the breakdown of anti-pruritic and anti-inflammatory dermal endocannabinoids; whereas inhibition of NFkB mediated inflammatory gene expression reduces dermal levels of inflammatory cytokines and chemokines.

There are three formulations of the product, an SD Cream for seborrheic dermatitis (approved in EU as Class III medical device), an AD Cream for atopic dermatitis (Phase 3), and a scalp solution for pityriasis capitis (cradle cap) and dandruff (Phase 3). Dermatitis often affects infant and school-aged children. The efficacy of the drug has been proved in two placebo-controlled, multi-center clinical trials (436 patients) where it displayed a marked and statistically significant effect on the symptoms of facial seborrheic dermatitis with a fast onset of action and an increasing effect over time. We believe Cipher can plug Dermadexin into the company's existing product suite in Canada with Epuris for acne and eventually Ozenoxacin for impetigo. In the U.S., the product will fit within the infrastructure acquired via the INNOCUTIS acquisition in April 2015, which we discuss below. We think the prescriber base overlaps quite nicely here between all the recent transactions.

- Pruridexin is similar to Dermadexin in that the product utilizes Astion's dual anti-neuro-inflammation technology platform and the Micro Lipid Crystallization delivery system. The active ingredient is the same P3GCM, as such the mechanism involves inhibition of FAAH and NFkB. However, Pruridexin was developed for the treatment of chronic intractable pruritus, a severe dermatological disease that has profound impact on quality-of-life due to the painful, debilitating nature of the disease.

Pruridexin was submitted to the European Medicines Agency in 2014 as a Class III medical device and is under active review with a response expected in the first half of 2015. Pruridexin cream has been tested in two placebo-controlled, multi-center clinical trials (352 patients) and displayed a marked and statistically significant effect on the pruritus with a fast onset of action and an increasing effect over time.

- ASF-1096 is a product candidate in Phase 2 that is being investigated as a treatment for Cutaneous Lupus Erythematosus (CLE), a severe chronic inflammatory and disfiguring skin disease that affects nearly five people in every 10,000 worldwide (below). ASF-1096 has a unique mechanism of action in dermatology and is conveniently administered topically for the treatment of CLE. ASF-1096 has already been granted orphan drug designation by the European Medicines Agency (EMA) and a full development program for registration has been agreed. A placebo-controlled clinical Phase 2 study has demonstrated that it has an excellent efficacy and safety profile. We believe an effective product for CLE could have peak sales in excess of $100 million in North America.

Under terms of the acquisition, Cipher paid an upfront payment to Astion of $6.0 million, which was funded from Cipher's cash balance of $52.6 million as of December 31, 2015. A subsequent $2.5 million milestone will be paid upon regulatory approval and commercialization of Dermadexin or Pruridexin in the U.S, which is where Cipher will focus its commercialization efforts. We believe peak sales for Dermadexin plus Pruridexin in the U.S. are $40-50 million combined ($20-25 million each), with another potential $5 million combined sales in Canada.

Management expects to file the 510(k) applications for Dermadexin and Pruridexin in the next month or so. Upon acceptance of the U.S. applications, the company will determine when to file for approval of both products in Canada. Our model assumes the Canadian submission for Dermadexin and Pruridexin come before the end of the year. As for ASG-1096, Cipher will need to conduct a Phase 3 trial for U.S. approval. Management needs to meet with the U.S. FDA to discuss the Phase 2 data before beginning the Phase 3 study. This meeting has not yet been set. Once the Phase 3 trial protocol is cleared, we estimate it will take Cipher 2-3 years and upwards of $10 million to bring ASF-1096 to NDA/NDS-ready.

Over time, Cipher expects to out-license the products to partners in certain other regions. As noted above, Dermadexin SD has already been approved in the EU and Pruridexin is under review. We believe Cipher can out-license the EU rights to these products and recoup a good chunk of its upfront expense. The agreement also includes approximately $31.5 million in additional payments contingent upon clinical milestones, regulatory approvals, commercialization and sales milestones in the both the U.S. and other regions. Similarly, out-licensing these products for regions outside North America, such as Europe, will help Cipher greatly fund these backend milestones to Astion.

Deal-4: Acquisition of Canadian Rights to Can-Fite’s CF101

On March 23, 2015, Cipher announced it had licensed the Canadian rights to CF101, a novel chemical entity being developed by Can-Fite Biopharma for moderate to severe plaque psoriasis and rheumatoid arthritis. Under the terms of the agreement, Can-Fite received an upfront payment of CDN $1.65 million and is eligible for milestone payments of up to CDN $2 million as well as royalties from Canadian product sales. Additionally, Can-Fite will deliver finished product to Cipher. Cipher believes that CF101 could be a complementary therapeutic to its existing Beteflam patch, which would then give the company two products that target psoriasis, one of the most common autoimmune conditions in Canada and the U.S. We highlight CF101 and its potential indications below:

- CF101 is an A3 adenosine receptor agonist that is a novel, small molecule, first in class, orally bioavailable drug that is currently being developed for the treatment of autoimmune inflammatory diseases including psoriasis (Phase 2/3) and rheumatoid arthritis (completed Phase 2).

Unfortunately, on March 30, 2015, only a week after Cipher’s announcement of acquisition of Canadian rights, Can-Fite announced that its Phase 2/3 psoriasis trial for CF101 did not achieve its primary efficacy endpoint. The Phase 2/3 trial was a double-blind, placebo-controlled study, which was designed to test the efficacy of CF101 in patients with moderate to severe plaque psoriasis. Can-Fite enrolled 326 patients through 17 clinical centers in the U.S., Europe, and Israel. The primary efficacy endpoint was a statistically significant improvement in the Psoriasis Area Sensitivity Index (PASI) score relative to placebo treatment at week 12. Secondary endpoints included the Physicians' Global Assessment (PGA) score as well as several safety parameters.

In both the PASI and PGA scores, there was no real effect seen in the patient group vs. placebo. The proportion of patients treated with CF101 who saw at least a 75% improvement from baseline in disease severity at week 12, as measured by PASI 75 was 8.5% vs. 6.9% in the placebo group. In regards to PGA, 6.4% of patients treated with CF101 achieved clear (or almost clear skin) at week 12 compared to 3.4% in the placebo group.

However, on April 27, 2015, Can-Fite announced positive results from further analysis of the Phase 2/3 psoriasis trial for CF-101. Specifically, after 32 weeks of treatment, 33% of patients treated with CF101 achieved PASI75 with a mean percent improvement in PASI score of 57%. This means that, on average, patients who were treated with CF101 saw a 57% reduction in their psoriatic lesions. The company indicated that the change in PASI score was a "linear improvement during weeks 16-32", which we take to mean that the graphs would look very similar to the interim analysis, where the percentage of patients achieving PASI75 essentially increases linearly over time.

Another data point disclosed by the company was that after 32 weeks of treatment, 20% of patients treated with CF101 achieved PASI90, which corresponds to a 90% improvement in PASI score. A subset analysis of that group of patients revealed that there was a response rate of 27% to CF101 treatment in those patients who had not received prior systemic psoriasis therapy. The company believes that this data allows for the opportunity to develop CF101 as a first-line therapy in previously untreated patients with moderate-to-severe psoriasis who do not wish to be treated with currently available systemic therapies (e.g., monoclonal antibodies) due to safety concerns or due to an aversion to injections.

We have low expectations for CF101 sales in Canada. While the full analysis at week 32 from the Phase 2/3 trial reported by Can-Fite was a nice reversal from the primary endpoint data at week 12, CF101 still lags far behind a number of psoriasis competitors, both biologics and other oral treatment options. We believe the opportunity is only niche size, perhaps with potential Canadian sales of $5 million (additional analysis of CF101 and the market opportunity can be found in our article on Can-Fite).

Deal-5: Acquisition of INNOCUTIS

On April 13, 2015, Cipher announced it had acquired INNOCUTIS Holdings LLC, a privately held specialty dermatology company, for US $45.5 million in cash. With the acquisition, Cipher enters the U.S. dermatology market, specifically with infrastructure to launch products with the current 31 full-time sales representatives covering approximately 3,500 dermatologists across 28 states in the U.S. The products consist of established revenue-generating branded prescriptions that provide physicians with alternate solutions for the management of challenges experienced in daily dermatological practice. INNOCUTIS has seven marketed products and we highlight several of these products below.

- Sitavig® (acyclovir) 50 mg employs the proprietary Lauriad® Muco-Adhesive Buccal technology where a single dose tablet is placed in the gum, delivering a high concentration of acyclovir directly to the site of the cold sore infection. INNOCUTIS claims this is the only treatment proven to reduce the occurrence of future outbreaks of herpes labialis (cold sores) and represents a breakthrough for the treatment of herpes, which is composed of over 20 million prescriptions and approximately $4 billion in annual sales in the U.S. alone. In a recent study, over 1/3 of patients were cold sore free after 10 months of treatment with Sitavig® (Bieber et al., 2014).

The product was launched in the U.S. during the third quarter of 2014, and we expect that Cipher will file for Canadian approval at some point in 2016. We also think there may be an opportunity down the road for Cipher to sell (partner or sublicense) Sitavig® to other specialty markets including primary care, geriatric medicine and women’s health, as studies have shown that a greater percentage of women suffer from herpes labialis than men, with increased susceptibility in the elderly population. Sitavig® currently has three active patents with expiration dates in 2027 and 2030.

Cold sores or fever blisters are small, contagious blisters that can appear on the face, lips and inside of the mouth and are caused by the herpes simplex virus, commonly referred to as HSV-1 or HSV-2 (below). Cold sores are contagious during an outbreak but also during a process known as “viral shedding” which can occur even when no blister is physically present. The virus is most commonly spread through kissing or sharing food and/or drink with an infected person. The blisters can itch and burn, and can be extremely painful when they break open.

Herpes labialis is a widespread condition and according to the World Health Organization (WHO), an estimated 400 million people worldwide are currently infected with HSV-2. By the age of 50, up to 80% of Americans will have been exposed to HSV with approximately 25-35% of adults suffering from recurrent cold sores.

With approximately 100 million cold sore outbreaks occurring in the U.S. alone, this represents a significant market potential of hundreds of millions of dollars. It is speculated that by 2017, the herpes simplex treatment market could reach $4.8 billion. We believe that this represents a great market opportunity for Cipher’s newly acquired Sitavig® as it could be change the treatment care for cold sores. We think that the drug will gain more popularity with prescribers as Cipher expands on its potential and we look forward to seeing how Cipher does with this drug in North America pending Canadian approval. Sales of Sitavig in the U.S., launched only in the middle of 2014, totaled $2.1 million. Based on our analysis of the data and the market opportunity, we believe Sitavig as peak U.S. sales of $200 million, with another $10-15 million potential in Canada.

- Nuvail™ (poly-ureaurethane 16%) nail solution is a patented biocompatible polymer that is FDA approved for managing the signs and symptoms of nail dystrophy, such as nail splitting and nail fragility. The product helps prevent nail brittleness and dries quickly, with an invisible matte finish and can be used in both men and women. Nuvail™ improves overall nail appearance by penetrating the intracellular spaces and nail surface ridges, creating a stable, yet flexible molecular structure and providing mechanical support (below). It does not wash off because it is comprised of hydrophobic (non-water soluble) molecules and continues to work following first application with continual protection of nails to environmental factors. We believe that the ease of application will appeal to both men and women who suffer from nail dystrophy.

U.S. Nuvail sales in 2014 totaled $3.5 million. We see peak U.S. sales in the $25-30 million range, with another $2-3 million potential in Canada.

- Bionect® (hyaluronic acid sodium salt, 0.2%) is a non-sensitizing, water based, non-steroidal, topical low molecular weight hyaluronic acid (LMW-HA) formulation that can be used for the dressing and management of partial to full thickness dermal ulcers (pressure sores, venous stasis ulcers, arterial ulcers, diabetic ulcers), wounds including cuts, abrasions, donor sites, and post-operative incisions, irritations of the skin, and first and second degree burns. LMW-HA, which is found in Bionect® is a substance that is naturally found in the skin and other parts of the body and attracts and holds up to 1,000 times its weight in water. This key feature allows for the transport of oxygen, protein and nutrients through the skin and also helps to maintain an intact dermal matrix structure (below).

According to studies, LMW-HA also plays a crucial role in the processes of tissue repair and inflammation (Weindl et al., 2004).

Bionect® is available in cream, gel and aqueous-based spray formulations and also promotes skin healing and is intended to cover a wound or burn and in turn, protects against abrasion, friction and desiccation. U.S. sales of Bionect in 2014 totaled only $2.1 million. We believe peak U.S. sales are around $5 million.

- Inova® 4% & 8% and Inova® ACT 4/1 & 8/2 include benzoyl peroxide preparations for mild to moderate symptoms associated with acne vulgaris. Although the exact mechanism of action of benzoyl peroxide is not known, it is an oxidizing agent that has antibacterial properties against Propionibacterium acnes and patients that have been treated with benzoyl peroxide show a reduction in free fatty acids, lipids and mild desquamation (drying and peeling activity) with concurrent reduction in comedones and acne lesions. Inova® 4% & 8% have either 4% or 8% benzoyl peroxide while Inova® Acne Control Therapy (ACT) 4/1 & 8/2 incorporates benzoyl peroxide 4% and salicylic acid 1% and benzoyl peroxide 8% and salicylic acid 2%, respectively. Both are individually wrapped pads and employ the Easy Pad® Delivery System. These pads also have Tocopherol 5% Topical Antioxidant, which is a pure formulation from natural sources, and include sunflower oil as well as a silicone delivery vehicle.

We believe these products will be popular with the adolescent and teenage populations due to their convenience and ease of application and use. We believe Cipher can plug both Inova® products (as well as Dermadexin) into the company's existing product portfolio in Canada with Epuris for acne and eventually Ozenoxacin for impetigo. Inova U.S. sales in 2014 were $1.5 million. We believe peak sales are roughly $3-4 million.

- CNL8 (ciclopirox topical solution, 8%) nail kit provides up to six months of nail therapy and includes 15ml (3-5ml bottles) of ciclopirox 8%, 25 SwabPlus® nail lacquer remover swabs, and 1 emery board for treatment of mild to moderate onychomycosis (nail fungus) due to Trichophyton rubrum. The management program also includes removal of the unattached, infected nails by a physician as frequent as once a month. Ciclopirox is a synthetic antifungal and one in vitro study suggests that it works via chelation of polyvalent cations (Fe+3 or Al+3) resulting in the inhibition of the metal-dependent enzymes that are responsible for the degradation of peroxides within the fungal cell.

INNOCUTIS recorded approximately $9.6 million in net product revenue for all of 2014, driven largely by Nuvail at $3.5 million, Sitavig at $2.1 million, and Bionect at $2.1 million. We see Sitavig as having the largest upside potential, with peak North American sales approaching $250 million. We also believe that Nuvail has peak North American sales at around $30 million. Cipher expects that within two years, the INNOCUTIS acquisition to be accretive to earnings per share. The acquisition of INNOCUTIS will bring in 31 sales representatives to Cipher to target some 3,500 U.S. dermatologists and high-prescribing primary-care physicians for things like psoriasis, pruritis, and cold sores. We expect that Cipher will expand to approximately 60 representatives, similar to the size of the sales force that Sunpharma is using to promote Absorica, in the U.S. in 2016. This should allow the company to double its target prescriber base.

The agreement consists of $45.5 million in cash to be paid by Cipher on closing of the deal and additional INNOCUTIS management incentive payments of up to $3.0 million in cash over a three-year period based on the achievement of certain financial milestones. So all-in-all, at a price-to-trialing-twelve-month sales ratio of less than 5x seems very reasonable to us, especially considering we believe Cipher can get Sitavig and Nuvail to over $250 million sales at peak.

Deal-6: Acquired Vaniqa & Actikerall in Canada

On May 6, 2015, Cipher announced the acquisitions of Canadian rights to Vaniqa® and Actikerall® from Almirall S. A., a Spanish pharmaceutical company. Both products have been approved by Health Canada. Vaniqa is a prescription cream clinically proven to reduce the growth of unwanted facial hair in women. The cream is an enzyme inhibitor and works by blocking an enzyme necessary for hair to grow. The product was approved by Health Canada in May, 2001. Cipher plans to launch the product around the middle of the year.

Actikerall is indicated for the topical treatment of slightly palpable and/or moderately thick hyperkeratotic actinic keratosis, a pre-cancerous patch of thick, scaly, or crusty skin. Actikerall has been shown to be superior to placebo and non-inferior to diclofenac gel in the treatment of actinic keratosis. The product was approved by Health Canada on July 31, 2014 and will be launched by Cipher in early 2016.

Cipher management believes that both products have peak sales potential in Canada between $1 and $2 million. Though small products, they still fit very nicely in with the company’s dermatology focus. Under the terms of the agreement, Almirall will receive an upfront payment of CDN$0.45 million and is eligible for certain milestones from product sales in Canada. Almirall will supply finished product to Cipher.

Acquisitions Fit Nicely In With Existing Derm Products

All of the deal-making at Cipher over the past several months has been orchestrated to build a premier independent special pharmaceutical company with a laser-focus on the North American dermatology market. As a reminder, Cipher has two existing dermatology products, an improved formulation of isotretinoin, sold in the U.S. as Absorica® by Ranbaxy US and Epuris® in Canada by Cipher, and Beteflam Patch, currently under regulatory review by Health Canada.

Beteflam Patch

On February 12, 2015, Cipher announced that Health Canada has accepted for review the new drug submission (NDS) for Beteflam Patch (previously referred to as Betesil Patch). The actual application was filed on December 15, 2014. As a reminder,Cipher licensed the Canadian rights to the Beteflam Patch in 2012 from Swiss-based Institut Biochimique SA ("IBSA"). IBSA owns the U.S. rights to the product. Acceptance for review by Health Canada resulted in a CDN$150,000 milestone payment from Cipher to IBSA.

Beteflam Patch is a novel, patent-protected, self-adhesive medicated plaster containing 0.1% betamethasone valerate, for the treatment of inflammatory skin conditions such as chronic plaque psoriasis (CPP). The efficacy and safety of the product has been established in two successful Phase 3 trials and one successful Phase 4 trial conducted by IBSA. IBSA recently published positive results from a large non-inferiority study, which compared the product to Dovobet (betamethasone plus calcipotriol), a commonly prescribed combination product containing a corticosteroid and a vitamin D analogue.

The Beteflam Patch is applied once-daily to the affected region and may be cut to fit the particular size and shape of the psoriatic lesion thereby reducing potential contact of the steroid with healthy areas of skin. The occlusive format of the Beteflam Patch is designed to provide a consistent distribution, delivery and absorption of the active ingredient and enhances the potency of the corticosteroid. The patch also helps to moisturize the skin, which accelerates healing and provides a protective barrier that reduces local trauma to the lesion due to scratching and prevents transfer of fluids from the lesion onto clothing. Beteflam patch will be the first topical betamethasone patch on the market in Canada once approved.

If approved in late 2015, we think the Beteflam Patch is an excellent complement dermatology product for Cipher’s contract sales force to co-promote along with Epuris and newly acquired products like Dermadexin and Pruridexin, or even CF101. We expect a decision from Health Canada in the fourth quarter 2015.

We think Cipher can achieve breakeven Canadian operations based on the launch of Epuris alone by the end of 2015. This would be sales in the area of $3 million. Adding several more dermatology products to the portfolio, like Beteflam Patch, Dermadexin, Pruridexin, Sitavig, and CF101 will help improve the overall efficiency and profitability of Cipher’s Canadian operations. We think the Canadian operations can generate sales in the $50 million range in time. The prescriber overlap for these newly acquired products and Epuris looks fantastic, likely over 70%.

Cipher Secures Access To $100 Million in Cash

On April 13, 2015, Cipher announced, that it had closed on a private offering of $100 million in aggregate principal amount of Senior Secured Notes due 2020, provided by investment funds managed byAthyrium Capital Management. Cipher received an initial drawdown of $40 million, which was used to fund the majority of the upfront purchase of INNOCUTIS. The remaining balance of the Senior Secured Notes will be made available to finance future acquisitions and is subject to certain conditions. The five year fixed rate 10.25% Notes are payable on the last day of each quarter. The Notes are interest-only and are secured by assets of Cipher and its subsidiaries, subject to certain exceptions.

Executing on its Growth Strategy

As a summary, Cipher has completed five transactions since the start of 2015 that execute on its 3-point growth strategy:

1) Acquire dermatology companies and/or products in the U.S. and establish commercial infrastructure

- Acquired INNOCUTIS, establishing Cipher's commercial presence in the U.S. dermatology market.

- Acquired worldwide rights to three products focused on inflammatory dermatological diseases (Dermadexin, Pruridexin, and ASF-1096) from Astion Pharma. Cipher's commercialization efforts will focus on the U.S. initially.

2) Expand Canadian dermatology franchise

- Licensed the Canadian rights to Ozenoxacin, a topical treatment for adult and pediatric impetigo.

- Announced that Beteflam Patch has been accepted for review by Health Canada.

- Licensed the Canadian distribution rights to CF-101, a novel chemical entity being developed by Can-Fite Biopharma for moderate to severe plaque psoriasis and rheumatoid arthritis.

- Acquired Canadian rights to Vaniqa and Actikerall, two approved dermatology products each with $1 to $2 million sales potential.

3) Acquire potentially transformative technology that can be commercialized efficiently

- Acquired seven pre-clinical compounds for the treatment of melanoma, skin cancer and other cancers from Melanovus Oncology Inc.

Conclusion

Cipher has kept itself extremely busy over the past five-and-a-half months, expanding its pipeline through several key advancements, including six acquisitions and licensing deals all designed to turn Cipher into a fully-integrated dermatology-focused specialty pharmaceutical company by 2020. Cipher’s newly expanded product portfolio includes products focused on acne, psoriasis, dermatitis, pruritis, lupus, impetigo, melanoma, hyperkeratotic actinic keratosis, ulcers, nail dystrophy, herpes, onychomycosis, hyperpigmentation, un-wanted facial hair, and rheumatoid arthritis. Through these acquisitions, Cipher is on its way to building an integrated North American sales force comprised of 31 U.S. (serving over 3,500 dermatologists in 28 states in the U.S alone) and 7 Canadian sales reps. We expect that both numbers are going higher in the next several quarters.

We believe the opportunity to leverage the existing sales force to cover multiple products. If approved later this year, we believe that the Beteflam Patch will be an excellent complement dermatology product for Cipher’s contract sales force to co-promote with Epuris, Dermadexin, Pruridexin, and potentially CF101. Similarly, we also see considerable overlap between the acne products, Inova and Epuris, with Dermadexin and possibly Ozenoxacin. We believe that Cipher’s new combined sales force and combined customer base, will offer considerable cross selling opportunities as they continue to expand their offerings in dermatology in the U.S. and Canada and will keep profit margins well above industry average.

Cipher exited the first quarter 2015 with $47.1 million in cash in the bank. Between the existing cash balance and access to new cash, Cipher has over $100 million in dry powder to continue their future expansion plans. If management continues to capitalize on selective acquisitions, continues to develop their deep and growing pipeline of dermatology products, we believe the shares continue to offer significant upside potential. With the recent acquisitions, we believe Cipher is on its way to building a leading pure play dermatology based specialty pharmaceutical company with a focus on growing its North American presence. And what is even more impressive is that execution remains excellent, with Epuris sales growing at 139% in the first quarter 2015 and pro forma adjusted EBITDA margins as 67%. As such, we continue to have faith in management’s vision, growth strategies and strategic priorities, and expect another solid performance for 2015 and beyond.

Valuation

Our model is consistent with management’s guidance that the INNOCUTIS deal will become accretive in two years. By 2017, we model $21.0 million in Canadian product sales, consistent with Cipher’s goal to generate $50 million in product revenues from Canada by 2020. In the U.S., we think product sales will eclipse $100 million in 2018.

We believe Cipher shares are fair-valued at $16 per share. The specialty pharmaceutical industry trades at an enterprise vale (EV) to EBITDA of around 9.5x. Cipher’s current EV is $250 million. Adjusted EBITDA in the first quarter 2015 was $5.1 million, or 55% net EBITDA margin. Backing out the $1.1 million in deal-related costs and pro forma adjusted EBITDA was $6.2 million, or an impressive 67%. For 2015, we model revenues at $52.2 million, with adjusted EBITDA of $24.3 million. That equates to an EV/EBITDA of 10.3x, about on par with the peer group.

However, given all the product acquisitions and growing sales force in both the U.S. and Canada, Cipher should be able to post revenues in 2016 of $83.2 million and in 2017 of $136.3 million. For 2016, we are calculating an adjusted EBITDA number of $39.9 million, meaning Cipher is trading with an EV/EBITDA of 6.3x 2016 estimates. For 2017, our calculated EV/EBITDA ratio is only 3.7x. Our $16 twelve month target on Cipher assume the EV/EBITDA ratio one year from now is 10x – essentially the same valuation the stock is trading for right now plus expected growth.

As such, we think if Cipher can demonstrate that they can execute and drive meaningful revenue and earnings growth over the next several quarters, the stock will be an excellent buy at this level. Finally, we see the end-game for Cipher shareholders as an acquisition, and inversion, by a larger U.S. pharmaceutical player.

Income Statement

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