Arena Falls On Quarterly Results

| About: Arena Pharmaceuticals, (ARNA)

It may not have made me very popular with Arena (NASDAQ:ARNA) retail longs, but my article this morning spelled out that the sales numbers were not likely to impress the Street when Arena announced its quarterly results. After hours, Arena is trading down about 4% to around $6.50.

As I said, the company will focus on the positives and accentuate them as much as possible. That is what any company would do. The difference here is that the lead product, Belviq, is not yet delivering the type of sales numbers that will take Arena to the next level. As each respective quarter passes without compelling sales results, the Street begins to lose interest and patience. It is simply the way these things work. That does not mean that the potential reward has vanished. It simply means that the influx of potential investors may now have focused their attention and dollars elsewhere for the time being. Concrete results can bring investors back in a hurry. As yet we do not have concrete results. We do still have potential.

Arena recognized $2.4 million in product revenue related to Belviq in the fourth quarter of 2013. The company has recognized $5.7 million since the June 2013 launch. Arena reported a loss of 11 cents per share in the quarter, and an overall 2013 loss of 9 cents per share.

One big focus of many retail investors is the cash and cash equivalents that Arena has. In particular, there seems to be an overall focus on the sums generated from the collaborative agreement with Eisai. I have fielded many questions about this money and how it impacts the bottom line. Investors should understand that the cash exists, but how it is booked can and does impact the financials.

Arena is amortizing the collaborative agreement money. This places the money into the deferred revenue line in the financials. Deferred revenue is actually a liability on the balance sheet. The money exists, but from an accounting standpoint is a liability. Essentially, deferred revenue is money that has not yet been earned. If, as an example, Arena failed to live up to its end of the deal, the money would then have to be returned. Until it is earned, it is not revenue. A quick and simple example:

If you pre-pay for $120.00 for 12 months of a magazine subscription, the company has $120 in its bank account. However, the company has not yet earned the money. The company owes you 12 magazines delivered to you on the first of the month. If the company does not live up to its end of the deal, it will need to refund you money. In month 0, the full $120 is in deferred revenue. In month 1 $10 is removed from deferred revenue and place in revenue. In month 2, another $10 is removed from deferred revenue and placed into revenue. This process continues month after month until the company has fulfilled its obligations.

In the case of Arena, there is now about $139 million in deferred revenue. As each month passes, Arena will take some money from collaborative payments and apply it to the revenue line. In the past quarter, almost $3.5 million dollars was moved from deferred revenue to revenue. This is why you do not really see the $60 million payment in the earnings. It is not that it does not exist. It is how GAAP accounting works.

What I have stated about one time payments received or one time expenses is that they do not really tell the story of the company performance. This is why such events are oft not really considered by the Street. Yes, they can carry a temporary impact either up or down, but they do not tell you if the company is doing well or not.

The story with this latest quarterly report is not the pipeline, not the potential, and not the numbers in and of themselves. The story is the Street beginning to asses when the tide will turn on sales and how big or small the market for anti-obesity pills is. Between Vivus (NASDAQ:VVUS) and Arena, the net sales of these pills was about $5 million per month in Q4. Arena's share of that $15 million net sales quarter was $2.4 million or about $800,000 per month. Simply stated, these types of numbers do not yet excite the Street. Again, this does not mean that the potential has evaporated, but certainly some of the excitement and enthusiasm has.

Arena did offer up some guidance for 2014. Arena expects that the majority of revenue will be from its share of product sales. On top of that, the company expects about $17 million from milestones, recognition of revenue from milestones, and manufacturing. Essentially, that points to a minimum of $18 million from product sales (or at least $35 million in overall revenue). Investors should consider that $18 million just a starting point is assessing Arena's share of 2014 potential of Belviq sales. The company anticipates between $90 million and $98 million in research and development expenses. Operations are expected to cost between $30 and $36 million, and capex could approach $10 million. All told, expenses this year should be between $130 and $145 million, or about $12 million per month.

In summary, the quarter spoke to potential, but the Street wants to see some of that potential beginning to be realized. The guidance offered should be helpful for investors and analysts to assess the company expectations better. The cost side of 2014 should now be well understood. The revenue side is still a big question mark, but at least has some flavor. The next bit of news on tap is weekly prescription data. Those numbers need to show some good improvement, or the equity will find it difficult to move up beyond the recent highs of the last few weeks. So far in Q1, sales are tracking about 15% better than Q4. That will not be enough to excite the Street. Stay tuned!

Disclosure: I am long ARNA. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I have no position in Vivus.