DRI Healthcare Trust (DHTUN) Earnings Call Transcript & Summary

Good morning, everyone. Welcome to DRI Healthcare Trust's 2022 Third Quarter Earnings Call. Listeners are reminded that certain statements made in this earnings call presentation, including responses to questions, may contain forward-looking statements within the meaning of the safe harbor provisions of Canadian provincial securities laws. Forward-looking statements involve risks and uncertainties, and undue reliance should not be placed on such statements. Certain material factors or assumptions are applied in making forward-looking statements, and actual results may differ materially from those expressed or implied in such statements. For additional information about factors that may cause actual results to differ materially from expectations and about material factors or assumptions applied in making forward-looking statements, please consult the MD&A for this quarter, the Risk Factors section of the Annual Information Form and DRI Healthcare Trust's other filings with Canadian securities regulators. DRI Healthcare Trust does not undertake to update any forward-looking statements. Such statements speak only as of the date made. The presentation today also references certain non-GAAP measures, including total cash receipts, total cash royalty receipts, adjusted EBITDA and certain non-GAAP ratios, including adjusted EBITDA margin and adjusted cash earnings per unit. These measures and ratios are not recognized measures under IFRS and do not have a standardized meaning prescribed by IFRS and are, therefore, likely to be comparable to similar measures disclosed by other issuers. Rather, these measures and ratios are provided as additional information to complement IFRS measures by providing further understanding Of DRI Healthcare Trust's financial performance from management's perspective. Accordingly, these measures should not be considered in isolation nor as a substitute for analysis of financial information reported under IFRS. Please note that all dollar amounts discussed today are in U.S. currency unless otherwise specified. I'd like to remind everyone that this conference call is being recorded today, Tuesday, November 8, 2022. I would now like to introduce Mr. Behzad Khosrowshahi, Chief Executive Officer of DRI Healthcare Trust. Please go ahead, Mr. Khosrowshahi.

Thank you, operator, and good morning, everyone. We very much appreciate you taking the time to join us today. With me today are Chris Anastasopoulos, our Chief Financial Officer; and Stewart Busbridge, our Chief Operating Officer. We are excited to share our third quarter results and update you on our key priorities for the remainder of 2022. This quarter, we made significant headway in advancing our growth strategy centered on purchasing royalty streams on pharmaceutical products that will generate sustainable cash flow growth for our unitholders. In Q3, we deployed $185 million across 3 transactions, purchasing royalties on Empaveli, Zejula and Omidria. While Stewart will provide more details on the specifics shortly, it is important to highlight that each transaction is consistent with our investment parameters while having unique terms that make the deals individually attractive. Most importantly, they provide a foundation for sustained accretive growth. Transaction for Empaveli was structured to include the option at our discretion to increase our exposure should events including a potential new indication make that advisable. The Zejula deal includes a milestone payment upon the granting of regulatory approval of a specific pipeline indication, mitigating our risk while providing the counterparty a path to realizing value for success. And the Omidria deal is structured to provide good visibility into cash flows that we expect to receive through 2030 in a way that helps replace expected expiries in our portfolio as they occur. These transactions advance our goal of replacing the cash flows from our existing assets, as they expire while continuing to roll forward the duration of our portfolio at over 9 years. We look forward to leveraging the momentum from this quarter moving forward. As we enter the final quarter of 2022, we remain poised with a strong balance sheet to capitalize on our robust pipeline. Importantly, we continue to deliver unitholder returns and last night declared a $0.075 per unit distribution for this quarter. Not considering any special distributions, this represents an annualized distribution of $0.30 per unit and a current yield of about 6%. This was a strong quarter for our portfolio, which continues to perform well. In Q3, we generated $18.8 million of total cash receipts, $26.5 million in royalty and interest income and $15.8 million in adjusted EBITDA. We generated adjusted cash earnings per unit of $0.57 in the quarter. Before handing over to Stewart, I would like to take a moment to reflect on our progress since our IPO. Over the past 19 months, we have deployed $345 million with the potential of an additional $56 million in milestones and options. We're almost halfway to the high end of our initial 5-year target range of $650 million to $750 million. Importantly, with the transactions that we have completed, we now have visibility on flat to growing cash receipts through to the end of 2025 without any further deployment. On that foundation, with our continuing deal activity, we are able to build towards the long-term growth target of 7% to 9% in cash receipts that we discussed during our IPO. In addition to growing cash flows, we are looking to demonstrate sustainability by continuing to extend the duration of our portfolio. I will now ask Stewart to discuss our recent asset performance.

Thank you, Behzad. I'll start by recapping our recent transactions for royalty interest in Empaveli, Zejula and Omidria. Empaveli is a hematology product approved in the United States and the EU for PNH, paroxysmal nocturnal hemoglobinuria, a genetic disorder characterized by the complement-pathway-mediated destruction of red blood cells. Empaveli is a pipeline and a product which is currently being reviewed by the FDA for geographic atrophy, an ophthalmological condition with a PDUFA date expected in February 2023 as well as being in development for other indications, including cold agglutinin disease and C3 glomerulopathy. This transaction entitles us to a little under 1% royalty on the worldwide net sales of all formulations of Empaveli up to an annual sales cap of $500 million. As part of the transaction, we acquired an option to increase our exposure to Empaveli by increasing the annual sales cap to $1.1 billion in exchange for a onetime payment of $21 million. In September, we acquired a royalty interest in Zejula from AnaptysBio for $35 million. Zejula is an oncology drug approved by the FDA and EMA for treating ovarian cancer, with multiple oncology pipeline indications in development. The transaction entitles DRI to a 0.5% royalty on GSK's net worldwide sales. And in the event that Zejula is approved by the FDA for endometrial cancer by the end of 2025, DRI will make a $10 million milestone payment to an AnaptysBio. Most recently, we completed a transaction for Omidria from Omeros Corporation for $125 million. This transaction will provide us with substantial near-term cash flows with long-term structural growth built into the terms of the deal. Omidria is an ophthalmological product for intracameral use during cataract surgery or intraocular cell -- lens replacement and was approved by the FDA and EMA in 2014 and 2015, respectively. We are entitled to royalties on Omidria subject to annual caps through 2030. For the remainder of 2022, we are entitled to royalties of up to $1.67 million, $13 million in 2023; $20 million in 2024; $25 million annually from 2025 through 2028. We are also entitled to up to $26.25 million in 2029, and $27.5 million in 2030 with no entitlements thereafter. These caps are significantly below the royalties that Omeros has been collecting historically. With the inclusion of Empaveli, Zejula and Omidria, our portfolio now sits at 22 royalties, including a secured loan on 17 products. Behzad touched on at the time of our IPO, we stated a 5-year deployment target of $650 million to $750 million. In 19 months, since the IPO, we have completed 5 transactions. We're almost halfway to the high end of this target with $345 million deployed with the potential deployment associated with these transactions to be as large as $401 million upon the achievement of certain milestones, or our exercise of options. Looking at the overall portfolio, we show here the breakdown of cash royalty receipts by asset for Q3 2022 as compared to Q3 2021 and Q2 2022. Cash royalty receipts decreased by 13% from the same period in 2021 and 27% compared to the second quarter. However, adjusting the second quarter to take out the semiannual Zytiga's receipt, our royalties receipts are up 16% over that -- Q2 of this year. The year-over-year decline was primarily driven by the contractual step-down in royalty rate for Eylea in Q1 of this year, a decrease in royalties from Oracea due to a change in the sales mix of the asset and the continuing evolving market conditions in the treatment of spinal muscular atrophy affecting Spinraza. This decrease was partially offset by the inclusion of Vonjo, which we acquired after Q3 2021. We expect to continue to realize growing royalty receipts from Vonjo as well as Empaveli, Zejula and Omidria in Q4 2022 plus compounding growth, as we continue to execute on acquisition opportunities in our pipeline. We continue to review the trust options related to Natpara given Takeda's recent announcement and will provide updates accordingly. In the quarter, Natpara continued to perform in line with past performance, and we expect that to continue over the next several quarters. I will now turn the call over to Chris to discuss our financial stat. Chris?

Thank you, Stewart. We continue to generate strong cash flow from our assets. For the 12 months ended September 30, our total cash receipts were $101.4 million, including total cash royalty receipts of $95.7 million and interest receipts of $5.7 million on the loan to CTI. Our operating expenses, servicer and management fees for the 12 months ended September 30 totaled $14.4 million, resulting in an adjusted EBITDA of $87 million and an adjusted EBITDA margin of 86% for this period. For the 4 quarters ended September 30, we have generated a total of $1.90 in adjusted cash earnings per unit. As at September 30, we had cash and cash equivalents of $20.5 million, along with $36.4 million of royalties receivable. Following the transactions closed this quarter, we have drawn $216.9 million of our $350 million total credit facility. Combining our cash on hand, the cash we generate each quarter from our assets and the funds available from our credit facility, we have significant access to the capital needed to continue to grow our portfolio. I'll now turn the call back over to Behzad.

Thank you, Chris. This has been a very busy quarter for us. We have never been more excited about the business and have built the needed cash flow foundation to achieve both our near-term and long-term goals. We have 3 key priorities for the remainder of the year and to guide us through first half of 2023. First, we will continue to execute on our strong pipeline. As we have laid out, we are poised for growth with the pipeline of targets with attractive royalty streams and have access to the capital necessary to successfully close these deals. Our growth strategy targets an attractive and underserved market niche, which capitalizes on small- to medium-sized transactions. We have completed 5 transactions to date and are on pace to exceed the high end of our royalty acquisition target as laid out in 2020 and '21. Second, we are focused on generating sustainable cash flows through accretive growth. Our acquisition strategy focuses on targets with potential to generate long-term royalty receipts for medically necessary products with long patent lives and potential for expansion through new indications or new geographies. Finally, we remain committed to providing solid and reliable unitholder returns by distributing between 20% to 30% of our available cash flows. With that, we will now take your questions.

Thank you, sir. Ladies and gentlemen, we will now begin the question-and-answer session. [Operator Instructions] Your first question will come from Ash Verma of UBS.

I had a few on Empaveli. So I guess, like what are the considerations for you to opt in into this annual sales cap increase to $1.1 billion as you approach the PDUFA, which is now in February? Are there any label considerations at play here? And we saw this update from Apellis last week that they submitted the 24-month GA efficacy data, as the major amendment to the NDA, which seems like from their commentary, it appears to be like an unsolicited amendment. Does that, in any way, change your view on the approvability or the time line in which we are expecting to get the decision on that? And then I have a couple of follow-ups that I can take after that.

Ash, thank you. It's Stewart here. Thanks for your question. On Empaveli, I mean, I think I make a few points on that. First, the deal that we've done so far, the $24.5 million, is really underwritten to PNH. So I think we feel pretty comfortable with that just on a stand-alone basis. Obviously, we have the option to increase the cap -- the sales cap. One of the obviously important factors that would go into -- in exercising that option would be GA and the sales we would expect to see there. We do have until June of next year to exercise that option. So we have some time to evaluate the approval -- potential approval there but also how sales are tracking on PNH as well. So I think we'll obviously take the time and see how sales are tracking, see how that approval -- how that PDUFA date goes in -- now in February and make a judgment accordingly at the time. In terms of the delayed PDUFA from the end of November to February, our understanding there is that Apellis elected to submit some additional data that was a material change and required the delay. They did it voluntarily, and we understand that they did it in order to sort of obtain a broader label and, obviously, help sales in the long run. It shouldn't really affect the ramp too much because, again, our understanding was that they were planning on launching GA in January anyway. So it's essentially a 1-month delay that this would cause. And in the long run, they felt it was worth it. So I hope I answered your question, but those were kind of the thoughts on Empaveli.

Yes. Great. And then on Omidria, yes, trying to understand this end market. I guess, what's your view of the cataract surgery market? Is this like a growing addressable opportunity? And are there any underlying factors impacting the cataract surgery market that may positively or negatively impact Omidria use? Like I think there is a couple of trends like addressable patients are getting younger, and there is more of an adoption of the same-day procedure. Is that like an accelerant for Omidria use? Or do you think it could change the trajectory of how you realize the cash flows over the period of this deal?

Ash, thank you very much for the question. Omidria, I think you correctly have outlined some of the tailwinds associated with the cataract surgery market. Certainly, there is increasingly a young patient population that is electing to get cataract surgery for various lifestyle sort of reasons, let's call it. And that's certainly impacting the size of that market or the growth of that market. You're still seeing sort of the elderly population elect for cataract surgeries, as it comes up. And that's also impacting that market as well. Our understanding is also that they're going to try to file for the approval of Omidria in Europe, which should be a significant tailwind on the sales of the drug outside of just the cataract.

Yes. And just my last question, so on Zejula, like for the endometrial cancer, like -- when can we expect the data readout on this endometrial indication? Is this something that we could get by ASCO next year? Or is kind of the -- what would like good data look like to you for this indication?

Obviously, we're not in charge of clinical trials, and we don't have a lot of privity into that. But our expectation is that positive data, hopefully showing at least PFS, if not OS, will be released sometime next year in time for approval shortly thereafter.

Your next question comes from Adam Buckham of Scotiabank.

So first one for me. I was just hoping to get an update on deal pipelines versus Q2.

Good morning. Thank you very much for taking the time. Appreciate it. Our deal pipeline is showing a great deal of strength or continued strength relative to Q2 and certainly relative to other periods of time over the past 20 years that we've been in this is business. And so we have a good pipeline that's continuing to develop, and we're seeing strength in our pipeline across the 3 verticals, in which we do business so both deals with inventors, academic institutions as well as corporations. The deals that are coming into our pipeline are quality deals, sort of to meet the criteria that we look for. The size of our pipeline is sitting at slightly over $1 billion. We have 2 deals under exclusivity right now. We have a number of deals, about 3 or 4 deals that we hope to get under exclusivity this month or early part of next month before the holidays. And then we have a couple of deals that are earlier stages of development that we hope to get under exclusivity.

Great. That color is helpful. And just in terms of the liquidity position, is there anything we need to be thinking about in terms of the available credit that you guys have in terms of your ability to sort of execute on those near-term deals?

As you know, we have our credit facility in place. And obviously, that's all in good standing, and we continue to have access to that. There are covenants within that based on EBITDA and net book value that the pro forma for each deal. So we continue to monitor the availability for individual deals on that basis. But the banks have been very supportive, and we're -- we work with them pretty regularly, and we feel pretty comfortable that we have access to the capital needed for -- to execute on the pipeline.

Your next 1 comes from Endri Leno of National Bank.

I'll start -- I have a couple of product commentary just towards the MD&A, but I was wondering if you can talk a little bit about the Spinraza royalty outlook, number one. And then Oracea's sale mix that you said impacted a bit of royalty this quarter? And just how you see that sales mix going forward.

P Yes. On Spinraza, obviously, the -- there's the competitive environment out there that has put some volatility into that. Our understanding is that sales have stabilized. Biogen has put out their Q3. So we have some visibility into what we expect in the next quarter and that appears to be flat to the previous quarter. So that, again, appears to be stabilizing. We -- so it's an evolving market there and an evolving competitive dynamic. But again, we continue to see good value in Spinraza and good cash flow coming out of that asset. In terms of Oracea, the issue there is our mix of the branded Oracea and the branded generic that we have an entitlement on. And obviously, the branded generic has a lower price point. And it's really the mix of which is covered by the various payers. And this past period has been -- the mix has drifted towards the branded generic. That -- the version that's covered is reviewed annually, and we're hoping that the payers switch that coverage to the branded version, which would help our sales and royalty forecast there.

Okay. That's good color. And one last one for me. Also, if you can talk a little bit. I mean, there was an announcement from the federal government in Canada on the buyback tax and just kind of how you're thinking about it, whether it impacts you and any kind of change on the return of capital strategies.

Yes. I mean without getting into opinions, I guess. The -- obviously, it has an impact. I mean, it puts an additional cost on buying back shares. So in evaluating the price at which we would buy back shares and relative to the other alternatives capital that puts a bit of an anchor on to the share buyback. But at the end of the day, it's really going to be the total price that we would be required to pay to buy back our units. And we'll evaluate that accordingly. This just puts a little bit of an extra cost on it.

Your next question comes from Douglas Miehm of RB Capital Markets.

A couple of questions. Just following on the sort of pipeline question. I am curious, given the company has been adding to the team, some significant members, how should we think about the pace? You indicated that we've got a couple under exclusivity and perhaps a few more in the short term, but can you talk about those products relative to your 12% targeted IRR? And how we should be thinking about that in a rising rate environment?

Doug, thank you for the question, and thank you for taking the time to join the call. I think our underwriting, just like anybody else's and anybody in any business has to be ultimately related to interest rates. We operate in a fairly what I call private market. And so it's an environment that typically takes -- has a little bit of a lag to catch up to where the interest rates are. But as time goes on, the pricing in our market will be -- will eventually reflect the interest rate environment that is prevailing and I expect that to happen over next quarter as sort of people become accustomed to it. And this particular market catches up to things. I think from our end, we want to be super disciplined about the assets that we're deploying our capital into, and we want to pick and choose the highest quality deals that we can find. And ultimately, we want to deliver portfolio returns that are consistent with our past track record, and we don't intend to sort of deviate from that.

Okay. That's great. Second question, you've accomplished a lot in the last little while with the number of deals that you've completed. I'm just wondering, when you've been talking to investors more recently, the primary focus or general focus of these investors and what are they happy with? And what do you feel they're concerned with? And then just in talking about that given that you're trading at about 0.7x our estimated NAV anyway.

That's a complicated question, Doug. Look, I think not to speak for all investors, but I think there's a recognition that the execution of our business plan and the plan that we articulated at the time of the IPO and since that we've been executing and executing at a high level, there's just the raw deployment numbers, but there's also the deals that we've done and the types of deals that we've done, and there's a recognition of the individual merits of each relative to our existing portfolio and the characteristics of it. So we've heard and received support for that. In addition, our assets are performing well overall, and we tend to certainly relative to internal expectations are meeting or exceeding. And hopefully, those of you and your colleagues. But we -- our assets are performing well. We're generating a lot of cash and the value at which the Trust acquired those assets has been a positive. In terms of challenges, obviously, we're in a tough capital markets environment and our stock has been affected by that. And certainly, we've received lots of suggestions and advice around what we can do. We've -- and we've done that over the last 1.5 years. You saw we put the normal-course issuer bid back in place just to allow us to provide a little bit of support and use some of our balance sheet to buy back some units, should the price allow. But I think there's a lot of support and encouragement to continue to do what we do, and that's by high-quality assets that will deliver good returns and growth for unitholders. And that's kind of what we're hard at work in doing.

Your next question comes from Rahul Sarugaser of Raymond James.

Just wanted to quickly start with Natpara and Takeda’s struggles. You put out an update back in early October. Just wondering if there was any further updates to that and what your strategy is around at Natpara.

Yes, with the news from Natpara, it triggered us to do an internal review. From an accounting perspective, it was an impairment trigger. So under IFRS, we had do that. So we've got an internal team that reviewed the various potential scenarios for Natpara given the commercial and legal options that we have available to us to mitigate the impact of Takeda's announcement. So at quarter end based on that initial assessment, given it was only a few weeks since the announcement was made, we didn't record an impairment because those scenarios did not result in one. We're going to continue to review these scenarios, as we've got more time and sort of refine them, and we'll continue to look at that to see where we land in terms of how we value Natpara going forward. In terms of performance, as Stewart mentioned, Natpara continues to perform well. We expect that to continue over the next period just based on the fact that it is the only drug in the market for that condition at this time.

Okay. That's great. That's very helpful. And then just a second -- quick second question. We're sort of seeing a bit of a bimodal distribution in the size of your deals initially around $25 million to $35 million. And then the most recent deal at $125 million, is that you talked about your relatively robust pipeline. So going forward, how should we be thinking about the average size of the deals? Or should we be thinking about again sort of this more bimodal distribution of types of deals?

Appreciate the question. I think our average size of deal historically has been anywhere in sort of the $65 million to $85 million range, depending on the time period that we've been operating in. I don't really see that changing. I appreciate the bimodality that you've seen recently. I would just say that, that's just -- is not on an indication of the future necessarily, just is more of a coincidence than anything else.

[Operator Instructions] Your next question will come from Tania Armstrong-Whitworth of Canaccord Genuity.

Just a couple for me. So first off, I noticed you started including that loan to CTI and you're counting at the royalty entitlements you have. Wondering, looking at your pipeline, would you consider making any additional loans just given where interest rates are sitting? Or are you still primarily targeting royalty entitlements and would only consider loans if it helped you get a royalty entitlement for instance?

Tania, thank you very much for taking the time. I think I would go with option 2 if -- our main focus is to buy royalties on approved and commercialized pharmaceutical products. If in the course of a deal, having a loan as part of that deal, helps us get the deal then certainly, we would consider it. But the core part of our portfolio and the majority of our portfolio will always be focused on royalty streams or traditional royalty streams.

Okay. Excellent. And then in terms of what you're seeing pipeline-wise, it seems like the size of the pipeline has stayed relatively stable quarter-over-quarter. But looking ahead, just as some of these companies may need access to capital and it may not be coming from the equity markets, do you think there's a potential to see an uptick in available royalty entitlements kind of for sale?

Yes. And I think we're already seeing that in the longer-term pipeline that we also have. So the pipeline that I go through with investors and yourselves is sort of our near-term next 6 to 9 months kind of deals and then our longer-term pipeline is already growing pretty rapidly, as an indication of further deals that could happen during the course of the year next year.

And is that weighted 1 way or another towards more big pharma deals versus biotech deals? Or is it kind of all over the place?

It tends to be weighted right now more towards biotech than other segments, but there's academic deals in there. There's inventor deals in there as well. But -- at the present time, which is, I think, a reflection of the market, it's more biotech weighted.

Okay. Excellent. And then in terms of competition in bidding, as money is moving away from the equity markets, have you seen any uptick in competition, perhaps investors want to put more money towards things like stable investments like royalties?

No, we haven't seen any increase in the amount of competition in royalties.

There are no other questions. So at this time, I will turn the conference back to Mr. Khosrowshahi for any closing remarks.

Thank you very much. Thank you very much, everybody, for taking the time to join this conference and ask questions. We appreciate it. Thank you.

Ladies and gentlemen, this does conclude your conference call for this morning. We would like to thank everyone for participating, and you may now disconnect your lines.