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Investment Thesis

On May 31, 2012, I wrote a blog post on Cadence (CADX) entitled "Ofirmev Launch has Gained Traction: Reiterate Buy" when the stock was at $2.72. At that time the stock was still suffering from the widespread investor concern that the Ofirmev launch was a disappointment and that a legal challenge from generic competitors could lead to generic competition in the 2014 to 2016 period.

Since then it has become clear that the Ofirmev launch to the surprise of many is extremely successful. In the first quarter of 2013, the Company reported Ofirmev sales of $21 million which represented a year over year increase of 163% and a sequential increase of 23% from 4Q, 2012. During the first quarter conference call, Cadence raised its sales guidance for 2013 from a range of $94 to $100 million to $97 to $103 million.

My current Ofirmev sales estimates for 2013 is $106 million which is above the high end of management guidance and for 2014, 2015 and 2020 my estimates are $164 million, $230 million and $480 million, respectively. These assume no generic competition until 2019. My sales estimates may not be that aggressive. For the balance of 2013 they assume sequential quarterly unit sales increases of 6.5% which is considerably less than the 9% rate seen in 1Q, 2013. However the sales metrics that I am looking at show no sign of slowing. (In a following section, I discuss several sales metrics.) I am also assuming an annual price increase of 6%. However, I believe that the Company initially underpriced the product to gain market share and has greater pricing flexibility than I am estimating.

In December, 2012 Cadence reached a settlement with Perrigo, one of the two companies challenging the Ofirmev patents, which will prevent Perrigo from entering the market until 2020. This provided another boost to the stock, but there remains a challenge overhanging from Exela, a small generic company that is believed to be was the first to file. There are strong reasons to believe that Exela also will settle with Cadence. Perrigo has much greater financial strength and infrastructure than Exela and its decision not to fight the patents, suggests that the patents are strong and defensible. My best estimate is that Exela lacks the financial strength to wage an expensive legal battle which has a highly uncertain outcome and will settle.

We may know shortly what Exela will do as the trial starts on May 20 and is scheduled to run for 7 to 8 business days. Exela could agree to a settlement on the courthouse steps or sometime before the case is handed to the judge. If there is a settlement that is in line with that reached by Perrigo, I would expect a nice bounce in the stock. With no settlement, I would look for the stock to trade sideways pending the judge's decision. No one can ever tell what a judge may rule and the possibility that Exela stays the course and wins the suit cannot be dismissed even though I think it is unlikely. In that event, I think that Cadence would appeal, but I think the stock might drop to the $3.00 range.

The strength of the Ofirmev launch is a given in my mind and if there a favorable patent settlement with Exela, there is the potential for a sustained run in the stock so that my $14 price target for 2015 would appear achievable. However, the bears might still drag out one last argument that Cadence is a company with one product having only seven years of patent life. My view is that the strong presence of the Cadence sales force in the hospital through the success of Ofirmev is an invaluable platform that will allow the Company to acquire numerous new products through licensing, acquiring a product or acquiring an entire company. During the conference call, management affirmed that it is looking at numerous opportunities. Based on past experience, if my estimate for Ofirmev sales of $480 million in 2020 is correct, I would not be surprised to see other products contribute $500 million.

Sales Launch Metrics

My confidence in the strength of the Ofirmev launch is based on the strong sales metrics that it is showing as discussed below.

Revenues

Net product revenues were $23.6 million in 1Q, 2013. However, about $2.6 million was due to an accounting change in which deferred revenues relating to previously shipped products were booked. As of the beginning 2013, the Company's auditors felt that there was sufficient product return history to reasonably estimate future wholesaler returns. The practice had been to book sales only after Ofirmev was shipped from the wholesaler. Now, they will be booked when they are shipped from the company.

Adjusting for this accounting item, sales in 1Q, 2013 were $21.0 million which compares to $17.0 million in 4Q, 2012 and $8.0 million in 1Q, 2012. The sequential increase form the fourth quarter was 24% and the year over year increase was 163%.

Gross Margin

The reported product gross margin in 1Q, 2013 was 65.4%. Adjusting for the increased sales booked due to the accounting change, the gross margin was still 65.4%. This compares to 58.0% in 4Q, 2012 and 47.0% in 1Q, 2012.

Vials Sold

Ofirmev sold 1.82 million vials in 1Q, 2013 which compares to 1.67 million in 4Q, 2012 and 0.81 million in 1Q, 2012. The sequential gain was 9% and the year over year increase was 106%.

Since its launch in January of 2011, hospital have purchased about 8.1 million vials of Ofirmev and it is estimated that 3.2 to 4.0 million patients have been treated.

Pricing Trends

Cadence took its first price increase of 6% on July 9, 2012 and another price increase of 9% on January 1, 2013. The price per vial is about $12.46. The Company believes that this price is so low that it will allow pricing flexibility for several years.

The effective year over year price increase in 1Q, 2013 was about 15% and the sequential increase form the fourth quarter was 9%.

Market Share

The quarterly market share in the IV analgesic market based on units sold was 2.85% in 1Q, 2013. This compares to 2.52% in 4Q, 2012 and 1.41% in 1Q, 2012. There is lots of room to grow market share.

Average Vials per Patient

It is estimated that on average there are 2 to 2.5 vials used per patient. At maturity, this could reach 4.0 to 5.0.

Average Order Size

The average order size for 1Q, 2013 was about 96 vials which compares to roughly 92 in 4Q, 2012 and 70 in 1Q, 2012.

Average Order Frequency

The average order frequency for all customers was approximately 4.7 orders per quarter in 1Q, 2013 and about 4.7 for 4Q, 2012 and 2.5 in 1Q, 2012.

Repeat Orders

As of 1Q, 2013, 3,300 accounts, approximately 83% of customers, had placed repeat orders for Ofirmev. This compares to 3,100 in 4Q, 2012 and 1,600 in 1Q, 2012.

Number of Unique Accounts

The number of unique accounts that have ordered Ofirmev increased to 4000 in 1Q, 2013. This compares to 3,750 in 4Q, 2012 and about 2,000 in 1Q, 2012. There are only 5,000 hospitals in the US, although some have more than one unique account. Going forward, increasing usage per hospital will be much more important than adding accounts.

Number of Hospitals Using Ofirmev

Ofirmev is now been used in more than four out of five of the top 2,000 hospitals in the U.S. when ranked by the quantity of IV analgesic products purchased.

New Accounts Added

There were 300 new accounts added in 1Q, 2013. New accounts being added are primarily smaller accounts.

Disclosure: I am long CADX. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Source: Cadence Pharmaceuticals: Ofirmev Launch Is Strong; Resolution Of Patent Issues Could Be Soon