Is The Turnaround At Neos Therapeutics All Done?

NEOS is a junior biotech that is recuperating from a near-debt, er, near-death experience, from too much debt.

They market 3 generic products aimed at ADHD that have novel delivery systems–that’s their competitive edge. Now sales are increasing, cash burn is decreasing, they got funding and…is it time to buy this company ?

QUICK FACTS

Trading Symbols:                                         NEOS
Share Price Today:                                      $1.50
Shares Outstanding:                                   50 million
Market Capitalization:                                $75 million
Net Debt:                                                      $20 million
Enterprise Value:                                         $95 million
2019 Consensus Revenue Estimate:        $67 million
EV/Sales                                                         1.4x
2020 Consensus Revenue Estimate:        $86 million
EV/Sales                                                         1.1x

BACKGROUND

Neos Therapeutics (NEOS – NASDAQ) is focused on drug delivery – they are like another stock I highlighted in an earlier blog – Opiant Pharmaceuticals (OPNT – NASDAQ). 

Like Opiant, Neos takes already approved drugs and repackages them with a better delivery system that makes patients more likely to take their meds.

The indication that Neos is tackling is attention deficit disorder (ADHD).

Their products are known treatments: amphetamines and methylphenidate. 

What Neos does that is novel is put these active ingredients into easier to administer forms: extended release (XR) medication, orally disintegrating tablets (ODT) and liquid suspension (OR) dosing.

Neos’s strategy depends on these unique delivery systems providing enough value to patients and physicians to justify a higher price than the generic.

They have 3 drugs on the market targeting ADHD:

  • Adzenys XR-ODT (orally disintegrating tablets)
  • Cotempla XR-ODT (extended-release ODT)
  • Adzenys ER (oral suspension)

Adzenys targets adult ADHD and is amphetamine based. According to the CDC, approximately 4% of the US adult population has ADHD.

Cotempla is used for children, ages 6 to 17 and is methylphenidate based.

Approvals of these drugs has been recent (2016-2018). They are all generating revenue and growing.

Hitting the Pharma Growth Wall

Late last year Neos hit the same wall that a lot of small pharma companies do. 

The template for a failing micro-biotech is as follows.

  1. Spend a bunch of money to get through the FDA process.
  2. In an effort to limit stock dilution, take on debt with restrictive covenants or short term payments.

The consequence is this: even if your drug is successful, it is inevitably unprofitable for years and your marketing budget far exceeds revenue.

The debt repayment schedule or covenants become impossible to meet and your company is left scrambling to figure out what to do.

In a nutshell, this is what happened to Neos last year.

In the third quarter of last year Neos was growing but losing money – a lot of money.

While the company saw revenue double year over year, cash usage had barely improved at all.

They burned $36 million in the first nine months of 2018. 

Keep in mind the stock had market capitalization of ~$120 million at the time.

The market saw this as unsustainable and took the stock down.

Source: StockCharts.com

With one tranche of debt coming due in November, 2018 and another in May, 2019, the company scrambled to change tack. 

In November of last year Neos implemented initiatives aimed at reducing losses and eventually generating cash:

  • Flattening the reporting structure
  • Eliminating executive positions
  • Adding a new Vice President of Sales and President of Commercial

Strategy and Market Access.

  • Realigning (ie. reducing) the sales force
  • Limiting sales to approximately 75 territories
  • Focusing remaining sales on physicians with the highest net revenue potential
  • Focusing on commercially insured patients
  • Reducing co-pays for patients to as low as $0
  • Bringing more pharmacies into the co-pay program

The Turnaround

When a small pharma company tries to change course, they often fall flat on their face. 

This has not been the case with Neos. Their plan appears to be working.

Their aim was to limit cash losses. The company has done just that.

Source: Company Filings

Continuing in the Right Direction in the Third Quarter

The focus has been margins, and Neos has done a pretty good job of improving them. 

Neos went from 44% to 63% gross margins in the third quarter. They also dropped all expense line items: sales and marketing expense dropped over $3mm, G&A by $750k and R&D by $500k.

Meanwhile revenue actually increased by 40%.

Source: Neos Therapeutics Investor Presentation

Maybe most importantly, the company appears on the cusp of breakeven cash flow.

The one negative is that script volume declined.

Here is the crux of the story, which I will add to shortly. Can the company grow scripts while reducing staff? Or will they get overwhelmed by competition with more marketing dollars to spend?

The company says no problem. But of course, they would.  The decline in script volume, they say, goes hand in hand with the change in commercial strategy – targeting key accounts.

To their credit, when they narrow the year-over-year comparison to the remaining targeted sales territories, they have seen scripts increase by 45%. This is maybe the most positive datapoint I can see.

Cash and Debt are worries

Good results get Neos part way back to health but there was still the debt overhang. 

The black cloud that has loomed over Neos head for most of the year, even as the turnaround has progressed, is $45 million of debt – $15 million of which is due in May 2020.

While the company has cash – $25 million, the market anticipates that using $15 million of it to pay debt will leave very little cushion.

It hasn’t helped that Neos has had a $100 million S-1 filing sitting unused for much of the year and an at-the-market (ATM) sales agreement with Cantor to sell another $30 million of stock.

You can forgive the market for thinking some sort of dilution, maybe significant, was coming.

But those fears look less likely to be realized now – Neos raised money from Encina in October:

On October 2, 2019, the Company entered into a senior secured credit agreement with Encina Business Credit, LLC… Under the Loan Agreement, Encina will extend up to $25.0 million in secured revolving loans to the Company With an extra $25 million facility for working capital, the cash on-hand now seems ample to pay off the May 2020 debt.

Why I’m Still on the Sidelines

Neos has a market capitalization of $77 million, $45 million of debt and $25 million of cash.

For a company with $62 million of trailing-twelve-month (TTM) revenue and growth, this is not an unreasonable price.

My concern is twofold. 

First, there is nothing novel about the drugs they offer – these are generics available cheaper from other providers. 

What Neos provides is simply a different delivery mechanism.

The success of Neos becomes a sell-job that this delivery mechanism is worth the price.

Two of the three products that Neos provides are amphetamines, which have a mixed history in the treatment of ADHD.

While amphetamines can be effective in preventing ADHD symptoms, they also can produce adverse cardiovascular effects, such as increased heart rate and blood pressure. They also affect eating habits and have been associated with suicidal thoughts.

A few searches on Google will turn up studies linking the use of amphetamines in ADHD with psychotic episodes, albeit rare.

They are also classified as controlled substances.

The move is to non-stimulants, though they have their drawbacks.

The big advantage of stimulants is that they work fast. A lot of patients out of patience when they try nonstimulants because they are slow to change the patient’s behavior.

Strattera, from Lilly (LLY – NYSE), which is the biggest non-stimulant, can take 4-6 weeks to begin to work. The drug, which is recently available as a generic, had $850 million in sales in 2017 before generic alternatives were allowed.

More potential non-stimulant competition is coming from Supernus (SUPN – NASDAQ), which has a drug SPN-812, that they say avoids the time lag of other non-stimulants. Patients will know whether the drug is working within a week.

SPN-812 has been passed Phase 3 for use in children. An adult Phase 3 study has started.

On the methylphenidate side (Cotempla XR-ODT) faces generic competition as well. Competitor Osmotica Pharmaceuticals, which offers a methylphenidate solution, noted on their last call:

“Net sales of methylphenidate ER, including M-72, decreased 46% during the quarter due to additional competitors entering the market, resulting in significantly lower net selling prices and volumes, partially offset by lower than estimated product returns.”

Osmotica’s Methylphenidate ER sales are down from $100 million to $55 million in the first nine months of the year. In their 10-Q they say that they expect “to experience, significant pricing erosion due to additional competition from other generic pharmaceutical companies.”

Can a Small Company with Budget Constraints Compete in ADHD?

Which brings me to concern #2. With a reduced salesforce and increasing competition, can a tiny player like Neos really compete over the long run?

So far, the answer has been yes. 

While Neos did experience a 6% prescription decline in the third quarter they did that while reducing their salesforce and reducing territories. 

It is hard not to see that as a positive.

That alone could be the case for buying the stock here. 

But I am going to take the safer approach, and wait for one more quarter of evidence before I take their word for it.

Keith


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