On November 10, 2016, Valeritas Holdings, Inc. (VLRX) reported financial results for the third quarter ending September 30, 2016. Below is a quick review of the Q3 numbers, which I believe show the company is making progress on the commercial front. Although Valeritas still has a way to go before they achieve profitability, things are definitely heading in the right direction.
Total revenues for the quarter were $4.9 million, an increase of 3% over the third quarter 2015. Revenues were slightly above my expectations of $4.8 million. The 3% year-over-year certainly does not sound exciting, but investors need to keep in mind that this growth is coming despite the over 50% reduction in the sales force. Recall, Valeritas restructured its operations to be more capital efficient earlier in 2016.
Starting in early 2013 up until February 2016, the company employed over five dozen sale representatives. In fact, throughout 2015 the company promoted V-Go with up to 64 representatives with an average of 59 territories filled throughout the year around the U.S. The thinking was that to effectively compete against blockbuster products like Lantus® and Levemir®, each which are promoted by over 1,000 full-time reps, V-Go would need to build a sizable sales force.
Unfortunately, while the strategy was effective and ramping up sales and use of the product, the business model was not capital efficient. The gross margin during the third quarter 2015 was only 13% and net loss totaled $26.7 million. In the third quarter 2016, the company averaged only 27 reps and the gross margin was 36%. The restructuring is still a work-in-progress, but year-over-year gross profit increased by 280% and the net loss improved by $17.5 million to $9.2 million.
The strategy going forward will be to focus on fewer high volume territories and drive sales rep productivity. Right now, about 40% of the business is coming from endocrinologists. The other 60% is nurse practitioners, physicians assistants, and general practitioners. On the third quarter conference call management talked about the "Ah ha" moment that happens when prescribers see the benefits V-Go provides to patients - i.e. improved compliance, convenience, and better glycemic control. The challenge is getting the prescribers to try to recommend the device to their patients.
Valeritas has not actively engaged in DTC advertising on V-Go. Nor should they, DTC is incredibly expensive and management needs to spend wisely at this stage. That being said, the company is doing strategic marketing and increasing its efforts around targeted the highest prescribing cohorts to drive sales in the coming quarters. Based on conversations with management, there is tremendous upside in revenues (likely 2-3x) simply by increasing the productivity of the existing prescriber base. Additionally, as the number of units sold increases, management has been able to see the gross margin increase as well.
Operating expenses in the third quarter 2016 were $9.4 million, consisting of $1.2 million in R&D, $8.0 million in SG&A, and $0.2 million in other expenses. This is an improvement of $2.0 million from the third quarter 2015. Going forward, management expects only modest increases in the SG&A line in 2017. I suspect that the company will strategically add sales reps throughout the year and as noted above, the company will continue to do targeted advertising and keep the call details high on the top prescribers, but in order to achieve a profitability management is going to have to keep a close eye on expenses.
Below is a graph showing the operating results over the past seven quarters. Investors can see that operating expenses have come down meaningfully over the past 21 months while gross margin has improved. For the stock to take off, the revenue line needs to start heading up. This is the challenge for the company at this stage - how to grow the top-line without also adding back significant cost.
As noted above, net loss for the quarter totaled $9.2 million. This equated to $0.72 per share. Valeritas exited the third quarter ending September 30, 2016, with $15.5 million in cash in the bank. Net cash usage in the third quarter totaled $4.9 million. At this rate, the company will require new cash to fund operations around the middle of 2017. The current market value is approximately $50 million. With an approved product on the market, I see no reason for the company to not be able to raise new cash in 2017 at acceptable terms.
My Thoughts On The Business
Although not yet profitable on an operating basis, I think Valeritas is heading in the right direction. Management has a clear progression that I think makes sense. To get the revenue run-rate from $5 million per quarter to $10-15 million per quarter, management is focusing on increasing call details and facetime with the top prescribers for V-Go right now. We've all heard the saying, "It's easier to get a repeat customer than a new customer" and that's clearly the low-hanging fruit.
If Valeritas can get endocrinologists or general practitioners to go from writing one script per week, to two scripts per week, revenues can double. If they go to three scripts per week, revenues triple. Right now investors may look at the notion of going from $20 million in revenues to $50 million as a huge leap, but in medical device terms, that type of trajectory inflection is what typically happens after the "Ah ha" moment.
Central to this strategy is increased promotion and marketing around the highest prescribing docs. The company has 28 reps right now. The restructuring earlier in the year took the company from 64 reps to 28 today, but "capital efficient" does not mean "capital scared". I think as management learns where and how to spend they will be far more strategic in 2017. This may include adding reps, but only where there is a direct correlation between spend and revenue growth.
I also think investors need to consider expansion of the business model outside the U.S. V-Go is approved in Europe. One obvious way to grow revenues in 2017 is to launch the product in Europe. Valeritas needs to be strategic in its thinking here. It does not make sense for the company to train and hire a European sales force; but, it might make sense for them to sign distribution agreements where they are supplying product at fixed-transfer prices, receiving cash for upfront orders, and/or earning a royalty on sales. More product being sold means more efficiency on the manufacturing side as well, so I think Europe is a big part of the Valeritas 2017 growth story.
I also think investors needs to consider the pipeline as an avenue for future growth. The first-generation V-Go product on the market is very good, but next-generation products may include wireless transmission to handheld devices and pre-filled devices that save the patients both time and cost on prescription insulin. These are obvious vertical expansions for the company.
I also think the potential for indication expansion exists, as the H-Patch technology on which V-Go is built has applicability into any disease where a constant flow of (subcutaneous) medication might prove advantageous. I can think of CNS indications (Parkinson's, Huntington's), acute and chronic pain indications (opioids, NSAIDs), metabolic indications (thyroid deficiency), or women's health issues (infertility, hormone replacement) where the H-Patch device looks like an excellent fit. I do not think we will see Valeritas make any huge horizontal leaps in 2017, but the potential for business development and collaborative R&D is certainly there.
For 2016, I'm expecting $20.0 million in revenues (Q4 estimate is $5.2 million). I think the cash position is sufficient to fund operations into the middle of 2017. For 2017, I think 20-25% topline growth is achievable. With only a modest increase in SG&A expected in 2017, the burn rate should really start to come down in the coming quarters.
In my next article, I plan to tackle the most important question for investors - What's Valeritas Worth? In the meantime, the current market value of Valeritas, which came public via a public offering in May 2016 is $50 million. Assuming the company reports revenues in 2016 of $20 million (they have reported $14.8 million for the first nine months of the year), the current Price-to-Sales ratio of 2.5X in 2016 revenues looks cheap compared to the average "big med-tech company". This essentially means investors can purchase Valeritas today and any upside to the revenue numbers over the next few quarters should result in outperformance of the stock.
See my detailed overview of the V-Go product >> HERE
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