Insys Therapeutics (INSY) Q4 2018 Earnings Conference Call Transcript

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.