By Jason Napodano, CFA
On October 30, 2013, Cipher Pharmaceuticals (CPHMF) (DND.TO) reported financial results for the third quarter 2013. Total revenues in the quarter were $5.6 million, up 166% over the third quarter 2012 and just shy of our estimate for revenues of $6.0 million. Despite the lower-than-expected number, the revenue up-tick was driven by the strong performance of Absorica (CIP-Isotretinoin) at Ranbaxy. Royalties from partners on Lipofen and ConZip / Durela were lower than expected. We note the company recorded product revenues of $0.044 million in the third quarter from the launch of Epuris in Canada that took place in late June 2013.
Total net Absorica revenues in the third quarter 2013 were $4.5 million, comprised of $0.5 million in amortization of upfront licensing fee and $4.0 million in royalties on U.S. sales at Ranbaxy. We note that Cipher receives a “mid-teens” royalty (we believe 15%) on U.S. sales of Absorica at Ranbaxy, but then shares that royalty with manufacturing partner Galephar 50/50. Cipher collects a mark-up on transfer to Ranbaxy (we believe ~1.5%). Thus, we believe Absorica sales in the third quarter equated to roughly $44 million.
The launch to date has clearly been impressive. Ranbaxy has 50 sales representatives promoting Absorica to roughly 3,500 prescribing dermatologists. Cipher reported that Absorica held roughly 17.3% market share at the end of September 2013. The product has been gaining approximately 2% market share per month since the launch in December 2012. In fact, Ranbaxy stated on its earnings call that market share will be near 19% by the end of October 2013. The graph below shows the impressive ramp to date, clearly driven by the improved formulation advantages of Absorica over generic isotretinoin.
The market share gains are clearly encouraging, but what’s even more exciting is that the overall isotretinoin market seems to be bouncing as well (see graph below) – perhaps driven by Ranbaxy’s active promotion of Absorica. Management noted that total U.S. isotretinoin prescriptions grew by 12% in 2012, with a surge at the end of the year. Total isotretinoin prescriptions in the first quarter 2013 grew by 13%. That number increased to 15% in the second quarter and was 19% in the third quarter. Investors can see the uptrend in the overall market since 2011 (please note the seasonality in the graph below, with September usually being the yearly low).
Not only is Ranbaxy taking a bigger slice of the pie, but the pie is getting bigger at the same time. Absorica is a differentiated product, promoted by a highly motivated and focused sales force, into a nicely growing market. The trend should continue in 2014.
Based on existing trends, we estimate the total isotretinoin market in the U.S. is around 1.1 million prescriptions per year. When equated into Absorica (branded) price, this is around $1.2 billion in potential sales. Ranbaxy’s ~19% market share at the end of October 2013 equates to a $225 million annualized run rate. We previously believed that Ranbaxy could capture 25% market share at peak, putting sales in the $300 million range. We have now upped that target to 30% market share, putting peak sales for Absorica at around $360 million.
For 2013, we see Cipher collecting net Absorica revenues of $15.8 million. We think the number can grow to over $22 million in 2014 and over $25 million in 2015. At peak, Cipher is looking at collecting over $32 million per year in royalty on Absorica. Besides royalty, Cipher is entitled to two cumulative sales-related milestones. Cipher management believes it will achieve the first $10 million milestone under this agreement in the first quarter 2014. Similar to the royalty split, Cipher will book 50% of this figure and pay the balance to Galephar.
On September 19, 2013, Cipher announced that Ranbaxy had received a Paragraph IV Certification Notice of filing from Watson Laboratories, a division of Actavis plc, of an abbreviated new drug application (ANDA) for a generic version of Absorica. Ranbaxy and Cipher intend to vigorously defend Absorica's intellectual property rights and pursue all available legal and regulatory pathways in defense of the product. We note that Ranbaxy filed an injunction under Hatch-Waxman earlier this week. That filing automatically institutes a 30-month stay from generic competition for both sides to prepare their case for a potential battle in court. As these cases are rarely settled more quickly, the 30 month stay usually is the earliest time point at which the generic manufacturer can launch. In the present case with Absorica, this would be March of 2016. Below we provide some ideas on what are the "base", "best", and "worst" case scenarios are resulting from entry of a generic Absorica and the outcome of the Paragraph IV challenge.
Net Lipofen revenues in the third quarter 2013 were $0.5 million, surprisingly below our forecast for $0.8 million. This was the second quarter in a row that Lipofen revenue came up shy of forecasts. In the second quarter, Cipher noted lower-than-expected shipments, and prescriptions shrank by 6% compared to the second quarter 2012. In the third quarter, prescriptions shrank again by 6%. It is clear now that Lipofen prescriptions are being negatively impacted by the launch of a generic version of AbbVie’s TriLipix (fenofibric acid). In fact, Lipofen is the only remaining non-generic fenofibrate product on the market. Kowa has been raising the price of Lipofen to maintain sales growth, but we expect a difficult road ahead in 2014. Additionally, the year-over-year net revenue comparisons for Cipher were difficult in the third quarter because the company experience a one-time step-up in royalty rate, from 15% to 18%, in the third quarter 2012.
At this point, it is looking like Lipofen is peaking. It may be difficult for Kowa to maintain sales growth ahead of the patent expiration in 2015. Kowa will continue to promote the product in the number two position for the remainder of 2013. It remains to be seen what Kowa does with the product in 2014 and 2015. We think it will remain in the number two position for 2014 but not 2015. For all of 2013, we peg Lipofen net revenues at $2.8 million. For 2014, we see revenues down slightly to $2.5 million for Lipofen.
…ConZip / Durela…
Net revenues from ConZip / Durela in the third quarter 2013 totaled $0.5 million, mostly driven by sales of ConZip by Vertical Pharmaceuticals Inc. in the U.S. We note that Vertical expanded its sales force on ConZip in the fourth quarter 2012 from 60 to 75 representatives. We are expecting to see this increase promotion out of Vertical Health reflexed in the ConZip royalty payments coming in the next few quarters. We note that total ConZip prescriptions grew by a solid 15% in the first quarter and 5% in the second quarter year-over-year. For the third quarter, things seem to be slowing down slightly, but still grew by 3% nevertheless.
We note that Cipher has the potential to earn an additional $3.8 million in future milestones from Vertical Pharmaceuticals, contingent upon the achievement of certain future net sales targets. We do not include any additional sales milestones for ConZip in our model given the slow ramp to date. However, should Vertical gain traction and pick up meaningful market share, this additional $3.8 million represents upside to our model.
Sales of Durela by Medical Futures in Canada remain underwhelming to date, although management did note on the third quarter earnings call that the signs of steady improvement by Medical noted in the second quarter have carried into the third. Sales grew by 25% in the quarter at Medical. Medical continues to promote the product with 22 sales representatives in Canada.
One area we may see some new growth from the CIP-tramadol-ER franchise is in Latin America. In late April 2013, Cipher entered into an exclusive distribution and supply agreement with Tecnofarma International Ltd. for the right to market and distribute CIP-tramadol-ER in 18 Latin American countries, including Brazil and Mexico. Under the terms of the agreement, Cipher received an upfront payment and is eligible for additional milestones based upon regulatory approval in Brazil and Mexico. Cipher will supply product to Tecnofarma at a fixed-transfer price.
Cipher and Tecnofarma are working towards regulatory filings in these 18 countries. Management tells us that some of the small countries, ones that work of the U.S. FDA or Canadian regulatory authority, may see some approvals in 2014. Larger countries, like Brazil for instance, may see filings in 2014 and regulatory approvals in 2015. We do not model meaningful revenues from CIP-tramadol-ER outside the U.S. or Canada, so if Tecnofarma can being to generate revenues and start paying royalties to Cipher in 2014 and 2015 it would represent upside to our model.
…Tight Cost Control…
One of the things that continue to impress us at Cipher has been management’s ability to control costs despite a surging top-line. Operating expenses for the third quarter 2013 totaled approximately $2.3 million. This was down from $2.5 million in the second quarter. Operating expenses at Cipher are essentially flat in the first three quarters, this despite growing revenues by 82% in the first quarter, 241% in the second quarter, and 166% in the third quarter. We are impressed that the company can grow its top-line so significantly while seeing its expenses stay so tightly under control. The leverage to the bottom-line is impressive.
Cipher has done an outstanding job over the past few years out-licensing its products to U.S. partners. This has allowed the company to sit back and collect license fees and royalties, growing the top-line nicely while keeping operating overhead low – as noted above. However, in late June 2013, Cipher launched Epuris (the same product Ranbaxy launched in November 2012 as Absorica), on its own. This is a big shift in strategy for the company.
During the first quarter 2013, the company hired Joan Chypyha as Vice President of Marketing and Sales. Ms. Chypyha will head up the company’s commercial operations in Canada, and manage the recently created 7-person sales force contracted for the Epuris launch. We note that Ms. Chypyha seems uniquely qualified for this role, having spent more than 25 years in the pharmaceutical industry with an emphasis on marketing, sales and business development in the dermatology area. We note her previous role as for 16 years with Hoffman-La Roche, escalating to Business Unit Director for the Dermatology franchise where she was responsible for the management of a specialty sales force that promoted Accutane, among other brands.
On the first quarter conference call, Cipher management noted that this specialty sales force that promoted Accutane was 6 to 8 representatives and achieved peak sales between $25 and $30 million. The current Canadian isotretinoin market is only around $15 million in size, but it has been fully genericized and there is no active promotion of any branded products. We believe that Epuris can be a $10 to $15 million product for Cipher in Canada based on the early success of Absorica in the U.S. The company currently has 6 full-time and 1 part-time representatives selling the product now. Cipher noted that half of the sales reps the company hired to promote Epuris have prior experience promoting Accutane at Roche in Canada. Some private insurers have already picked up coverage of Epuris and Cipher has submitted dossiers to each Providence in Canada for public reimbursement. We note that Saskatchewan is the first to provide coverage to date. We suspect this process will take several more months to play out, but by end of the first quarter 2014 we should see broad coverage reimbursement for Epuris throughout the country.
Cipher is also working to file a new drug submission (NDS) for the Betesil Patch in Canada. Previous guidance was to have the filing in by the end of the year. However, management is speaking with Health Canada about the necessity to conduct some additional CMC work prior to the filing. Cipher is working with IBSA on this issue to see if the FDA will request the data prior to the U.S. NDA filing. Cipher has two options here – conduct the additional CMC work along with IBSA for both Health Canada and the U.S. FDA, or file the Canadian NDS without the data and then wait to see if it is required. If it is required, Cipher can then do the work and file the information as a supplement. We are waiting for guidance on this issue, but note that management stated on the call that the time to conduct the additional work is only six months. We believe the costs are minimal, so we do not see this as a major issue either way. Our hope is that management just goes ahead and does the work to eliminate risk.
If approved, we think the Betesil Patch is an excellent complement dermatology product for Cipher’s contract sales force to co-promote along with Epuris. We would also not be surprised to see the company look to in-license or acquire another specialty dermatology product in Canada. We think Cipher can achieve breakeven Canadian operations based on the launch of Epuris alone by the end of 2014. This would be sales in the area of $3 million.
…Solid Cash Position…
Cipher exited the third quarter 2013 approximately $20.0 million in cash and investments. The company generated $2.2 million in cash during the quarter. We find the current balance sufficient to fund operations for the foreseeable future, as we believe that Cipher will continue to report positive cash flow throughout 2013 even in the face of launching its own specialty dermatology sales force to promote Epuris and Betesil Patch in Canada. We believe the current cash balance allows management significant flexibility to continue to build its Canadian product suite through in-licensing or M&A activity.
Stock Still Attractive
Based on our financial projections, Cipher should report total revenues in 2013 of around $21 million, with net income of around $12 million, or $0.48 per share. This equates to a P/E ratio of only 16.3x our 2013 figure. In 2014, we model growth in revenues to $32 million, net income of $19 million and EPS of $0.76. A P/E ratio of 15X our 2014 estimate for $0.76 in EPS yields a price target of $11.43 per share. We note our EPS forecast of $0.76 includes 0% tax rate given the company held $21.5 million in deferred income tax credits as of the end of the third quarter 2013. We do not see the company paying a full tax rate until 2017.
We expect the company to continue to receive growth from existing products, led by Absorica, while they focus more and more on building a commercial sales and marketing presence in Canada. The company began marketing Epuris in Canada in late June 2013. This will be complemented by the Betesil Patch, should it receive Health Canada approval, in 2014 or 2015. In addition, we fully expect the company to license in and/or acquire other products, with an emphasis on late-stage to commercial-stage product candidates in specialty dermatology market in Canada. The company’s $20+ million in cash creates significant opportunity for new product licensing or M&A in our view. Finally, we expect the company to leverage its regulatory approvals in U.S. and Canada to pursue licensing agreements in other markets for our once-daily CIP-tramadol and CIP-isotretinoin products.
We continue to recommend the shares and have adjusted our price target to $11.
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- Base Case: The "base case" scenario assumes Cipher and Ranbaxy actively and aggressively defend the IP of Absorica against Watson's challenge, but in an effort to avoid a lengthy and costly court battle, an arbitration settlement allows the entry of an "authorized generic" nine months ahead of the expiration of the two Orange Book patents which expire in September 2021. Thus, a generic Absorica is launched in January 2021. We view this as the most likely scenario and it is what we use in our current financial model.
- Best Case: The "best case" scenario assumes Cipher and Ranbaxy actively and aggressively defend the IP of Absorica against Watson's challenge, and win. The two listed patents in the FDA Orange Book protect the product through September 2021. This is the modeling we used prior to the Paragraph IV filing. The financial and valuation differences between the base and best case scenarios are minimal.
- Worst Case: The "worst case" scenario assumes Cipher and Ranbaxy actively and aggressively defend the IP of Absorica against Watson's challenge, but lose. Watson launches a generic Absorica product in April 2016, and the market for Ranbaxy collapses (assume multiple other generics follow six months later). This would have a material negative affect on our financial model roughly to the tune of $6 per share hit to our price target.