Reviewing Arena Pharmaceuticals' Q2 Results: Insights From The Conference Call

| About: Arena Pharmaceuticals, (ARNA)

A company's conference call is a great way to see just what is going on and what the company plans to do in the quarters and years ahead. It is essential to listen to what management has to say. And when the company in question is as debated (for better or worse) as Arena Pharmaceuticals (NASDAQ:ARNA), it becomes even more important. On August 9, Arena posted its Q2 2012 results, and there was much to discuss, and we delve into those earnings below. For the record, unless otherwise noted, the financial data and management commentary used will be sourced from either the company's Q2 earnings release or its conference call.

Overview And The Financials

Given the fact that Arena is still preparing to launch Belviq, its numbers this quarter mean little in the grand scheme of things. The company posted a loss of 12 cents per share on revenues of $21.977 million, which includes a $20 million milestone payment from Eisai. Arena's results included a $16.77 million charge related to the revaluation of the company's derivative liabilities. While the company's earnings for this quarter mean little, it is important to see what the company has to say regarding its outlook for 2012 and beyond.

Arena ended the quarter with $143.811 million in cash and equivalents on the balance sheet, and expects to end 2012 with $215 million in cash and equivalents. That guidance includes a $65 million payment from Eisai relating to when the DEA completes its scheduling of Belviq (the pharmacology of Belviq warrants its labeling as a controlled substance). While Arena does expect scheduling to be completed by the end of 2012, that may not be the case, and that payment may be pushed into 2013. Arena's guidance implies that the company will receive just over $6 million in cash from other sources. Arena's revenue guidance for all of 2012 comes in at $94 million at the midpoint. In Q3 and Q4, revenues will accelerate substantially, for the company has recorded just $24.166 million of revenues for the first 6 months of 2012. That revenue guidance, however, is tied to the Eisai milestone payment for the DEA's scheduling process. But investors need not worry about that. The payment will arrive, it is just a matter of which exact quarter it is in. What is more interesting, however, is Arena's R&D expense guidance. Arena is expecting R&D expense of $62 million at the midpoint of its range, and had R&D expense of $28.546 million so far in 2012. That implies an acceleration in R&D spending for the remainder of 2012, the implications of which we will discuss a bit later.

Belviq: Manufacturing And Regulatory, and Market Developments

Arena is readying itself for the next stage of its corporate lifecycle and management sounded upbeat on the conference call (investors must always remember that with management what they say is often less important than how they say it). CEO Jack Lief reiterated Arena's plans to launch Belviq in early 2013, and noted that the company has patent protection in most major markets through 2023, but that it has filed an extension for its U.S. patent that should extend protection to 2026. Arena has 2 regulatory filings pending around the world, in Switzerland and the European Union. Craig Audet, Arena's head of regulatory affairs, provided an update regarding one of them when he spoke on the company's conference call.

The CHMP (Committee for Medicinal Products for Human Use), Europe's version of the FDA, has released its 120-day response to Arena's filing. And in our view, the response is a net positive, albeit in a slightly roundabout way. The CHMP raised several issues, with 3 standing out as key concerns: the incidence of tumors in rats, the dropout rate of patients in Arena's clinical studies, and the incidence of valvulopathy. Those 3 issues are the ones raised by the FDA prior to its approval of Belviq. And it can be argued that if Arena could successfully explain them away to the FDA and gain approval for Belviq in the United States, it should be able to also explain them away to the CHMP. Craig Audet said that the company expects a decision regarding Belviq within the first half of 2013 from the CHMP.

Arena will be manufacturing Belviq in Switzerland, and as part of its 2008 buyout of that manufacturing facility, the company received a 10-year tax break, which will begin when the company starts manufacturing Belviq, according to CFO Robert Hoffman. And while Arena's main focus is currently on preparing to launch Belviq in the United States and its filings in the EU and Switzerland, those are not the only markets that Belviq is being targeted for. Analysts quizzed the company on where Arena and Eisai are looking to in terms of future markets. The expanded agreement between Arena and Eisiai covers most of North and South America. And CEO Jack Lief stated on the call that Canada, Brazil, and Mexico are 3 of the markets that Eisai has put at the top of its list of potential future markets (for those unfamiliar with the Arena-Eisai deal, in its essence it states that Arena will sell Belviq to Eisai, which will then be responsible for marketing and selling the drug to end-customers. Arena will then receive a certain percentage - it varies depending on the markets - of those sales).

Analysts asked the company about its plans for finding a partner for Belviq in Europe, and CEO Jack Lief responded that while Arena is talking with multiple companies, there is no rush to do a deal. In our view, the simplest solution would be to just partner with Eisai, and expand the current agreement between the companies to cover Europe as well. That, however, begs the question of whether or not Arena even needs a partner. After all, Vivus (NASDAQ:VVUS) is launching Qsymia on its own. We think that Arena should indeed find a partner for its European operations. The company's structure is already built around the model it currently has with Eisai, and it makes no sense to run the company in two different ways, with Arena and Eisai responsible for marketing Belviq in different countries. It is better to choose one approach and stick with it, unless there is a valid reason to scrap the deal with Eisiai. And from what we have seen so far, there is no rationale for doing so. Eisai has been a productive partner, and should be for many years to come. Arena has been silent on the issue of pricing, and has consistently stated that it will announce pricing once the DEA finishes its review and Belviq launches. Vivus, Arena's competitor in the weight loss sector, has also declined to provide a price for Qsymia.

Arena's Pipeline: A Free Call Option

Most biotechnology companies live and die based on their pipelines. But for years, that has not been the case for Arena. Investors, as well as the company itself, have focused on nothing but Belviq. But with Belviq now approved in the United States, the company's focus may turn to its pipeline. Already, a change in management's stance is evident. CEO Jack Lief spoke much more about Arena's pipeline than he has in past conference calls, and we believe that in the quarters to come, there will be a much bigger focus on Arena's pipeline. Currently, investors have not assigned any meaningful value to the company's pipeline, but that may soon change.

To be fair, Arena's pipeline compounds are in very early stages of development. APD811 is the farthest in the clinical trial process, and it is in Phase I trials. Arena has 4 compounds in its pipeline.

In this regard, Arena is solidly ahead of Vivus and Orexigen (NASDAQ:OREX). Vivus' pipeline consists of just 2 studies, and both are new indications for Qsymia, for sleep apnea and diabetes. Vivus' saving grace is that both are in Phase II trials, and that the company has another approved drug on the market, Stendra, in addition to Qsymia. And Orexigen's pipeline is the weakest of the 3 major weight loss companies. Its pipeline consists of only 2 compounds, one of which is Contrave. The other is Empatic, another weight loss pill, which is in Phase II trials. And while Arena's pipeline is in much earlier stages than those of Vivus and Orexigen, it is the most diverse, which is what matters in the long run.

CEO Jack Lief stated on the conference call that Arena will be prioritizing 2 of its pipeline compounds going forward, APD811 and APD334. APD334 is set to advance into the clinical stage this year, and APD811 will move into Phase Ib trials in Q4 2012. CFO Robert Hoffman stated on the call that of Arena's $62 million in projected R&D expenses for 2012 (at the midpoint of guidance), $6 million will be dedicated to the company's pipeline, with the rest going towards Belviq. In 2013, however, that may change. As Belviq begins selling and Arena begins receiving more and more cash, it is likely that Arena will accelerate its R&D spending on its pipeline, which we think will be a catalyst for the stock, for it will turn investor attention to the company's pipeline in a much more meaningful way. In our view, Arena's pipeline is a free call option. Currently, it has virtually no presence in the valuation models we have seen for Arena, and once it does, the potential upside becomes greater, in our opinion.


The executives of Arena Pharmaceuticals sounded upbeat on the company's Q2 conference call. They are confident about Arena's positioning, and so are we. The company, as well as Eisai, are preparing for Belviq's launch, and in the next few years, we believe that the drug's addressable market will expand substantially as Belviq is approved in new markets. And in the second half of 2012, and especially 2013, the stage is set for a renewed focus on the company's pipeline. For long-term investors in Arena Pharmaceuticals, the stage is set for a profitable journey.

Disclosure: I am long ARNA, VVUS, OREX.

Additional disclosure: We are long ARNA, VVUS, and OREX via the SPDR S&P Biotech ETF and the iShares NASDAQ Biotechnology Index Fund.