Heron Therapeutics, Inc. — Q3 2018 Form 10-Q Summary
Business context and reporting period
Heron is a commercial-stage biotechnology company developing treatments for chemotherapy-induced nausea and vomiting and postoperative pain. The filing covers the unaudited three and nine months ended September 30, 2018, compared with the corresponding 2017 periods.
- Commercial products: SUSTOL, launched in October 2016, and CINVANTI, launched in January 2018.
- Pipeline: HTX-011, an investigational extended-release bupivacaine/meloxicam formulation for postoperative pain. Heron submitted an NDA to the FDA and had received Fast Track and Breakthrough Therapy designations.
Financial performance and liquidity
| Metric | Q3 2018 | Q3 2017 | 9M 2018 | 9M 2017 |
|---|---|---|---|---|
| Net product sales | $19.8 million | $8.6 million | $48.6 million | $20.7 million |
| Cost of product sales | $7.6 million | $1.1 million | $15.9 million | $3.3 million |
| Gross margin | 61.7% | 87.7% | 67.2% | 84.3% |
| Research and development | $30.4 million | $28.8 million | $100.1 million | $90.8 million |
| General and administrative | $7.3 million | $6.5 million | $20.5 million | $19.4 million |
| Sales and marketing | $16.3 million | $13.5 million | $44.6 million | $39.9 million |
| Net loss | $38.3 million | $41.9 million | $129.3 million | $135.0 million |
| Net loss per share | $0.49 | $0.77 | $1.81 | $2.55 |
| Operating cash flow | Not separately provided in the statements | Not separately provided in the statements | $(158.3) million | $(123.2) million |
Q3 sales increased 131% year over year, while nine-month sales increased 135%. Q3 gross profit was approximately $12.2 million and nine-month gross profit was approximately $32.7 million. The lower gross margin primarily reflects the greater contribution of CINVANTI and the capitalization of its manufacturing costs after FDA approval.
As of September 30, 2018, Heron had $53.9 million of cash and cash equivalents and $310.9 million of short-term investments, or $364.8 million in total. Total assets were $470.9 million, compared with $234.3 million at December 31, 2017. Inventory increased to $31.4 million from $10.1 million.
Heron used $158.3 million in operating activities during the first nine months, including $21.5 million invested in inventory and $11.8 million in accounts receivable. Financing activities provided $354.5 million, primarily from $363.1 million of net proceeds from two common-stock offerings and $15.8 million from option exercises. Investing activities used $286.9 million, mainly due to net purchases of short-term investments.
Debt and capital structure
- The $25.0 million related-party promissory note, plus accrued interest, was repaid in August 2018.
- Convertible notes had a $6.6 million principal balance and a $4.3 million carrying value at September 30, 2018, after a $2.3 million debt discount. The notes bear 6% interest, mature in 2021, are secured by substantially all assets and were convertible into approximately 8.3 million shares.
- Potential conversion of the convertible notes would create substantial dilution; the filing estimates approximately 8.35 million shares, or 9.7% of outstanding shares after conversion.
- Accumulated deficit was $911.2 million at September 30, 2018. Management stated that available cash, cash equivalents and short-term investments should fund operations for at least one year from the filing date.
Material changes versus the prior comparable period
- Product mix changed materially: Q3 2018 CINVANTI sales were $16.4 million and nine-month sales were $32.8 million; there were no comparable CINVANTI sales in 2017. SUSTOL sales were $3.4 million in Q3 and $15.8 million for nine months.
- SUSTOL pressure: Management reported that generic palonosetron entered the market in Q1 2018 and is expected to negatively affect SUSTOL provider demand for several quarters.
- Expenses increased: Nine-month R&D rose 10% to $100.1 million, driven mainly by a $15.5 million increase in HTX-011-related costs. Sales and marketing increased 12% to $44.6 million.
- Loss per share improved: The nine-month loss declined to $1.81 per share from $2.55, aided by higher revenue and a larger share base following equity financing.
- Cash burn increased: Nine-month operating cash use increased to $158.3 million from $123.2 million, largely due to working-capital requirements associated with the SUSTOL and CINVANTI launches.
- Accounting change: Heron adopted ASC Topic 606 on January 1, 2018 using the modified retrospective method, recording a $1.6 million cumulative adjustment. Revenue is recognized on a sell-in basis under Topic 606 rather than the prior sell-through approach.
Guidance, outlook, commentary and risks
Management did not provide quantitative revenue or earnings guidance in the filing. Management expects continued losses and negative operating cash flow while it funds commercialization, HTX-011 development and regulatory activities.
- HTX-011 achieved reported primary and key secondary endpoints in Phase 3 bunionectomy and hernia-repair studies and in Phase 2b total-knee and breast-augmentation studies. The company had submitted the HTX-011 NDA, but approval and timing remained uncertain.
- A CINVANTI J-code was assigned in November 2018 with an effective date of January 1, 2019; the filing states that this should simplify billing and reimbursement for prescribers.
- Revenue is concentrated among three customers, representing 99.3% of Q3 sales, 99.6% of nine-month sales and 99.8% of accounts receivable at September 30, 2018.
- Product sales allowances, particularly returns, rebates, discounts and distributor fees, require estimates and could materially affect revenue and earnings. Related accrued allowances totaled $18.8 million at September 30, 2018.
- Key risks include competition from generic and branded antiemetics, reimbursement and pricing pressure, regulatory approval and clinical-development risk for HTX-011, reliance on third-party manufacturers and suppliers, potential inventory write-downs, customer concentration, future financing needs and dilution.
- Future minimum operating-lease payments totaled $18.7 million. The company also expects a final cash payment related to its prior realignment in Q1 2019.
- The filing reported no legal proceedings, no defaults upon senior securities and no off-balance-sheet arrangements. Management concluded that disclosure controls were effective at a reasonable-assurance level.
Important facts for investors to verify
- Whether CINVANTI’s launch trajectory and the new J-code offset continuing SUSTOL pressure from generic palonosetron.
- The FDA review status, approval timing, labeling and commercial launch requirements for HTX-011.
- Quarterly operating cash burn relative to the stated $364.8 million liquidity and the timing of any additional financing.
- The effect of ASC 606’s sell-in revenue recognition on comparisons with 2017 and on future product-sales allowances.
- Customer concentration, reimbursement trends, gross-margin development and inventory levels.
- The potential dilution and covenant restrictions associated with the secured convertible notes.