By Brian Marckx, CFA
Q4 Results / Equity Raise, Beefed-Up Sales Force Heading Into 2017
Valeritas (NASDAQ:VLRX) reported financial results for the fourth quarter ending December 31st. Results were largely inline with our numbers with revenue slightly below, gross margin moderately better, operating expenses a hair higher and EPS almost dead-on with our estimates.
Revenue, at $4.80M, was inline with management’s prior guidance and while down about 1% sequentially, was up by 4% yoy. And while Q4 revenue was about 2% lower than our number, the fact that VLRX again churned out yoy sales growth remains impressive given that the sales force was more than twice the size in the year-earlier period as compared to the most recent quarter.
For the full year 2016, revenue increased 8% - again, despite the massive headcount reductions in the sales team. As a reminder, in an effort to rapidly improve profitability Valeritas recently revamped their marketing strategy to one which now focuses more resources in territories with higher prescribing physicians. The sales force was trimmed from 63 field reps (covering 63 territories) at the end of 2015 to approximately 33 (covering 33 high potential territories) at the end of 2016.
Management noted on the Q3 earnings call that despite the lack of high-touch direct detailing, sales remained fairly robust in these vacated territories which we think explains much of the continuance of yoy revenue growth. Prescription attrition was estimated at only about 10% in these areas, reflecting high levels of physician and patient stickiness to V-Go.
The other factor contributing to revenue growth in 2016 was an increase in average pricing. So while total V-Go prescriptions fell by an estimated 2.6% from approximately 92k in 2015 to about 89.6K in 2016, this was more than offset by a gain in average price of just better than 10% over the same period. The company notes that about two-thirds of all prescriptions are refills, which also can be used as a rough proxy for patient stickiness. We note that the slight attrition in total prescriptions is of no concern to us as we think that mostly reflects the vacated territories. Clearly patient retention appears to remain very robust, particularly as compared to traditional needle/pen insulin therapy which after one year can be as low as 20% - 30%.
Moving on to the rest of the income statement, Q4 gross margin was 37.1% which looks to be a record high. While VLRX did not offer details, we think the increase in average pricing may have contributed to the relatively beefy margin in Q4. For the full year, gross margin was 35.5%, up significantly from 21.3% in the prior year. While management continues to expect gross margin to widen, accounting treatment related to anticipated inventory burn-through will likely result in crimping of GM during the first half of 2017 (this is purely GAAP accounting-related with no cash impact). We look for GM to rebound in the back half of ’17.
Reduction in operating expenses and cash flow and improved operating loss are the other beneficiaries of the leaner sales force. While SG&A jumped about $1M sequentially from Q3 to Q4, a significant portion appears to be some D&A catch-up. Importantly, on an annual basis total operating expenses came way down from 2015 – total OpEx (excluding restructuring costs) were $38.3M in 2016, down 25% from $51.2M in 2015. The trimmed fat, along with gross margin widening and 8% revenue growth pushed operating loss down from $47.3M in 2015 to $31.4M (ex-restructuring expenses) in 2016.
Meanwhile, cash burn also improved. Cash used in operating activities was $5.7M ($7.0M ex-changes in working capital) and $29.7M ($27.8M ex-changes in working capital) in the three and twelve months ending 12/31/2016, compared to $10.1M ($7.8M ex-changes in working capital) and $40.9M ($41.2M ex-changes in working capital) in the comparable year-earlier periods.
Cash / Equity Raise / Debt Amendment
VLRX exited 2016 with $9.9M in cash on the balance sheet. In late March 2017 they closed on a secondary public equity raise, selling $52.5M worth of common shares – which after selling expenses and fees netted VLRX about $48.3M. This followed an 8-for-1 reverse stock split which was affected in order to gain compliance for uplisting to Nasdaq.
Cowen and Co. and Wedbush co-lead the offering. The shares priced at $10/each, a substantial discount to the ~$28/share price they traded at following the reverse split. While we are disappointed by the pricing, the raise not only significantly beefs up the cash balance, providing what we think should be a runway of at least 18 – 24 months, but also substantially relaxes the debt burden. Concurrent with the equity raise, VLRX converted 50% of the total $55M in outstanding debt into preferred stock. And while the debt-to-preferred conversion will not have an immediate significant positive impact on reducing cash-related debt servicing (given that the debt interest was PIK), amendments extending by one year the final maturity as well when cash interest payments begin on the remaining debt balance will provide additional flexibility and liquidity down the road. Additionally, the minimum cash balance covenant was reduced from $5M to $2M.
Expect Return To Sequential Revenue Growth in 2017
While revenue grew on a yoy basis every quarter in 2016 as well as for the full year, the topline incrementally slid the last three quarters of the year. Almost certainly much of this had to do with the hangover of shedding lower performing territories (i.e. lower volume prescribers). From the end of Q3 ’16 to today VLRX increased the sales force from about 28 reps to ~45 (which is where it is expected to remain through the end of 2017) as they began implementation of a more refined sales and marketing strategy.
Marketing strategy aimed at prompting patients to engage their physician about V-Go…
They have seen early success with a higher-touch sales strategy – that is, spending more time calling on higher-prescribing accounts. Supplementing this they will be rolling out more patient-centric marketing initiatives focused on building awareness among insulin-experienced (i.e. those currently using pens/needles) type 2 diabetics about the benefits of V-Go including improved insulin compliance, lower insulin usage and better patient outcomes.
Given that it is often challenging to change physician prescribing habits, including their choice of insulin delivery, clearly the goal is to prompt patients currently using pens/needles to ask their physician about V-Go. The challenge with motivating physicians is that they have limited time to meet with patients and engaging in discussions about new and novel therapies is often time consuming (particularly if there is a training component involved) and therefore often not addressed. VLRX’s marketing strategy is essentially aimed at doing an end-around the physician and straight to the patient which has the influence to prompt discussion about new therapies such as V-Go.
Management noted that these targeted marketing programs will include email, direct mail, search-engine optimization and physician office literature, among potentially other initiatives. While these are new programs that the company is rolling out, we expect these to be cost-efficient and potentially offset by elimination of legacy marketing activities and related costs.
International Expansion Could Offer Complementary Revenue Opportunity…
Along with being FDA-cleared, V-Go is also CE Marked, allowing it to also be sold in Europe as well as other territories that recognize that designation of regulatory and marketing approval. While VLRX has spoken only relatively sparsely about potential international expansion, we think it remains on their radar and alluded to it again on the Q4 conference call. If and when that happens, we expect it would be via distribution agreements which, while likely not quite as profitable at the margin as compared to direct sales, all but eliminates any downside risk and could afford relatively rapid and broad geographic coverage in parts of Europe. This will be something we hope to hear updates about in the future, particularly as international expansion could provide upside to our current model.
J&J’s OneTouch Launch Could Actually Benefit V-Go Adoption…
We also note that Johnson & Johnson (JNJ) recently announced that they expect to launch their OneTouch Via mechanical patch pump in 1H 2017. While a direct competitor to V-Go (in fact OneTouch will be the only other pure mechanical insulin patch pump on the U.S. market), we think the OneTouch launch could actually benefit V-Go adoption, particularly if JNJ puts a national DTC marketing campaign behind it. While that may sound counterintuitive, we think JNJ’s marketing muscle, reach and budget can provide greater awareness to the (still very novel) patch pump category – the tails of which VLRX may be able to ride on, particularly if it helps prompt more patient-physician engagement about insulin patch pump options.
As we have noted in our ongoing coverage of VLRX, we see several advantages of V-Go relative to OneTouch including that, unlike V-Go, which delivers both basal and bolus doses, OneTouch Via provides only on-demand bolus doses (at the touch of two buttons). We view this as a significant competitive drawback of OneTouch Via given the clinical (such as greater A1C lowering efficacy) and other (such as less insulin used) benefits of continuous insulin delivery. It also means that OneTouch users on multiple daily injections (i.e. pen/needle users) must go through the extra step of manually injecting long-acting insulin (and tote those supplies). And finally, in terms of reimbursement and cost, a patient using OneTouch Via would have three co-pays, one each for the device, bolus insulin and whatever form of basal insulin they use.
Clinical Data Continues To Support Health Benefits of V-Go vs. Pens/Needles
Valeritas remains very active in adding to their clinical evidence database supporting the clinical and economic benefits of V-Go, particularly as compared to traditional insulin delivery methods. Clinical evidence continues to show V-Go more effectively controls A1C than insulin pens/needles and does so with lower insulin doses.
Most recently, data from a retrospective study comparing V-Go to traditional insulin delivery in nursing home patients was published in the January 2017 issue of the Journal of Gerontological Nursing. The study, which included 1,937 blood glucose levels of eight nursing home patients collected over 61 days showed V-Go was not only associated with highly statistically significant superior blood glucose lowering efficacy and control as compared with needles/pens, it also reduced the time consumed by nursing home staff to administer insulin and lowered the related cost (as compared to traditional insulin delivery).
Specifically, V-Go patients exhibited significant improvements in the amount of time that A1C remained in the recommended range (V-Go 59.1% vs. traditional 34.0%, p<0.001), reduced blood glucose fluctuations (p<0.001) and improved mean daily blood glucose (p<0.001). In addition, estimated A1C change among the V-Go cohort fell from 8.9% to 7.2% while the traditional insulin cohort exhibited an increase from 9.0% to 9.4%. Relative to staff time and cost, V-Go decreased the average amount of staff time required for insulin administration by 26 minutes per patient per day and related labor cost by almost $329 per patient per month.
We value VLRX at approximately $20/share. See below for free access to our updated report on the company which includes our financial model and valuation methodology.
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