Legal Gets a Shout Out in Conference Call
Updated: May 13, 2020
There was something to delight everyone in ChromaDex's Q1-2020 quarterly earnings conference call -- it was the longest call yet. Head over to SeekingAlpha for the full transcript. But here's a look at three particularly interesting points raised: Business Strategy, Financial Results, and Legal Outlook.
Some will love it and some will hate it, but Rob Fried clearly described the strategy behind the company's notoriously cautious approach to marketing health claims:
We do a very, very good job of conducting research. And once the research comes out and is published, we use that as the foundation of our marketing, creative materials. We are very, very careful to not make any claims that are not justified by published science and by published data. We try to operate the company in general, as a very conservative one and fundamentally sound one. And what we like to think is a model for how companies should operate in this industry. We see ourselves scientifically as a biotech company. But our product happens to be a consumer product company – consumer product and because it's a consumer product, that doesn't mean we give up an inch on the science.
But it does mean that you have to be very careful in the ways that you market. So because we play by the rules and because we get NDINs from the FDA and we get regulatory approval and we patent our products and we conduct studies and we invest in research and we are very conservative with our messaging. We are at a strong disadvantage from companies out there that are willing to cross the line.
We recently read a warning letter to one such company from the FDA on NMN making false claims about NMN. NMN is a product that doesn't have an NDIN. It's not a legal product in the U.S. technically. But if the FDA doesn't enforce it, what can we do? We are at a disadvantage. If we are going to pay royalties to patent holders like Dartmouth we are at a disadvantage if other companies are just going to infringe on the patents and not pay those royalties or not conduct those science, but that is what we have chosen to do.
We believe in the long run by being a fundamentally sound operation and by communicating that message to our consumers. The brand will resonate with time as a genuinely truly trusted brand. We think we've done a very, very good job of creating a trusted brand as indicated by the very high retention rates that our customers have. But there is no magic bullet. It's just taking one step at a time and operating the business in a very, very strong, fundamentally sound way and then we keep steadily growing steadily improving. (emphasis added)
On the surface Rob says that ChromaDex isn't going to market as aggressively as some would like. But what's interesting, I think, is the reasons for that, which have broader implications.
ChromaDex used to be a white lab coat science company -- wholesale ingredients and analytics. But they fell in with evil companions, and in 2016 Elysium attempted to destroy the company. In 2017, rather than be destroyed, ChromaDex became a direct-to-consumer company focusing on a single product.
Rob is telling us now that the company's original DNA informs the new business model, which means that ChromaDex isn't going to act like your typical get-rich-quick single-product health supplement company that hypes vague bullshit to gullible consumers. There are many such companies, and others that outright misrepresent who they are. And they seem to make good money doing so.
ChromaDex believes there's no future in that kind of behavior.
But ChromaDex's belief is faith-based, not evidence-based. The evidence says that the FDA doesn't enforce its regulations, and the legal system does not punish or even deter infringers.
ChromaDex's faith is that (1) eventually the legal system will catch up with miscreants, and/or (2) eventually the market will reward good actors through familiar market mechanisms like brand-trust and customer-retention.
It's possible, although one could be forgiven for harboring doubts.
Another way to cast the business strategy would be as prudent risk management. The risk of getting punished for over-promising might be medium-to-low, but the punishment for doing so could be severe -- if you only have one brand and one product -- so playing it safe might be the smart move even if another potentially more lucrative but more risky path were available.
However, playing it safe makes all the sense in the world if you think you have a bird in the hand -- a sure path to decent profits -- so there's something to lose. That's why Rob's "conservative" approach to me does not sound timid, but actually sounds very confident. He believes that in the long run there's a pretty big win here, and one of his primary jobs is to not jeopardize that.
If you're an investor, that's music to your ears, because one of the great mysteries for us is whether there's a there there -- we don't have access to the best data on that, but the company does. And they can't share that with us. But this kind of talk is evidence that they believe it in their hearts.
Another peculiarity was Rob's statement that ChromaDex is at a "strong disadvantage" compared to its competitors. Normally companies talk about their advantages over competitors -- we have unique assets, capabilities, etc. So it's weird to hear the opposite, and not as a set-up to some plot twist, but just more like a confession -- the word "disadvantage" was repeated three times.
If I told my CEO that we were making decisions that would put us at a "strong disadvantage" compared to our competition, he wouldn't necessarily broadcast that at an investor conference call. When Rob says that, it's an expression of faith, it's an expression of risk mitigation, it's a plea to the industry to self-regulate or get itself regulated, and I think it's one more thing, too: a moral imperative.
Rob doesn't come from the health supplement industry, but Chairman-and-Founder Frank Jaksch does -- in fact, that's the only place he's ever been. And how did ChromaDex get its start? Measuring. Purity.
You just gotta think that we are hearing the equivalent of Google's "Don't Be Evil" guiding principle.
Google abandoned that principle long ago, which may offer a glimmer of hope for ChromaDex's money-hungry impatient investors.
But for the foreseeable future, this company is going to "Play by the Rules" and "Be a Model for How Companies Should Operate in This Industry," and be "very, very careful to not make any claims that are not Justified by the Published Science" And if investors think that's the wrong strategy, they should get out, because that's just who ChromaDex is. They couldn't say it any louder or clearer.
Oppenheimer's Brian Nagel himself wasn't on the call, but his designee asked three questions: (1) Are ChromaDex's very high gross margins sustainable, (2) When might Tru Niagen become a factor in the fight against COVID-19, and (3) When will ChromaDex begin to put more marketing spend behind Tru Niagen?
I have to think the answers were music to investors' ears, and to Brian Nagel's, too, if he is contemplating a higher target share price.
1. Margins. Kevin Farr said, "Yes, we think that the gross margin improvements are sustainable, and we think there's more opportunities to continue to cut costs...and...it's going to continue to move in the direction that it has been moving is because of the fact that we've got a tailwind from...our DTC business, which has margins over 60%."
Those are just very high margins, which is why the analyst asked about it. Obviously if you can grow sales and simultaneously grow already-high margins, the path to profitability is straight and short.
And for investors unhappy about the product's high price (relative to generic vitamins, not relative to pharmaceuticals), if the industry analysts set a higher share price target because of the margins, that's the reward for sustaining the high retail price. Because if the retail price collapses, so do the gross margins.
2. COVID-19. Frank Jaksch said, "There has been quite a bit of research over the past few months or so that's published essentially showing...NAD under attack in Coronavirus. And we know now mechanistically why that's happening..So it's very similar to the aging story. It's just happening in days rather than in years...We have to do studies confirming the link between nicotinamide riboside's ability to essentially rescue or raise NAD when it's getting knocked down in that coronavirus cell. So those studies are still ongoing...We don't have to prove that NR can raise NAD, we know it does that. ...What we need to do here in connecting the dots is just showing that in this particular model that we can successfully use nicotinamide riboside or Niagen to rescue NAD supply in coronavirus. [Those studies] are underway. We're hoping those will publish as soon as we can get them published."
There's a very subtle shift that Frank makes when he describes what we already knew, what we just learned, and what we must prove.
I am going to paraphrase the above quote, but what Frank said essentially was this: We already knew that Niagen raises NAD in humans. What we just learned is that COVID-19 reduces NAD in humans. What we need to prove is that Niagen raises NAD in humans with coronavirus. And those studies are underway.
So the question for investors is whether there is any plausible scenario where Niagen raises NAD in humans but NOT in humans with COVID-19? Or whether successfully raising NAD in humans with COVID-19 might have no positive effect?
There are actually three possible scenarios here. One is that the presence of the infection prevents replenishment where it would otherwise occur -- for example, by blocking the NR-Kinase pathways. That possibility is very farfetched.
The second possibility is that the coronavirus burns through NAD faster than Niagen can replenish it, so that you end up no better off -- no matter how much Niagen you take, your body cannot absorb it as quickly as the coronavirus can deplete it. That possibility is not farfetched, but it's pretty unlikely.
The third possibility is that coronavirus significantly knocks down NAD, but the diminished NAD levels don't have any negative effect, so successfully replenishing NAD doesn't have any positive effect. Also very unlikely.
So if you are an investor or an analyst, you might be positioning yourself for what's likely to result from those studies that are underway.
3. Marketing Spend. Rob Fried said, "We are constantly measuring the effectiveness of our marketing campaigns...and we hit the gas pedal when we find a vein that works...We hope that those healthcare practitioners and our large and growing customer base, feel compelled to share the information, the special information about Tru Niagen and how it could be helpful, not just with Coronavirus, but with cellular stress in general."
I have mixed feelings about Rob's suggestion that ChromaDex's fans should spread the word. We do that, of course, but it feels like a long slow path. All geometric growth functions start with a long, slow growth period before the explosion. And there is no marketing campaign that is as convincing as the heartfelt recommendation from a trusted friend or family member. But if it's up to us, it's going to take a while.
Rob's phrase "hit the gas pedal" contains some ambiguity -- you could just slightly tap it, or you could floor it. My impression is that they've never floored it because they've never found a vein that warrants that kind of spend.
I say this with no criticism. Big corporations with great marketing campaigns make it look easy, but 99.9% of marketing efforts fail by comparison, and nobody points to all the expensive failures. From a CEO's standpoint, it's a minefield, and one false step blows $1M and your quarter's profit goals.
But more fundamentally, I don't understand the urgency around predicting the scientific results. Suppose that the science eventually shows that Niagen cures COVID and causes you to age backwards. Then the stock will be worth a lot.
Suppose, alternately, that the science shows otherwise. Then the stock will be worth way less.
So what is the benefit of getting out in front of the science? In scenario 1, you realize insane gains a number of months earlier than you would have anyway. So what? In scenario 2, you realize insane gains but then you have to give them right back after the truth becomes clear. What is the benefit in that second scenario, unless you're into pump-and-dump? Nothing.
So in my view, and I think the view of any serious long investor, the gains from getting out ahead of the science are just tiny, and accrue mostly to day traders. We've waited years; we can wait another. The first-expiring patents are still years away from expiring. In the meantime, Kevin Farr is going to ensure steady quarterly growth, so our backup plan is okay, too.
Nothing catches my attention more than ChromaDex people discussing the litigation, although it almost never happens. But yesterday Frank and Rob BOTH weighed in:
Frank said, "The Court of Appeals recently rejected, Elysium’s attempt to overturn the PTAB decision from last year on the 086 patent. So their position looks very weak with regard to these patents. These patents look extremely strong. We're confident in these patents. Not quite sure what their argument might be. We have some indication of that, but we're not completely sure. It's seems like a pretty clear case of infringement on the patents, so we're eager to have that day in court as well." (emphasis added)
That's really interesting. ChromaDex thinks the patents are extremely strong. ChromaDex is confident in the patents. ChromaDex isn't even quite sure what the invalidity argument might be.
That is our view, too, here at right-of-assembly. If we can't evaluate the patents well enough to find them extremely strong or to have confidence in them, at the very least we are not quite sure what the invalidity argument might be. And it could be a long time before we find out if dispositive motions are a year or more away. So it is a great comfort that this notoriously cautious and conservative company would express unequivocal confidence.
Then Rob Fried chimed in.
Rob Fried said, "As you know the trial date was initially supposed to be the first half of last year then it got moved to October. Then in January, it was scheduled for May 12. And then the coronavirus, hit and it got pushed back.
"There is no specific date. We're estimating it's going to be sometime around October, but we don't yet know. And I think - I hope that in June sometime next month, we will be able to set a - finally set a date. That's been a frustration for us. The fact - most of the facts or many of the facts have now come out into the public record. Anyone who bothers to read the public record can see that the facts are fairly clear.
"We're eager for those facts to come out in trial. We find it amazing frankly at this point with all the facts that have come out that there are investors, scientific advisors, frankly even employees that continue to be associated with that company given what has been disclosed into the public record, but it is what it is. One day there will be a trial, a jury will hear the facts, and we're confident in the decision that they will make.
"We are amazed at how this process has gone on. And there have just been delays after delays. It often seems to us that that's the primary strategy of the other side to just find more delays. And to that extent, they've been somewhat successful. There have been delays. But we are confident that this is the last one. The judge in New York seems a little - very eager to get this thing to trial. And based on their public decisions that you can read, you see that they're very, very eager to finally decide this case. In all these cases, this is one of the longest cases on their dockets. So all the judges seem to want to finally get this thing resolved as do we.
Actually Rob missed a step. It got moved from April to July to October before getting moved to May and then taken off calendar again. And Rob was generous to Judge Connolly to not mention that the Delaware proceeding got postponed for 17 months for no reason at all, and then was finally re-started even though none of the conditions potentially justifying the delay had changed.
But Rob is right that all three judges appear ready to move the case along.
And isn't it, indeed, really amazing at this point with all the facts that have come out that there are investors, scientific advisors, and even employees that continue to be associated with Elysium given what has been disclosed into the public record?
I think so.
Although the record is not THAT public. The LA Times or Orange County Register -- ChromaDex's home town newspapers -- have never discussed this litigation once, and the Boston Globe stopped covering it long ago.
And the most eye-popping facts are largely hidden in exhibits attached to motions that are only read by industry and company insiders. ChromaDex must have found out more than a year ago the sordid details of Elysium's machinations, but we have only known since last August, and the truth is that the public still mostly does not know.
So I agree with everything Rob said, and am cheered to hear it -- especially the eagerness to go to trial, which makes perfect sense.
But the most important thing that they said was something that they did not say.
What I am MOST excited by is the complete absence of any reference whatsoever to settlement negotiations.
Someone who I feel certain represents Elysium suddenly reappeared on the Yahoo Finance message board last week in a spasm of ill-advised exhilaration because its attorneys had filed a piece of easily debunked sophistry in Delaware. Here is what that person said: "It is open season on the Dartmouth IP. Good-bye, Chromadex." This appears to be from the same company that was fantasizing four years ago about "destroying" ChromaDex in an "all out war" and "taking control of everything" and feeling thrill in the mistaken belief that "Dartmouth is revoking the patent!" And they still have not let go of the fantasy.
That's why, as an investor, I really, really, really do not want to see a settlement of this litigation. We do not need a competitor in the space who is harboring a multi-year blood-lust fantasy to destroy the company -- especially one with so little regard for the legal process.
Maybe a settlement that entirely removes Elysium's senior management, or gets them out of the health supplement space entirely and moves them into something else, like DNA testing, would be okay. But that kind of settlement is not likely to be satisfactory to Elysium or its investors.
So the legal system must be allowed to complete its work at the best pace it can muster, and not be short-circuited by a short-sighted settlement.
The small consolation we have is that although the wheels of justice turn slowly, they grind exceedingly fine.
And THAT is why this was such a great exchange:
ANALYST: "What is the outcome of the ChromaDex’s conference with the court on May 4?"
Well, that analyst should spend more time reading Right of Assembly, because the complete answer to that question was posted here ON May 4, and all the retail investors already knew the answer. The ONLY topic of the May 4 report was settlement negotiations. That's all there was. The outcome was four paragraphs of text describing ongoing settlement negotiations.
Here's what Frank said in response: "The May 4 conference relating to California was just an exchange of documentation at this point. In June, we will determine what the next trial date is for California."
Sounds like we're all on the same page.