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Insys Therapeutics (NASDAQ:INSY) Q4 2018 Earnings Conference CallMarch 7, 2019 5:00 p.m. ET
Contents: Prepared Remarks Questions and Answers Call Participants Prepared Remarks:Operator
Good day, ladies and gentlemen, and welcome to the INSYS Therapeutics fourth-quarter 2018 earnings conference call. [Operator instructions] It is now my pleasure to turn the conference over to your host, Ms. Jackie Marcus, Alpha IR.
Jackie Marcus -- Alpha Investor Relations
Thank you, Haley. Welcome to the INSYS Therapeutics fourth-quarter 2018 results conference call. With me on today's call are President and Chief Executive Officer Saeed Motahari, Chief Financial Officer Andy Long, General Counsel and Chief Legal Officer Mark Nance; along with Dr. Venkat Goskonda, senior vice president of Research and Development; and Dr.
Ahmed Elkashef, vice president of Clinical Development. Earlier today, the company issued a press release detailing financial results for the fourth quarter ended December 31, 2018. You can access these materials through the Investors section at the company's website or you can also access a webcast replay of this call later today. Before we continue, I would like to remind everyone that all statements made on today's conference call that express a belief, expectation, projection, forecast, anticipation or intent regarding future events and the company's future performance are considered forward-looking statements as defined by the Private Securities Litigation Reform Act.
These forward-looking statements are based on information available to company management as of today and involve risks and uncertainties, including those noted in today's press release and the company's filings with the SEC. Such forward-looking statements are not guarantees of future performance. Actual results may differ materially from those projected in the forward-looking statements. INSYS Therapeutics specifically disclaims any intent or obligation to update these forward-looking statements except as required by law.
In addition to reporting all financial information required in accordance with the generally accepted accounting principles, the company is also reporting adjusted EBITDA, adjusted net loss and adjusted net loss per diluted share, which are non-GAAP financial measures. Since adjusted EBITDA, adjusted net loss and adjusted net loss per diluted share are non-GAAP financial measures, they should not be used in isolation or as a substitute for consolidated statements of comprehensive income or loss and cash flow data prepared in accordance with GAAP. In addition, the company's definitions of adjusted EBITDA, adjusted net loss, and adjusted net loss per diluted share may not be comparable to similarly titled non-GAAP financial measures reported by other companies. For a full reconciliation of adjusted EBITDA and adjusted net loss to GAAP net income, please see the attachments to the earnings release.
And with that, I'll turn the call over to the company's president and chief executive officer, Saeed Motahari.
Saeed Motahari -- President and Chief Executive Officer
Thank you, Jackie, and thanks to everyone on the line for joining us today. I would like to begin by covering our progress and our strategic priorities that are in line with our vision to become the leading cannabinoids and spray technology company, and then Andy will provide an overview of our financial results for the fourth quarter. I will conclude my remarks with discussion of our pipeline and after that, the team and I will take your questions. When I joined INSYS in 2017, my priorities were twofold.
First, to navigate the company through a difficult situation from both a legal and a market-dynamics perspective; and second, to align the company's vision with its core capability in R&D as a cannabinoid and a spray technology leader. We have spent the last two years executing with those priorities and we have come a long way. As a result, 2018 was a year of transformation as we put a number of legacy legal issues behind us, announced our intention to explore strategic alternative for our opioid-related assets and further advance our R&D pipeline. As we began 2019, we are keenly focused on maximizing the value of the business and to that end, in the fourth quarter, we retained Lazard to advise the company on our capital planning and strategic alternatives.
With that, let me walk you through our key priorities. First, on the legal front, we are continuing to file on the agreement in principle with the Department of Justice. We also continue to work with the state AGs to resolve outstanding issues, and we accrued $16 million in the fourth quarter for potential settlement of claims by certain issuers. Regarding our ongoing assets which stand in the foundation of the company, we took several steps to elevate our talent, strengthen on capability and processes, particularly manufacturing, and also control our operating expenses.
In terms of better aligning our cost structure to our current revenue profile, we continue to optimize the size of our sales force against the realities of the declining turf market. Our state-of-art manufacturing facility in Round Rock, Texas is a key differentiator for our business. In the fourth quarter, we improved our CBD manufacturing process, which included the 50% increase in yield while reducing our cycle time by 25%. Turning to R&D.
We addressed our potential product pipeline in 2018 and are well-positioned for 2019 to file two NDAs, including an NDA for our propriety formulation of naloxone nasal spray in April of this year and our proprietary formulation of epinephrine nasal spray in the fourth quarter of 2019. We are expecting data from our Phase II clinical studies of childhood absence epilepsy in April. In addition, we expect to have data from our Phase II clinical study of Prader-Willi Syndrome in the fourth quarter of 2019. We are also working in concert with our collaborative research partner, UC San Diego's Center for Medicinal Cannabis Research, to initiate a clinical trial this year as the IND for CBD in autism was accepted in February.
And finally, last November, we announced our intention to review a strategic alternative for opioid-related assets. These assets included our first commercial product subset as well as formulations of buprenorphine and the combination of buprenorphine/naloxone. I'm pleased to report that we are in the middle of active negotiations regarding the divestiture of SUBSYS. Furthermore, as I mentioned earlier, we also retained Lazard to advise the company on our capital planning and strategic alternative.
We will update you on both processes when we are able to. Let's turn to SUBSYS. The turf market continues to -- post declines, following approximately 42% in 2018 versus 2017. Despite these challenges, SUBSYS remained the branded turf leader, with almost 25% of all turf prescriptions written in the fourth quarter and nearly 28% unit share.
We have also made additional progress in recent weeks around the international distribution of SUBSYS, in particular, our licensing partner in Middle East, Lunatus, will begin the regulatory approval process in the United Arab Emirates in May. Our regulatory team also met with the European regulatory authorities in Netherlands in February to seek advice and the regulatory pathway on SUBSYS in Europe. Before I discuss our plan for 2019, I would like to turn the call over to Andy who will provide an overview of our fourth-quarter financial performance. Andy?
Andy Long -- Chief Financial Officer
Thank you, Saeed. To begin my review of Q4's financial results, I'll start at the top of the P&L, where we reported net revenue of $16.4 million, which was comprised of $15.7 million from SUBSYS and $700,000 from SYNDROS. Total net revenue was down compared to $18.3 million last year and $31.5 million in the prior year period. The decline in SUBSYS was primarily driven by reduced demand across the turf market, combined with a modest loss in share to generic options.
Sales returns continued to decline as Q4 returns were about 50% lower than in Q3. Net revenue in the current quarter was favorably impacted by approximately $1 million as we saw an uptick in inventory held within our distribution network. We expect this inventory position to unwind in Q1 of 2019. As Saeed noted, SUBSYS continues to be the leading and most prescribed branded turf product on the market.
We reported gross margin of 84% this quarter compared to 85.4% in the year-ago period and slightly down from 87% in the third quarter of this year. Gross margin was unfavorably affected by inventory write-offs associated with short-dated product. Turning to operating expense. Overall, our total Q4 operating expense of $62.7 million increased by $15.2 million compared to Q4 of last year.
However, operating expense before legal cost and settlements in the fourth quarter of $30.2 million is down from $38.1 million, representing a reduction of 20.7% year over year. This is indicative of our commitment to controlling operating cost to focus our resources on advancing the pipeline. Let's review the components of our fourth quarter operating expense before legal cost and settlement charges. Sales and marketing expense was $5.9 million, down 17.1% from the prior year period, driven by cost controls that were executed in the second half of 2018.
Based on reductions taken in Q4 of 2018 as well as Q1 of 2019, we are on track to beat the $20 million run rate projection for 2019 that I discussed on last quarter's call. Our R&D expense of $14.4 million in the fourth quarter was down 12.3% compared to the fourth quarter of 2017, almost entirely due to the nonrepeat of the application fee associated with our NDA filing of buprenorphine in Q4 of last year. Our general and administrative expense of $9.9 million was down 32% compared to this time last year as a result of tight cost control. We will continue to be disciplined with our cost structure while prioritizing investment in our pipeline in maintaining an appropriate level of infrastructure to support our commercial products.
Turning to legal expense, we reported $16.5 million in legal expense in the quarter, an increase of $11.4 million compared to the year-ago period. Almost 50% of our full-year legal costs were related to the indemnification obligation associated with the company's founder, John Kapoor. As I noted last quarter, the company does not dispute its indemnification obligation, however, we are disputing the reasonableness of the defense cost. The company is accruing for 100% of the disputed cost incurred for his defense.
However, cash payments associated with these expenses have been significantly reduced. We also accrued $16 million in legal settlement expenses in the fourth quarter of 2018, which includes a potential settlement of claims by certain insurers. We recorded a tax benefit of $2.4 million in the fourth quarter of this year. This benefit results from the completion of our 2014-2015 tax audit where our previously recorded uncertain tax position was resolved and taken as income.
This compares to a $25.7 million tax expense in the fourth quarter of 2017 due to the full valuation allowance that was taken against our deferred tax assets. In addition, we received a $12 million tax refund in Q4 associated with our 2015 federal tax filing. Our net loss in the quarter was $46.3 million, which compares to a net loss of $45.9 million in the prior year quarter. Looking at our total adjusted EBITDA, we recorded a loss of $28.7 million in the fourth quarter compared to a loss of $11.5 million in the fourth quarter of 2017.
In the fourth quarter of 2018, our reported net loss per share was $0.62 while our adjusted net loss per share was $0.37. Turning briefly to the balance sheet. We remain debt free with $104.4 million in cash, cash equivalents, and short and long-term investments. This represented a decline of $8.9 million from Q3.
That said, to seek additional liquidity, the company has engaged Lazard to advise the company on strategic alternatives, which may include a variety of different business arrangements, including strategic licensing, partnerships, joint ventures, divestitures, business combinations, and investments. Finally, with respect to 2019, we will continue to manage cost and prioritize spending within the organization. Specifically, we expect legal cost to trend lower over the course of the year as the trial of former executives concludes in Q2 of this year. And with that, I'll turn the call back over to Saeed.
Saeed?
Saeed Motahari -- President and Chief Executive Officer
Thank you, Andy. As I mentioned earlier in my remarks, the most important asset of our transformation is rooted in our pipeline. We are working toward filing two NDAs this year for our proprietary formulations of the naloxone nasal spray and epinephrine nasal spray. We believe these two life-saving drugs could be significantly disruptive to the current standard of care if they are approved.
Let's turn to naloxone first. We are ramping up a nonclinical, juvenile toxicity study related to the presence of alcohol in our formulation. As I mentioned in our last call, the FDA notified us in July of 2018 of this requirement. Then in September, the agency clarified that the result of these nonclinical studies should be included in the NDA.
Pending the announcement of these data, we will be in a position to submit the NDA for our naloxone nasal spray in April of 2019. Turning to our second life-saving nasal spray, epinephrine. As you may have seen in the second week of January, we published a press release regarding the result of a dose-finding PK study of our epinephrine nasal spray. Our result identified a dose that showed a PK profile similar to that of intramuscular injections of 0.3 milligram EpiPen and 0.5 milligram as roll-on.
Both of which are approved treatment for anaphylaxis, an acute life-threatening allergic reaction. This study was a single-dose, open-label, randomized, full treatment, four-way crossover to assess the PK of two doses of epinephrine nasal spray and the two reference products in 49 healthy volunteers. In addition, we presented a poster at the American Academy of the Allergy, Asthma, Immunology Annual Meeting on February 24 in San Francisco on our initial PK study in epinephrine nasal spray and EpiPen in adults with seasonal allergies, which we previously announced last summer. For those who missed it, a full poster with our data is available on our website.
All these support our belief that our proprietary formulation of epinephrine delivered intranasally potentially offers a viable attractive alternative and noninvasive delivery option to currently marketed products. We received Fast Track designation August 2018 and plan to initiate a confirmatory PK study later this year with the goal of filing an NDA by end of 2019. Moving to the cannabinoids platform. We are making continued progress in our Phase II study of CBD for childhood absence epilepsy and are expecting data next month.
Our Phase II study of the Prader-Willi Syndrome is under way, and we are continuing to actively activate more sites across the country. The Prader-Willi Foundation has been a critical ally for our program in bringing attention to the important work our team and the clinical partners are conducting for this under-researched disease. Given where we are in our clinical trial and assuming we receive positive data, we hope to meet with the FDA in early 2020 and file an NDA in 2021. Enrollment of Phase III study of infantile spasm is occurring at the lower pace than anticipated.
If we don't see an improvement, we may need to revise the protocol for this study. I will provide an update once we have further visibility into enrollment. Regarding our dronabinol inhalation formulation, we successfully completed an initial human proof-of-concept study in September 2018. We plan to have an advisory board meeting with the clinical experts in the coming months.
As I mentioned earlier, in 2019, our priorities are to work through our legacy legal issues, further demonstrating our commitment to culture rooted in compliance and advance our pipeline with a focus on filing two NDAs while continuing to reduce our operating expenses. I am proud of the work of our talented team during a very challenging time as well as their unwavering commitment to developing lifesaving treatments and improving the lives of patients with unmet medical needs. We have more to do, and we look forward to sharing more updates with you on our progress in 2019. That concludes my prepared remarks.
Operator, please open the line for questions.
Questions and Answers:Operator
Thank you. [Operator instructions] Our first question comes from Brandon Folkes with Cantor Fitzgerald. Your line is now open.
Brandon Folkes -- Cantor Fitzgerald -- Analyst
Hi. Thanks for taking my question. Maybe just on the childhood epilepsy, what kind of data do -- can we expect you to present to us next month? And have you completed the enrollment in the trial as yet?
Saeed Motahari -- President and Chief Executive Officer
As you know -- you are referring to the CAE trials. We have finished analyzing the result of the two cohorts. And we will be divulging the results as I indicated in the script in early -- in April of 2019.
Brandon Folkes -- Cantor Fitzgerald -- Analyst
OK. And maybe one follow-up, if I may. Any thoughts on the OTC pathway for naloxone? Is it something you would consider? And given the guidelines, how much work would you have to do on your current product, if any, to satisfy the OTC pathway?
Saeed Motahari -- President and Chief Executive Officer
I think this is an issue that we are investigating, Brandon. And as you know, we have two different formulation for naloxone, one with 20% of alcohol and one with 50% alcohol. It is an issue that is being investigated by the team currently. And when we have a point of view, we will communicate that.
But for now, it's still under assessment.
Brandon Folkes -- Cantor Fitzgerald -- Analyst
OK, great. Thank you very much.
Saeed Motahari -- President and Chief Executive Officer
Thank you, Brandon.
Operator
Thank you. Our next question comes from Yun Zhong of Janney. Your line is now open.
Yun Zhong -- Janney Montgomery Scott -- Analyst
Hi. Thanks for taking the question. So on the epinephrine program, is there anything else that you will need to complete other than the confirmatory study before you can submit the NDA?
Saeed Motahari -- President and Chief Executive Officer
I think based on our previous discussions with the FDA, there's also a dose-repeat study that we need to do. It's a small study. It's a safety-related study. But to the best of our knowledge at this point, we need to do two studies, a confirmatory PK study and a dose-repeat study as we have articulated in the past.
Now our team is actively working with the FDA, and we have constant communications with them. As we get more feasibility to the potential approval of this product, we will inform you in the coming updates.
Yun Zhong -- Janney Montgomery Scott -- Analyst
OK. Then on the naloxone program, have you decided or have you proposed that -- are you going to file the NDA for one formulation or two formulations?
Saeed Motahari -- President and Chief Executive Officer
I think that's a great question. We are preparing the last stages of the NDA, and that is something that we will obviously divulge when the NDA is filed, but we're still working on that. I mean, the good news here is that both formulation meet the criteria versus intramuscular injection, and that is the important thing here. And we're in a fortunate position to have options to decide which one is more appropriate.
Yun Zhong -- Janney Montgomery Scott -- Analyst
OK. Thank you.
Operator
Thank you. Our next question comes from Randall Stanicky. Your line is now open.
Dan Busby -- RBC Capital Markets -- Analyst
Hey, guys. This is Dan Busby on for Randall. I have a question. First, for the SUBSYS strategic review process, I realized you probably haven't put a time line on that, but would you anticipate having that completed in time to request shareholder approval at the annual meeting in early May?
Saeed Motahari -- President and Chief Executive Officer
I think it's hard to say, but we are working very hard. As I mentioned to you, we are in active negotiations with several parties, and our objective here is to complete this process, obviously, as quickly as we can. So -- but it's very hard to kind of give a time line. That would be our hope.
So we'll see how things will pan out ultimately.
Dan Busby -- RBC Capital Markets -- Analyst
OK, that's fair. And a follow-up question. Regarding the $16 million in legal settlement costs with the insurers that you recorded in 4Q, can you give us a sense of how much exposure is still out there? Differently, regarding the insurers and the states, what inning would you say you're in?
Saeed Motahari -- President and Chief Executive Officer
Well, I'm going to turn it over to Mark to talk about the $16 million, and then I will provide any additional commentary if it's needed. Mark, do you mind?
Mark Nance -- General Counsel and Chief Legal Officer
Right. Yes, yes. OK. The total number that you mentioned, all of that is related to insurers.
There's a mix in there. But there is more detail in case that you'll be able to read when that comes out. As for total exposure, as you know, it's very difficult for us to quantify or even discuss those announced at this time, given the stage of litigation and what we know about that litigation. So it's just too much of a challenge to give you additional detail around that.
Dan Busby -- RBC Capital Markets -- Analyst
I guess would you be able to say what percentage of the insurers or states you'd settle with at this point?
Mark Nance -- General Counsel and Chief Legal Officer
No.
Operator
Thank you. [Operator instructions] Our next question comes from David Amsellem of Piper Jaffray. Your line is now open.
Mickey Ingerman -- Piper Jaffray -- Analyst
This is Mickey Ingerman on for David. First on intranasal naloxone, can you guys provide your thinking on the commercialization of the product and whether you're going to prioritize the retail market or nonretail market? And then beyond that, what sales infrastructure do you think is necessary to support the product?
Saeed Motahari -- President and Chief Executive Officer
I think we are assuming a two-pronged approach right now. We are also putting a launch plan to gather, and the team is actively working on that. And obviously, given the uniqueness of this market and results of the business coming from multiple channels, particularly at both retail and nonretail, and obviously the government channel, we are trying to consider all aspects and prioritize those opportunities in terms of where we believe this product will bring incremental value to the current standard of care. But we are also are looking and actively talking to a number of companies who are interested in working with us on naloxone, both in the U.S.
and globally. And I think when we have more visibility, we'll update you on our plans.
Mickey Ingerman -- Piper Jaffray -- Analyst
Got it. And then on the infantile spasm study, do you guys get any benefit from the opening of international sites coming online? And then beyond that, have you guys flagged any potential changes to the protocol that you could make to potentially speed up enrollment?
Saeed Motahari -- President and Chief Executive Officer
I think we haven't seen yet. I think our focus has been at this one entirely to finish the CAE study as well as continue to get momentum around the Prader-Willi, those are two very important projects for us as we had actually looked at the overall value of the CBD in the context of the three programs that we have. I think the IS has been challenging. We are talking internally as well as externally with another potential partner to see what we can do to accelerate the trial, but it is slower than we had anticipated.
Mickey Ingerman -- Piper Jaffray -- Analyst
Got it. Thank you.
Saeed Motahari -- President and Chief Executive Officer
Thank you.
Operator
Ladies and gentlemen, this concludes today's question-and-answer session. I would now like turn the call back over to Saeed Motahari for any closing remarks.
Saeed Motahari -- President and Chief Executive Officer
Well, thank you for all your questions, and thank you to everyone for joining us today. I appreciate your time and the interest to our -- in our company. And I look forward to updating you on our progress in 2019. Thank you so much for your time.
Duration: 28 minutes
Call Participants:Jackie Marcus -- Alpha Investor Relations
Saeed Motahari -- President and Chief Executive Officer
Andy Long -- Chief Financial Officer
Brandon Folkes -- Cantor Fitzgerald -- Analyst
Yun Zhong -- Janney Montgomery Scott -- Analyst
Dan Busby -- RBC Capital Markets -- Analyst
Mark Nance -- General Counsel and Chief Legal Officer
Mickey Ingerman -- Piper Jaffray -- Analyst
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