Investors were left reeling in May after Vanda Pharmaceuticals (NASDAQ:VNDA) reported first-quarter 2019 operating results that showed a worrisome decline in revenue compared to the final quarter of 2018. The business also slipped back into the red, which only heightened concerns of Wall Street analysts, who were already questioning the company's decision to sue the U.S. Food and Drug Administration over an important pipeline asset, tradipitant.

Management said not to worry, as the business was simply encountering a short-term slowdown due to price increases that went into effect on the first day of 2019. While that didn't assuage the concerns of investors at the time, second-quarter operating results suggest management was right all along. There's still plenty of ground to make up considering Vanda Pharmaceuticals' shares have lost nearly 30% in the last year, but the most recent quarter might help the business win back the trust of investors and analysts -- if other red flags don't sabotage the recovery. Here's what investors need to know.

A stethoscope sitting on a blue background.

Image source: Getty Images.

By the Numbers

As CFO Jim Kelly explained on the first-quarter conference call, Vanda Pharmaceuticals increased the prices of its two drug products, Hetlioz and Fanapt, on the first day of 2019. Customers responded by stocking inventory at the end of 2018, which reduced purchases in the first three months of this year. Kelly said the worrisome quarter-over-quarter decline was "fully accounted for by inventory changes." Management confidently reaffirmed its full-year 2019 revenue guidance.

Second-quarter operating results appear to back up that confidence. Hetlioz, a drug approved to treat non-24-hour sleep-wake disorder in blind individuals, grew net sales 35% compared to the year-ago period. Fanapt, a drug approved to treat schizophrenia in adults, grew net sales 10% compared to the prior-year period. Both drug franchises delivered record quarterly sales.

Hetlioz and Fanapt getting back on track helped the business wrap up a solid first half of 2019.

Metric

First Half 2019

First Half 2018

Change (YoY)

Hetlioz revenue

$66.8 million

$53.5 million

25%

Fanapt revenue

$39.9 million

$37.5 million

7%

Total revenue

$107 million

$90.9 million

17%

Operating expenses

$98.9 million

$84.6 million

17%

Operating income

$7.8 million

$6.3 million

23%

Net income

$10.9 million

$7.7 million

42%

Operating cash flow

$30.1 million

$6.0 million

401%

Data source: SEC filing. YOY = Year over Year.

It's worth pointing out that Q2 operating income was $9.8 million, and operating margin was 16.7% during the quarter, but both are weighed down by the Q1 operating loss when first-half 2019 operating results are tallied.

That said, it wasn't all smooth sailing in the most recent quarter. Vanda Pharmaceuticals met with the FDA in May regarding the planned phase 3 trial of tradipitant in gastroparesis. The company agreed to shorten the duration of treatment to just three months -- the FDA won't allow longer duration studies in humans until long-term toxicology studies in large mammals are completed -- and continues to seek approval to conduct a 52-week study in humans. It's not clear how data collected from the current 12-week study will be viewed by regulators, if they accept the data at all.

Separately, Vanda Pharmaceuticals received a "Deficiencies Prelude Discussion" letter from the FDA regarding the company's supplemental new drug application (sNDA) to have Hetlioz approved to treat jet lag disorder. The letter didn't actually specify deficiencies, however, and with a decision date scheduled for Aug. 16, there's little time to address potential issues without causing a delay.

Additionally, more information became available about a pending lawsuit. Vanda Pharmaceuticals is being sued for allegedly violating the Federal False Claims Act related to marketing activities for Fanapt and Hetlioz. According to an FDA warning letter from October 2018, the company didn't transparently communicate the risks of the drug products, which is especially concerning considering Fanapt has a black box warning due to life-threatening risks and increased mortality for elderly patients. The lawsuit raises the stakes by also alleging fraudulent billing to the federal government and off-label marketing. The company must respond to the complaint by Aug. 13 and in a worst-case scenario, it could face significant fines and penalties. 

The lawsuit is a pretty serious red flag I've previously overlooked, but a tumbling stock price suggests the issues aren't being overlooked by investors. Nonetheless, management remains confident about the direction of the company.

A pair of hands holding a pair of binoculars overhead.

Image source: Getty Images.

Looking Ahead

Vanda Pharmaceuticals reported positive phase 2 results for tradipitant in motion sickness, and expects phase 3 results for the drug candidate in atopic dermatitis in the first half of 2020. The latter indication requires a second late-stage trial before a new drug application can be submitted to regulators, and that trial is expected to be initiated in Q1 2020.

In addition to the upcoming decision on whether or not to expand the use of Hetlioz to include jet lag disorder, Vanda Pharmaceuticals expects to file an sNDA in Smith-Magenis Syndrome in Q3 2019. The company also expects to initiate a phase 2 trial for the lead drug product in delayed sleep phase disorder for patients with a specific genetic mutation in Q3 2019.

It should be possible to fund the busy pipeline activities with cash generated from operations, especially if Vanda Pharmaceuticals meets full-year 2019 guidance. Management continues to expect:

  • Full-year 2019 revenue of $215 million to $225 million.
  • Hetlioz revenue of $137 million to $143 million.
  • Fanapt revenue of $78 million to $82 million.
  • A year-end cash balance of over $275 million, marking an increase from previous expectations to end the year with over $260 million in cash.

Not Making It Easy on Investors

On the one hand, Vanda Pharmaceuticals appears to be on a promising trajectory with its current drug products. Hetlioz and Fanapt are growing sales and driving operating income growth.

On the other hand, there are certainly red flags waving. The company's spat with the FDA over tradipitant in gastroparesis is an oddly stubborn stance, especially in light of separate ongoing legal issues related to Fanapt and Hetlioz. Vanda Pharmaceuticals should have the financial strength to survive a delay in tradipitant or pay potential fines related to false marketing claims, but investors may not feel comfortable owning the stock. A 40% year-to-date decline in stock price suggests that wouldn't be a minority perspective.