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VLRX: New High-Touch Strategy Showing Early Successes

05/24/2017
By Brian Marckx, CFA

NASDAQ:VLRX

Q1 Results / High-Touch Strategy Showing Early Successes, Expect Sequential Growth Throughout 2017  

Valeritas (NASDAQ:VLRX) reported Q1 financial results and provided a business update.  Relative to our estimates, revenue was almost dead-on, gross margin meaningfully wider (and what looks to be an historic best) and operating expenses higher.

Revenue, at $4.61M, was down 8% yoy, 4% lower than Q4 2016 and inline with our $4.63M estimate.  The yoy revenue contraction was attributed to a decline in the size of the sales force as well as weakness in the overall insulin market.  

Specifically, the sales force in Q1 2017 averaged 34 reps, or 15% less than the 40 averaged in Q1 2016 as VLRX vacated low performing territories and consolidated resources around higher prescribing accounts with their high-touch sales and servicing strategy.  While the vacated accounts were largely inefficient to service, their attrition nonetheless resulted in a ~10% decrease in total V-Go prescriptions – that was partially offset by a 2.4% net increase in average pricing.  Relative to the U.S. insulin market, management noted on the call that total prescriptions fell 9% in January and 15% in February 2017 as compared to the same periods in 2016.   

Gross margin, at 37.6%, was certainly a highlight and up from 34.2% and 37.2% in Q1 and Q4 of last year, respectively.  This is also the widest GM among VLRX publicly available financials.  Management has consistently noted that they expect GM to continue to improve as a result of manufacturing efficiencies and other expense containment measures and those activities appear to be bearing fruit.  While GM will contract in Q3 this year as a result of inventory burn-through (carried at a higher cost), that incremental expense should be non-cash.  VLRX continues to guide for gross margin to also benefit from higher production volumes as revenue accelerates and expects GM in Q4 to best that of the comparable prior year period (which was a relatively beefy 37.1%).  Longer-term, management believes they can now achieve 50% GM at a quarterly revenue level of approximately $13M. 

Meanwhile operating expenses moved up to $12.0M in Q1, compared to $9.7M and $10.1M in Q1 and Q4 2016, respectively.  An increase in stock-based compensation in the amounts of ~$840k (vs Q1 2016) and ~$970k (vs Q4 2016) accounts for much of the relative increase.  We model OpEx to remain flattish to Q1 through the remainder of 2017 as incremental expense related to additions to the sales force are offset by expectations of comparably lower stock compensation.  However, control over operating expenses will be key to improving profitability going forward – which in-turn will largely hinge of the efficiency and productivity (i.e. revenue per rep) of the sales force.  

As it relates to that, early indications are that the newly implemented high-touch sales process may be resulting in greatly improved productivity – with management noting on the call that many of their highest prescribing accounts were those with more sales rep visits and serviced with a more ‘hand-holding’ (our word) type approach.  As such, and assuming further roll-out of the high-touch and higher service strategy continues to result in an overall improvement in productivity, growth in revenue should outpace that of operating expenses.  

Cash 
Cash used in operating activities in Q1 was $8.0M ($8.5M ex-changes in working capital), compared to $10.9M ($7.4M ex-changes in working capital) in Q1 2016 and $5.7M ($7.0M ex-changes in working capital) in Q4 2016.  Cash balance, bolstered by the $48.8 (net) equity raise in March, was $51.8M at Q1 quarter-end.  At the current burn rate (~$8M/qtr), this represents approximately 19 months (or through ~October 2018) worth of operating capital. 

The equity raise not only provided a substantial operating runway, it also substantially relaxed the debt burden.  Concurrent with the equity raise, VLRX converted 50% of the total $55M in (then) outstanding debt into preferred stock.  And while the debt-to-preferred conversion does 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 provided additional flexibility and liquidity down the road.  Additionally, the minimum cash balance covenant was reduced from $5M to $2M. 

Weeding Underperforming Accounts, High-Touch Strategy Aimed at Accelerating Adoption

VLRX slashed the direct sales force from 64 in January 2016 to 37 as of the start of 2017 – the massive headcount reduction followed the decision to abandon underperforming accounts that were inefficient to service.  The relatively few prescriptions written from these offices were not worth the cost and effort to target.  Instead VLRX refocused with a higher-touch sales strategy on higher potential prescribers.  This higher-touch approach, as described by management, is more fully-encompassing as it relates to facilitating adoption of V-Go.  This includes educating not only the prescribing physicians on the benefits and use of V-Go but also addressing responsibilities of other patient-centric personnel, such as help in navigating any reimbursement-related nuances.  

Given the novel nature of V-Go, it may be that it takes a more in-depth and comprehensive amount of hand-holding at the physician-office level to spark adoption.  This may already be taking hold, however.  As noted, many of the current highest prescribing accounts are those that have had exposure to the higher-touch servicing approach.  And while the lack of revenue growth may not necessarily suggest traction in either adoption or prescription growth, other metrics, which management shared on the Q1 call, might.  

Specifically, VLRX noted that the eight territories which were detailed with the same sales reps throughout 2016 and through Q1 2017 (i.e. “stable accounts”) saw a 6% increase in revenue from 1H 2016 to 2H 2016.  As a reminder, VLRX began implementation of their new sales strategy around mid-2016, which cut the number of accounts that each rep was responsible for calling on from 60 down to 30 (“targeted accounts”).  Average revenue growth of these targeted accounts (i.e. targeted with the new high-touch sales model) was even stronger – up 10% from 1H 2016 to 2H 2016.

These metrics also certainly seem to support that the high-touch approach is resulting in revenue growth and, by extension, prescription growth and likely higher rates of adoption.  And, importantly, these “same-territory sales” are also a measure of efficiency and production as intuitively it should be less costly to service those accounts where the in-depth (mostly initial) hand-holding is no longer necessary.  As such, we think these metrics provide important insight into fundamental operational performance, particularly during the transition from a more shotgun sales approach with each rep detailing to a large number of accounts, to a strategy focused on a more select number of high potential prescribers.  

Q2 will be the first full quarter with the new sales strategy in place.  And with 48 reps on-board at the start of the quarter (with expectations this will average ~45), compared to an average of 34 throughout Q1 2017, we expect sequential revenue growth throughout 2017 with greater acceleration in the back half of the year.  Productivity gains from new reps should be the low-hanging fruit in terms of driving near-term revenue growth.  Longer-term, the ability of the sales force to successfully convey the clinical and lifestyle benefits of V-Go as compared to MDI will be key.  The high-touch approach appears to be bearing fruit in that regard, although the next few quarters should provide even greater insight.   

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.  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.     

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 and associated cost.  

The benefits of V-Go were on display during two clinical data-related presentations at the International Society for Pharmacoeconomics and Outcomes Research (ISPOR) annual meeting yesterday (May 23rd).  One study showed that among 86 patients who had difficulty controlling A1C and switched from MDI to V-Go, average A1C levels fell by 1.2%, daily insulin dose fell 44% and average monthly costs fell by $146.  

The other study compared treatment outcomes and costs between study sites using V-Go versus those using other type 2 diabetes therapies.  Results showed that the V-Go study sites had a larger decrease in average A1C (-1.015% vs. -0.377%) and lower average per patient cost ($30.59 vs. $32.60).    

Relative to recent publications, 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 .     

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