scr.zacks.com 111 North Canal Street, Chicago, IL (DEPO-NASDAQ) UPDATE ZACKS ESTIMATES

Transcription

1 Small-Cap Research January 12, 2012 Jason Napodano, CFA scr.zacks.com 111 North Canal Street, Chicago, IL Depomed Inc. (DEPO-NASDAQ) DEPO: Building Momentum With Gralise Current Recommendation Outperform Prior Recommendation Neutral Date of Last Change 08/09/2011 Current Price (01/12/12) $5.91 Target Price $9.00 UPDATE Earlier in the week we sat down with management at Depomed (CEO Jim Schoeneck and new CFO August Moretti) to receive an update on the business. We conclude that Gralise is on track and starting to build momentum here in early Additionally, Santarus new efforts around Glumetza should be a significant driver for cash flow to Depomed in the coming years. Finally, opportunities at Merck and Covidien provide meaningful upside we believe currently not reflected in the stock. We have increased our price target to $9 per share thanks to the strong Glumetza sales. Our rating is Outperform. SUMMARY DATA 52-Week High $ Week Low $4.32 One-Year Return (%) Beta 1.39 Average Daily Volume (sh) 828,890 Shares Outstanding (mil) 55 Market Capitalization ($mil) $259 Short Interest Ratio (days) 6.26 Institutional Ownership (%) 62 Insider Ownership (%) 5 Annual Cash Dividend $0.00 Dividend Yield (%) Yr. Historical Growth Rates Sales (%) 48.2 Earnings Per Share (%) N/A Dividend (%) N/A P/E using TTM EPS P/E using 2011 Estimate P/E using 2012 Estimate N/M N/M N/A Risk Level Type of Stock Industry ZACKS ESTIMATES Average, Small-Growth Med-Drugs Revenue (In millions of $) Q1 Q2 Q3 Q4 Year (Mar) (Jun) (Sep) (Dec) (Dec) A 24.4 A 20.1 A 20.9 A 80.8 A A 21.2 A 16.5 A 10.8 E E E 16.0 E 19.5 E 24.1 E 72.1 E E Earnings per Share (EPS is operating earnings before non recurring items) Q1 Q2 Q3 Q4 Year (Mar) (Jun) (Sep) (Dec) (Dec) $0.07 E $0.08 A $0.04 E $0.03 A $0.07 A 2011 $1.77 A -$0.11 A -$0.15 E -$0.33 E $1.21 E $0.21 E -$0.17 E -$0.12 E -$0.06 E -$0.56 E 2013 $0.13 E Copyright 2012, Zacks Investment Research. All Rights Reserved.

2 WHAT S NEW Gralise Launch Underway Meeting Expectations Depomed launched Gralise in October Since that time, we have been tracking prescriptions of the drug through the secondary market. Total prescriptions have been meeting our expectations, and we believe we are on pace for sales in the fourth quarter 2011 of roughly $0.9 million. Tidbits On The Launch We remind investors that Gralise is currently priced at $1.88 per 600mg tablet, with the daily dose of 1800mg. We estimate that the current market share of the gabapentin / pregabalin market for Gralise is about 0.1%. Management has stated in the past that breakeven for the product is around 1% market share, or around 380,000 prescriptions per year. We model this level of sales for the product by the middle of In the meantime, management continues to focus on driving market penetration into the core area for the product with Pain Specialists, Neurologists, and Managed Care organizations. Depomed s goal is to have Gralise annualizing at $100+ million by year end We sat down with management earlier this week and picked up some interesting tidbits of information around the early-stage Gralise launch. Firstly, the 30-day Gralise titration pack ( G-Pack ) is a hit, especially with Pain Specialists. The titration pack provides and easy to prescript step-up dose for the first 15 days of treatment, followed by another 15 days of fully dose prior to the first renewal. We think this provides a meaningful advantage over generic gabapentin. There have been over 1,000 unique prescribers for Gralise as of year-end More than 30,000 prescribers have been identified to-date. Pain Specialists currently account for just over one-third of the scripts, followed by primary-care and neurologists accounting for another 40%. To our surprise, nurse practitioners (NP) and physician s assistants (PA) are writing around 10% of the scripts. This is something that NP s and PA s can t do with Lyrica because it is a scheduled drug. We think the fact that Gralise offers Lyrica-like efficacy with more convenient dosing and tolerability is driving meaningful use by NP s and PA s. Management has been effective in obtaining coverage for Gralise. As of the end of 2011, over 90% of commercial plans have Gralise at Tier-3 or better. Management is also making significant progress with the government and Medicare Part D. Approximately two-thirds of the scripts are commercial reimbursement. Cash pay (~20%) and Medicare / Medicaid (~15%) account for the rest. Gralise is taking market share mainly from generic gabapentin. Approximately 60% of the new Gralise scripts are patients switching from other medications, with generic gabapentin accounting for over 50% of the total. However, we are encouraged by the fact that patients also seem to be switching to Gralise from Lyrica, Cymbalta, and Lidoderm as well. Approximately one-third of new Gralise scripts are naïve patients. We re Gralise Bulls We are admitted Gralise bulls. We see the superior side-effect and tolerability profile, the G-Pack, and the solid efficacy as reasons why we believe the drug can approach $400 million in sales. Continued building of the prescriber network and formulary coverage are key to our bullish forecasts. For 2012, we see Gralise sales at roughly $25 million, growing to $61 million in Zacks Investment Research Page 2 scr.zacks.com

3 Glumetza Benefiting From Strong Santarus Effort Santarus has really increased its promotional efforts around Glumetza over the past few months. We remind investors that in August 2011, Depomed and Santarus re-worked their commercialization agreement on Glumetza whereby Santarus would book the Glumetza sales and pay Depomed a hefty royalty. The royalty rate for 2012 is 29.5%. It grows to 32% in As part of their renewed efforts around Glumetza, Santarus raised the price of the drug by 60% on the 500mg and 62% on the 1000mg in August The Glumetza price is now par with Fortamet (branded metformin). Santarus has also launched an evoucher and savings card for Glumetza in an effort to increase patient access and reduce the out-of-pocket expense to equivalent of Tier-1 coverage ($10 co-pay). The evoucher program has been very successfully in driving uptake for Glumetza. Glumetza is now the #1 metformin product on the market with over 50% share. In January 2012, Santarus raised the price by another 8% for both the 500mg and 1000mg doses. The company also increased the number of field reps promoting the product, from 110 to 150. We expect that Glumetza sales will eclipse $120 million in 2012, up 70% from We remind investors that the royalty rate payable to Depomed increases to 32% in 2012 and 34.5% in We are expecting Glumetza sales to continue their run up until 2017, when we expect that we will see the first authorized generics on the product. Serada On Hold Depomed plans to meet with the U.S. FDA during the first half of the year (we guess in May or June 2012) to discuss a potential path forward on Serada. Management continues to do some additional analysis of the BREEZE trials, compiling all the data to present to the FDA at that time. Our expectations for Serada are low. We do not include any Serada sales in our model, nor do we believe that offlabel use of Gralise by primary-care physicians will be meaningful. At today s price, the market seems to have removed Serada from the valuation. We think this is good news because should Depomed and the FDA not agree on a path forward at their upcoming meeting, it would mean little to no downside to the stock. However, a potential path forward that did not include significant expenditures could provide upside to the story. We think that Depomed will look to out-license Serada if the FDA lays out a clear path to approval at a reasonable expense. Pipeline & Collaborations There s not much significant to report with respect to the pipeline or the company s collaborations / technology licenses. Two things worth noting are: 1. Merck has re-filed its NDA for Janumet-XR. We remind investors that Merck disclosed a complete response letter (CRL) for Janumet-XR in July The details of the CRL noted CMC issues, which Merck believes they have resolved. Merck expects to hear back from the FDA on Janumet-XR during the first quarter Depomed is entitled to a low single-digit royalty on Janumet-XR. Sales of Janumet (twice daily) totaled $977 million during the first nine months of 2011 and $954 million in all of Sales of Merck s Januvia were $2,364 million during the first nine months of 2011 and $2,385 million in all of We expect that if approved, Merck will quickly cannibalize sales of Janumet to Janumet-XR. At an estimated $1.5 billion in sales, Depomed s 2% royalty (our best guess) is quite meaningful. We remind investors that Depomed has two additional deals around its Acuform technology with Johnson & Johnson and Boehringer Ingelheim. While the J&J and BI deals may be more early-stage than the deal with Merck, they still provide a potential meaningful cash flow stream min the future. Zacks Investment Research Page 3 scr.zacks.com

4 2. In December 2011, Covidien announced it would spin-out its pharmaceutical division to shareholders. We think this is good news for Depomed, as the new stand-alone pharmaceutical company will be seeking to expand its top-line and provide growth through new products. Covidien has been working to develop acetaminophen / opioid analgesic combination products utilizing Depomed's Acuform gastric retentive drug delivery technology. Covidien has stated in the past that they plan to commercialize the first of these candidates in We expect this will be a Vicodin-XR formulation. Covidien expects to follow this up with a second product in We expect this will be a Percocet-XR formulation. Depomed receives milestone upon delivery of the final formulation product and low-single-digit royalty on sales. Cash Position Remains Strong Depomed exited the third quarter 2011 with $154.2 million in cash and investments a significant war chest. We find this to be sufficient cash to fund operations for the foreseeable future. Depomed will need this cash to fund the launch of Gralise over the next several quarters. We do not expect Gralise to become cash flow positive until The company will be in cash burn mode for the next several quarters as sales ramp. However, the previous solid financial stewardship by management has placed the company in an excellent position where, despite the significant need for cash to undertake the launch of Gralise, we see little dilution risk ahead. Additionally, the revised licensing agreement with Santarus on Glumetza should help reduce operating burn in Glumetza should provide nearly $35 million in non-dilutive cash to Depomed in For all over 2012, we see only an operating burn of $25 to $30 million, meaning cash should still be around $100 million at year end RECOMMENDATION We are maintaining our Outperform rating and increasing our price target to $9 per share target on Depomed. Our target has been adjusted higher on increased sales of Glumetza. Our DCF valuation can be found below. Zacks Investment Research Page 4 scr.zacks.com

5 PROJECTED INCOME STATEMENT Income Statement DEPOMED 2009 A 2010 A Q1A Q2A Q3A Q4E 2011 E 2012 E 2013 E 2014 E Total Product Sales $35.1 $45.6 $15.3 $16.2 $9.2 $0.9 $41.6 $24.7 $61.0 $94.6 YOY Growth 13.0% 30.0% 21.5% 38.6% -6.2% -92.1% -8.9% -40.7% 46.8% 55.0% Total Royalties $1.5 $0.3 $0.2 $0.1 $2.2 $6.1 $8.5 $38.4 $52.8 $61.5 YOY Growth -3.1% -80.0% 87.5% -26.4% % % % 353.2% 523.7% 16.3% Total Licenses Revenues $21.1 $34.8 $67.6 $5.0 $5.1 $3.5 $81.3 $9.0 $10.0 $11.5 YOY Growth 882.8% 65.2% % -60.6% -49.7% -62.2% 133.4% -88.9% -87.7% 15.0% Total Revenues $57.7 $80.8 $83.1 $21.2 $16.5 $10.5 $131.3 $72.1 $123.9 $167.6 YOY Growth 65.7% 39.9% 441.0% -13.1% -17.9% -49.8% 62.6% -45.1% -5.7% 35.3% Cost of Goods Sold $5.3 $8.1 $1.6 $2.1 $1.2 $1.1 $6.1 $3.7 $9.2 $14.2 Gross Margin 90.9% 90.0% 98.0% 89.9% 93.0% 89.1% 95.4% 94.9% 92.6% 91.5% SG&A $16.7 $17.5 $7.2 $10.0 $15.5 $24.0 $56.7 $87.0 $90.0 $94.0 % SG&A 28.9% 21.7% 8.7% 47.0% 93.5% 229.2% 43.1% 120.7% 72.6% 56.1% R&D $34.3 $20.1 $5.2 $4.0 $3.2 $3.5 $15.9 $14.2 $16.5 $20.0 % R&D 59.4% 24.9% 6.2% 19.1% 19.4% 33.4% 12.1% 19.7% 13.3% 11.9% Santarus Payment $23.6 $31.4 $10.3 $11.1 $6.0 $0 $27.3 $0 $0 $0 Operating Income ($22.1) $3.6 $58.8 ($6.0) ($9.3) ($18.2) $25.4 ($32.8) $8.2 $39.4 Operating Margin -38.2% 4.5% % -45.6% 6.6% 23.5% Interest & Other Net $0.0 $0.3 $40.0 $0.3 $0.4 ($0.0) $40.7 $1.2 $1.5 $2.0 Pre-Tax Income ($22.0) $3.9 $98.8 ($5.7) ($8.9) ($18.2) $66.0 ($31.6) $9.7 $41.4 Taxes $0 $0.0 $0.0 $0.0 ($0.3) $0.0 ($0.3) $0.0 $1.9 $13.3 Tax Rate 0% 0% 0% 0% 0% 0% 0% 0% 20% 32% Net Income ($22.0) $3.9 $98.8 ($5.7) ($8.6) ($18.2) $66.4 ($31.6) $7.8 $28.2 Net Margin -38.1% 4.8% % -43.9% 6.3% 16.8% Adjusted EPS ($0.43) $0.07 $1.77 ($0.11) ($0.15) ($0.33) $1.21 ($0.56) $0.13 $0.47 Source: Zacks Investment Research, Inc. YOY Growth N/A % % % -88.9% 249.6% Stock Options $2.7 $2.0 $0.7 $1.2 $0.9 $1.0 $3.8 $3.0 $3.5 $3.5 EPS Impact of FAS-123R ($0.05) ($0.04) ($0.01) ($0.02) ($0.02) ($0.02) ($0.07) ($0.05) ($0.06) ($0.06) Wt. Ave Shares Out Jason Napodano, CFA Copyright 2012, Zacks Investment Research. All Rights Reserved.

6 HISTORICAL ZACKS RECOMMENDATIONS DISCLOSURES The following disclosures relate to relationships between Zacks Investment Research ( ZIR ) and Zacks Small-Cap Research ( Zacks SCR ) and the issuers covered by the Zacks SCR analysts in the Small-Cap Universe. ZIR or Zacks SCR Analysts do not hold or trade securities in the issuers which they cover. Each analyst has full discretion on the rating and price target based on their own due diligence. Analysts are paid in part based on the overall profitability of Zacks SCR. Such profitability is derived from a variety of sources and includes payments received from issuers of securities covered by Zacks SCR for non-investment banking services. No part of analyst compensation was, is or will be, directly or indirectly, related to the specific recommendations or views expressed in any report or blog. ZIR and Zacks SCR do not make a market in any security nor do they act as dealers in securities. Zacks SCR has never received compensation for investment banking services on the small-cap universe. Zacks SCR does not expect received compensation for investment banking services on the small-cap universe. Zacks SCR has received compensation for non-investment banking services on the small-cap universe, and expects to receive additional compensation for non-investment banking services on the small-cap universe, paid by issuers of securities covered by Zacks SCR. Non-investment banking services include investor relations services and software, financial database analysis, advertising services, brokerage services, advisory services, investment research, and investment management. Additional information is available upon request. Zacks SCR reports are based on data obtained from sources we believe to be reliable, but is not guaranteed as to accuracy and does not purport to be complete. Because of individual objectives, the report should not be construed as advice designed to meet the particular investment needs of any investor. Any opinions expressed by Zacks SCR Analysts are subject to change. Reports are not to be construed as an offer or the solicitation of an offer to buy or sell the securities herein mentioned. Zacks SCR uses the following rating system for the securities it covers. Buy/Outperform: The analyst expects that the subject company will outperform the broader U.S. equity market over the next one to two quarters. Hold/Neutral: The analyst expects that the company will perform in line with the broader U.S. equity market over the next one to two quarters. Sell/Underperform: The analyst expects the company will underperform the broader U.S. Equity market over the next one to two quarters. The current distribution of Zacks Ratings is as follows on the 1025 companies covered: Buy/Outperform- 16.7%, Hold/Neutral- 75.7%, Sell/Underperform 6.7%. Data is as of midnight on the business day immediately prior to this publication. Copyright 2012, Zacks Investment Research. All Rights Reserved.