Nucryst Still Licking Its Wounds

Last December, when Nucryst (Nasdaq: NCST  ) spun off from Westaim (Nasdaq: WEDX  ) and filed for its IPO at $10 a share, I cautioned investors that they could get burned.

Well, I hate to tell you that I told you so, but . today the stock is hovering above just $6 a share.

Now, to be fair, I have to admit that the medical products maker with a nanotech bent ran up as high as $16 this past May on hopes that a new treatment it was developing to address eczema -- a skin condition that affects 15 million Americans and has no known cure -- would find its way to market within the next few years.

That hope, however, has recently been squashed. In late September, Nucryst announced that it had ceased phase 2 clinical trials on the cream after it failed to prove effectiveness. Such an outcome points to precisely why I was nervous about Nucryst in the first place. To quote my earlier article, my greatest concern centered on "the uncertainty of regulatory approval for some of Nucryst's future products."

In spite of the failed trial, not all is lost for Nucryst. Although after listening in on the company's third-quarter conference call on Tuesday, I don't see much promise for a quick turnaround.

Core business is soft
For starters, revenue for the past quarter was $7.3 million -- 30% lower than the $10.2 million the company brought in a year ago. Nucryst officials tried to spin this decrease by saying that last year's figure included a $5 million milestone payment from Smith & Nephew (NYSE: SNN  ) , the company that markets its wound dressings.

While this is true, it is also somewhat disingenuous, because such milestone payments remain an important source of revenue for the company and are one way to gauge whether it is on the right track. (The triggers for these milestone payments are confidential but most likely center on having Nucryst's technology pass certain regulatory hurdles, or having its sales surpassing a certain threshold).

A second problem concerns Nucryst's Acticoat wound-dressing business. The dressings, which use a nanocrystalline form of silver that can be applied in bandage form, have been solid performers in the commercial marketplace. The unique properties of the nanoparticles not only allow them to be released over a longer of time and thus help wounds heal faster; they are also known to inhibit more than 150 different types of pathogens. This feature helps reduce the risk that patients, especially those with severe wounds, will become susceptible to infection.

As a result of the bandage's effectiveness, Acticoat sales have demonstrated good growth over the past few years. But the market now appears to be softening. Quarter-to-quarter sales increased only 1%. Company officials cited intense competition -- most likely from Johnson & Johnson (NYSE: JNJ  ) and 3M (NYSE: MMM  ) -- as the cause.

Expanding the business is stalled
To compound matters, Nucryst officials said that rising health-care costs were forcing governments and health-care providers to seek lower reimbursement rates for the company's products. Even worse, it was suggested in the conference call that some of its wound dressings might no longer be approved for use because certain health officials questioned the cost-benefit analysis of the products. (Obviously, if some of your customers are questioning whether your product will save them money, you've got a problem on your hands).

To counter the decrease in revenue that might materialize from these competitive pressures, company President Scott Giles indicated that Nucryst would continue to develop new products for new markets, as well as look for ways to further reduce manufacturing costs.

Both initiatives, of course, sound good, but I didn't hear anything in the call suggesting that great promise lies on the horizon in either case. For instance, when asked whether investors could expect some new products by mid-2007 -- such as a new wound-dressing product or a new coating for medical devices -- Giles said that they shouldn't.

Giles was vague on manufacturing savings. My guess is that if there are any such savings, they have probably already been found.

No new treatments imminent
If there was any good news in the failure of the eczema treatment, it is that Nucryst's R&D expenditures should decrease. But while this might be good news in the short term, it is bad news in the long run. The key to long-term growth is new product development, and there is not much in the pipeline right now.

Up until yesterday, company officials held out the possibility that they might be able to revisit the efficacy results of the early trial on the eczema treatment and thus salvage the cream, but it was clear from yesterday's call that such a possibility has now been definitively ruled out.

They were quick to point out, however, that not all is lost. For instance, they stated that the cream has shown some effectiveness in pre-clinical trials for treating inflammatory bowel disease, including ulcerative colitis.

Investors need to understand, however, that testing this new application will take both time and money. And, of course, the outcome could -- as it did for the eczema treatment -- still turn out negative.

Foolish bottom line
All of this news leaves Nucryst in a precarious situation. The company's nanocrystalline technology still has potential, but until it can demonstrate some success in expanding the technology into new treatment for different types of wounds, develop new coatings for medical devices, and/or document tangible success that new treatments are on the verge of marketplace acceptance, the company's prospects look too tenuous to recommend it.

Check out these other nanotech-related articles:

Johnson & Johnson is aMotley Fool Income Investorrecommendation, and 3M is aMotley Fool Inside Valuepick. Try out these or any of our investing newsletter services free for 30 days.

Fool contributor Jack Uldrich is the author of two books on nanotechnology, including Investing in Nanotechnology: Think Small, Win Big. He owns stock in Harris & Harris. The Fool has a strict disclosure policy.


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