Arena Pharmaceuticals (NASDAQ:ARNA) beat the street by an impressive $0.14 per share. Some investors were thrilled with the news, but more experienced investors saw the quarter for what it was and removed the one-time event to look at this quarter from a business perspective. During the quarter, Arena sold $33 million worth of stock in Taigen. That $33 million alone accounted for $0.15, and thus represented even more than the delta between the expectations and the reported EPS results.
If we remove the $33 million sale from the equation, we are looking at a quarter where the loss was $25.8 million or ($0.11) per share on a fully diluted basis, or ($0.12) per share on a basic count basis. Those numbers were in line with what I expected prior to the call. However, the way that these numbers were arrived at will still raise a few eyebrows.
- The revenue from Belviq sales was lighter than I anticipated. I was looking for $4.1 million in revenue from Belviq sales. The company reported revenue of $3.5 million. The delta in the number is likely attributable to a substantial increase in free prescriptions during the period. As a result, I will shift my model from a 5% upward adjustment on IMS sales figures to no adjustment.
- The revenue from the Eisai collaborative agreement was an impressive $8.5 million. This was about $5 million higher than I had estimated. To say that I missed on my estimate in this section is an understatement. I missed badly. The reason for this miss is interesting, however. Of the $8.5 million, a whopping $6.6 million is actually reimbursement from Eisai for the cost of the phentermine and smoking trials. That is correct... Arena paid the cost of the trial, and Eisai reimbursed Arena. This then got counted as revenue. A pretty slick arrangement, to say the least. Even with that said, I would have missed the Eisai collaborative revenue in the other direction if we remove that delta. I was anticipating $3.4 million in this category. The category would have had $1.9 million if we remove the reimbursements counted as revenue.
- I anticipated that manufacturing services would have been $450,000. The company did an impressive $578,000.
- On the cost side, I expected the spend to be $35.4 million. The actual spend was $38.2 million.
The bottom line is that I overestimated revenue and underestimated the spend side. That means that the performance was worse than what I considered to be realistic expectations. That is not to say that the train has fallen off of the rails, but it should make investors stop and assess the quarter from a business perspective.
Prescription sales of Belviq were up about 43% on a quarter-over-quarter basis, while revenue was up just 22%. This indicates that the net price is coming down and the free trials are driving prescription numbers, but not revenue numbers. In concept, the free trials deliver POTENTIAL front-end growth. Whether that potential can be converted into paying patients is another matter that we will need to watch closely.
If we were to take the $3,529,000 in revenue in the quarter and divide it by the 110,000 scripts sold in the most recent quarter, we get Arena realizing about $32.08 per reported script. Last quarter, the numbers were $2,882,000 in revenue divided by 77,000 in scripts sold for a per bottle number of $37.43. Clearly, a big factor in the growth came as free samples. That is not necessarily a bad thing, but we do want to keep an eye on it. It is good if the freebies convert to paying patients. It is bad if people are not converting.
What we had this quarter was average script price dropping, while expenses were increasing. This is typically not the position that investors want to see. The exception is that the costs are rising in hopes of developing the pipeline, while the average price per bottle of Belviq is decreasing in an effort to drum up more future paying customers. Had doctors, consumers, and insurance companies embraced weight loss pills (or more specifically, Belviq), we would have a little less concern with the downward shift in per bottle price.
In shifting to cash and cash on hand, we can see that the company sold off a big chunk of its Taigen investment. That sale delivered $33 million. At the end of Q1, Arena had $203 million in cash and a Taigen investment worth $53 million, for a total of $256 million. At the end of Q2, the cash line went to $201 million, while the Taigen investment went to $18 million, for a total of $219 million. All things considered, the cash situation went from $256 million to $219 million, a loss of $37 million in liquidity in one quarter. Now that it is blatantly apparent that Arena is very willing to sell off its Taigen stock, the cash situation gains a quarter or two of reprieve. In my opinion, the company will finish the year with about $150 million in liquidity.
It was previously my belief that the Taigen investment would be used as a safety net of sorts. I felt that if the conditions were correct, that the Taigen investment would be held for strategic use to delay the need to raise capital. As it turns out, such a strategy is now off of the table. Thus, the need for capital has shifted from a concern in the next 6 to 12 months to one that is 12 to 18 months out. Should Belviq sales ramp up substantially (at least 5 times higher than we currently have), or a pipeline deal is struck, the need to raise capital would get minimized. However, it is better to raise capital prior to the actual need than to wait. The street will be watching sales and pipeline development to assess whether the cash on hand will be sufficient.
From a headline standpoint, the most recent quarter looked great. From a fundamental standpoint, the most recent quarter is yet another example of having to bet on potential rather than concrete performance. Belviq sales are slower than expected. Free trials are carrying a bigger percentage of the overall number than they should be, and refill numbers are not as robust as we want to see in order for the street to have confidence at this stage. Reasonably, we should have expected the launch of television ads to create an influx of free trials. What we want to watch for now is that the dip in average revenue per bottle levels off.
In my opinion, analysts will be assessing sales figures closely, as well as data that can relate to the number of free trials and the average time that a patient is spending on Belviq. Arena has been dodging, ducking, and sidestepping these two questions for quite some time now. If the numbers were good, it would not need to duck the questions. Anecdotal data suggest that Belviq is not as sticky as one might hope. In 2014, it took 16 weeks for total scripts to double. It took 10 weeks for new scripts to double, and it took 22 weeks for refills to double. With front-end growth being just above over the last 7 weeks, the impact to the trailing refill line will be showing for quite some time still.
In my opinion, Arena is still a story about potential. Thoughts of blockbuster should be placed where they really belong. That event is in 2017, at the earliest, and could even be a few years beyond that. Yes, there is smoking potential, phentermine potential, and pipeline potential, but consider the potential value that was assigned to Belviq as a standalone weight loss drug in 2011 and 2012 vs. where we are today. With Orexigen (NASDAQ:OREX) possibly entering the space in September, and a few other players still waiting in the wings (some with really impressive investors), the landscape will get more challenging before it gets easier. As long as you understand the potential and the risk, you should be well-grounded in your thesis. Stay Tuned!
Disclosure: The author is long ARNA. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I have no position in Orexigen.