Just over two years ago, I shared my top biotech pick of 2012 with Seeking Alpha readers where I spotlighted a small, San Diego based biotech company called Zogenix (NASDAQ:ZGNX). At that time, Zogenix had numerous positives which gave opportunistic investors a roadmap to its undervaluation and likely gains in the months ahead. Those attributes included a newer, FDA approved drug (Sumavel Dose Pro) to treat migraines showing triple digits year over year sales growth, an imminent New Drug Application (NDA) to be submitted to the FDA for the approval of Zohydro ER to treat chronic pain, recent insider buying, and a strong balance sheet of $70 million in cash.
At the time, I expected share price appreciation sooner than it ended up happening. I did not expect the extraordinary delays in the Zohydro review process which eventually resulted in the FDA s final approval of Zohydro ER in October 2013. The uncertainty of this approval process kept the share price stagnant for the entire year of the FDA review in 2013. But those who bought in January 2012 at $2.19/share and remained patient would have enjoyed a 137% gain when Zogenix hit its post FDA approval high of $5.19 on February 13, 2014.
Unfortunately most of us were not omniscient enough to sell at that recent $5.19 high and are now holding a stock which has dropped 65% over the last three months to its current price of $1.80. If you haven't been keeping up with Zogenix over the past three months, you may wonder what killed the stock. Now that Zohydro is approved and ramping in sales, shouldn't the stock be rising instead of dropping like a ton of bricks?
After all, if you were to just look at the bullish developments over the past three months, you would think the stock price would be rising instead of falling 65%. Those key, positive developments include:
2. Commercial launch of Zoyhdro ER with approximately $240 Million in revenue forecast
3. Insider buying by Chairman and Founder, Cam Garner (30,000 shares at $1.65 on June 13)
4. $100 million cash on balance sheet and no debt
This article will focus on the key element that I believe is once again depressing Zogenix's stock price - uncertainty. The uncertainty of FDA approval which crippled the stock in 2013 has been replaced over the last three months by the Governor of Massachusetts aggressive actions to ban and severely restrict access to Zogenix's new, potentially blockbuster drug, Zohydro.
Governor Patrick's actions to single out Zogenix and its FDA-approved drug Zohydro for special treatment in his state has many investors and analysts wondering if this could lead to depressed sales and perhaps similar restrictions in other states if Patrick is successful in Massachusetts. Therefore, it is prudent to provide an update on the pending legal matters in Massachusetts because the outcome could determine whether the uncertainty is lifted and the stock makes back its loses or whether it continues its slide to 52-week lows.
Following is a summary of this landmark case and where it stands today:
Summary of Zogenix, Inc. versus Deval Patrick (Civil Case No. 14-11689) in U.S. District Court for Massachusetts (Documents available via PACER.gov)
March 27, 2014: Governor Patrick Bans Zohydro
Governor Deval Patrick issued a Declaration of Emergency regarding opioid addiction and concluded that "an emergency exists which is detrimental to the public health" in Massachusetts. In conjunction with this declaration and on the same day, Massachusetts Department of Public Health Commissioner Cheryl Bartlett approved an emergency order banning Zohydro ER's from being prescribed, dispensed, and administered.
Governor Patrick's reasoning for declaring emergency on opioid addiction in his state centered on three citations: 1) 668 Massachusetts residents died from unintentional opioid overdoses in 2012, 2) opioid abuse has increased due to the proliferation of prescriptions of opioid pain relievers, and 3) opioid use serves as gateway to heroin use.
April 7, 2014: Zogenix Files Complaint
Just eleven days after Governor Patrick's actions against Zohydro ER, Zogenix filed a complaint with the United States District Court in Massachusetts and a motion for Temporary Restraining Order and Preliminary Injunction to stop the ban.
April 15, 2014: Judge Zobel Rules
Within a week, District Court Judge Rya Zobel ruled against the state's effort to ban Zohydro which effectively nullified Commissioner Bartlett's March 27 order to ban the drug. Judge Zobel concluded that Massachusetts' actions were preempted by federal law and declared that Zogenix was entitled to a preliminary injunction. In her April 15th order, excerpts from the Judge Zobel ruling include:
The FDA endorsed Zohydro ER's safety and effectiveness when it approved the drug.
When the Commonwealth interposed its own conclusion about Zohydro ER's safety and effectiveness by virtue of DPH's emergency order, did it obstruct the FDA's Congressionally-given charge? I conclude that it did.
The FDA has the authority to approve for sale to the public a range of safe and effective prescription drugs-here, opioid analgesics. If the Commonwealth were able to countermand the FDA's determinations and substitute its own requirements, it would undermine the FDA's ability to make drugs available to promote and protect the public health.
Defendants' arguments in support of the emergency order are without merit.
Plaintiff has shown injury to its reputation by defendants' highly publicized ban of its drug, and the ban also adversely impacts the Congressionally mandated arrangement for ensuring that drugs are safe and effective for those in need.
Accordingly, it is ORDERED that, pending further order of the court, defendants are enjoined from taking any action to implement or enforce the Governor's Declaration of Emergency and the order of the Commissioner of the Department of Public Health banning the sale and distribution of Zohydro™ ER as approved by the FDA.
April 22, 2014: Governor Patrick Issues New Restrictions
In response to Judge Zobel's ruling only seven days before, Governor Patrick issued another press release on April 22 targeting Zohydro by calling for "several new actions to restrict the availability of hydrocodone-only extended-release medication that is not in abuse-deterrent form (commonly known as Zohydro)."
Over the next two weeks, the boards (Board of Registration in Medicine - BORIM, Board of Registration in Pharmacy - BORIP, Board of Registration of Physicians Assistants - BOROPA) which regulate medicine, pharmacies, and doctors in the state promulgated new, emergency regulations directed exclusively at one company and one product - Zogenix and Zohydro. The regulations required doctors to "verify that other pain management treatments have failed" before prescribing Zohydro and also prohibited pharmacy technicians, trainees, or interns from handling Zohydro.
In response to these actions as they were rolled out, Zogenix filed multiple amended complaints with the court and also filed an emergency motion for a hearing on this matter. At a May 15 scheduling conference, Judge Zobel scheduled a Motion Hearing for June 10.
June 10, 2014: Motion Hearing (transcript available from Court Reporter Catherine Handel)
At this important Motion Hearing before Judge Zobel, Zogenix was represented by Attorney Steven Hollman and Massachusetts was represented by Assistant Attorney General (AAG) Jo Ann Kaplan. The motions under consideration were 1) Zogenix's Motion for Preliminary Injunction to stop Massachusetts from implementing restrictions, and 2) Massachusetts' Motion to Dismiss.
Before the discussion of the merits of the case occurred, AAG Kaplan pushed the Judge to strike Zogenix's two, late-filed declarations by Dr. Howard Heit and Dr. Gregory Bell on the harm caused by the new regulations. Judge Zobel immediately denied this request allowing the declarations to stand and then made it clear that she wanted to deal with the merits and not the procedural stuff.
The opening statement of Steven Hollman was:
The stated objective of the Governor's initial ban on prescribing or dispensing Zohydro Extended-Release in Massachusetts and the explicit escape hatch from the follow-on restrictions announced the day the Court's injunction order became effective was to force Zogenix to adopt an abuse-deterrent formulation of Zohydro that has not been approved by the FDA.
In order to accomplish its objective, defendants followed the now-enjoined ban on prescribing and dispensing of Zohydro with emergency regulations so restrictive, that they have both the intended purpose and the obvious effect of deterring physicians from prescribing and pharmacies from stocking and dispensing.
The Judge interrupted Hollman during his introductory statement and entered into a very interesting exchange with him which shed some light on the Zobel's view of the MA Board of Registration in Medicine regulations. It went like this:
Zobel: Now this - excuse me. This regulation taking the one that was putatively promulgated by the physicians' board -
Hollman: The BORIM regulations, yes, your Honor.
Zobel: I hate those.
Following this exchange, Zobel and Hollman discussed the various regulations promulgated against Zohydro. It became clear in his response to the judge's questions that Zogenix was most concerned with only two of the new regulations - the verification that other treatment options have failed and the requirement that only the pharmacist can handle Zohydro in the pharmacy. When asked about the other emergency regulations, Hollman expressed no objections.
The exchanges over those two items were as follows:
Letter of Medical Necessity with Verification That Other Treatment Options Have Failed
Zobel: In any event, is there any part of the - I gather, there are about four parts of this. Is there any part that you do not find objectionable?
Hollman: Yes, certainly, your Honor.
Zobel: Which one?
Hollman: The idea generally that you have to have a medical necessity before prescribing an opioid, that is a - as the state itself says, and we agree, that is a common-sense notion with which we have no dispute and which is consistent with what either is good medical practice or what Commissioner Margaret Hamburg of the FDA says should be good medical practice when it comes to prescribing opioids. The difference here, though, is when you couple that requirement of the letter of medical necessity with verification that treatment options have - that other treatment options have failed, that's different from the indication approved by the FDA and conflicts with that indication. It's not supported by the clinical work that was done -
Zobel: Is that the only part you object to?
Hollman: That is the only aspect of the BORIM, the regulation of the physicians' regulations to which we assert objections, your Honor.
Pharmacy Restrictions on Handling of Zohydro
Zobel: And which part of all the pharmacy regulation do you object to?
Hollman: The pharmacy restrictions that require that only the pharmacist himself, not certified pharmacy technicians, pharmacy technicians, pharmacy technician trainees, or pharmacy interns, anyone else who works in the pharmacy, but only the physician may handle Zohydro in a non-abuse-deterrent formulation. So, the licensed pharmacist is the one who has to unpack, stock and re-stock in special locked cabinets, fill every prescription, and hold it in a locked cabinet until the patient comes to pick it up, ring up every sale at the register, and hand every prescription to a customer. The others we don't challenge and we don't quibble with.
In summary, Hollman concludes his testimony with the Zogenix position on the emergency regulations citing the two which they find objectionable:
Hollman: The BORIM, BORIP, and BOROPA regulations all require a verification that other pain management treatments have failed and the BORIP restrictions prohibit anyone but the pharmacist from handling Zohydro Extended-Release and those are a substantial obstacle which have the effect of a ban in order to require Zogenix to do exactly what the Governor announced when he initially issued his ban, which is to force an abuse-deterrent formulation.
The forced failure requirement seeks to impose a new indication for Zohydro that is different from and not consistent with the indication which the FDA approved for the drug and, again, that's for which alternative treatment options are inadequate. Meaning, the physician determines that they are not optimal for the patient, not necessarily that they have failed.
The forced failure requirement prohibiting the prescription of the drug unless other pain management treatments have failed would require physicians to cycle patients through several other sub-optimal treatment and document failure before prescribing and the burdens of the forced failure requirement are so onerous, that physicians are unlikely to prescribe the drug, as the declarations of Dr. Heit and Mr. Bell attest.
The pharmacy restrictions broadly ban all people who could assist the pharmacist in handling the drug in any way whatsoever and, therefore, the licensed pharmacist alone would have to unpack, stock, fill the prescription, ring it up at the cash register and hand it to the customer.
The cumulative effects of those burdens is such as to accomplish exactly what Governor Patrick's April 22nd press release said, which is to restrict the availability of Zohydro and exactly what the board acknowledged is the intention, which is to deter people from going on this drug, and the confidential declaration of Roger Hawley will explain in practical terms, if it is received, how the restrictions have had exactly their intended effect.
Analysis of Case
It is undisputed that Governor Patrick has singled out one company, Zogenix, with his attempts to ban and now regulate access to Zohydro. In his overreaching effort to institute an outright ban in March 2014, the court strongly ruled that his actions interfered with the Congressionally-mandated role of the FDA to approve safe and effective drugs. That first phase of this case is settled and the governor has chosen not to appeal this decision.
The second phase of this case involves the Massachusetts restrictions imposed on Zohydro and this matter is still pending in the court. The judge heard arguments in the case on June 10th and her ruling could come at any moment on the motion to dismiss (by MA) and the motion for preliminary injunction (by Zogenix).
Based on the testimony at the June 10th hearing and what the judge has already said in her April 15th ruling, the motion to dismiss is likely to be denied. Zogenix clearly has a valid claim and standing in this court. The motion for preliminary injunction is not as clear cut and easy to forecast. It is my opinion that preliminary injunction will be granted on one of the two, emergency regulations (forced failure requirement and the pharmacist-only handling of Zohydro) in dispute.
Regarding the forced failure requirement, Massachusetts runs into the same problems with this regulation as it did with the effort to outright ban Zohydro. By requiring a change in the FDA-approved indication for Zohydro to include a forced failure mandate, Governor Patrick's actions are once again likely to be preempted by federal law.
Regarding the ban on anyone handling Zohydro except licensed pharmacists, this is a more difficult hurdle for Zogenix to cross because this burdensome regulation does not directly conflict with the FDA's Congressional charge. It is possible the judge could allow such a restriction to remain in effect along with the other, less onerous regulations of which Zogenix has no objections.
This case is being closely followed within the pharmaceutical industry and legal community for the precedent it will set going forward. With the likelihood of an imminent ruling by Judge Zobel on the motions heard at the June 10th hearing, Zogenix shareholders and prospective investors must be prepared for headline risks and rewards.
So far, the judge has been very skeptical of the Massachusetts actions against Zogenix and ruled their actions are preempted by federal law. This is bullish for Zogenix due to the precedent set as they confront other states seeking to single out Zohydro. Uncertainty will surely be relieved. If the Massachusetts motion to dismiss is denied and the forced failure requirement is stopped, I would expect ZGNX to rally significantly on the news and move closer to the $2.93/share price it held just before the Governor's March 27th emergency declaration and effort to ban Zohydro.
Recent indications show that at least one Zogenix insider, Chairman of the Board & Founder Cam Garner, expects a significant price advance too with his recent open market purchase of 30,000 shares at $1.65 on June 13, 2014.
Conversely, if the forced failure requirement is upheld or the motion to dismiss is granted, ZGNX share price would likely retreat back to a solid base and 52-week low of $1.50 based on the uncertainty this will bring to the sales models for Zohydro. From the short interest in the stock (currently at 18.8 million shares), some market participants are betting on this outcome.
Therefore, stay tuned to PACER.gov and the news wires as Judge Zobel's upcoming ruling will surely move the markets and help investors determine if this dip in Zogenix shares is the buying opportunity similar to early 2012 or if we are in store for more months of uncertainty and weakness.
Disclosure: The author is long ZGNX. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.