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Investment Opinion and Overview

Now is the moment of truth for Transcept (TSPT) as the launch of Intermezzo has begun. I recommended Transcept in a report published on January 24, 2012 and I continue to recommend the stock. I would suggest that investors who need a refresher or are not familiar with the Transcept story refer to my earlier article. This report is intended to be supplemental. It is based on a presentation and comments made at the BioCentury Conference in New York by Glenn Oclassen, founder and CEO of Transcept.

Intermezzo is the first product specifically approved for middle of the night awakening. It is a sublingual formulation of zolpidem, the active ingredient in the widely used insomnia drug Ambien that is now off patent. Intermezzo is a sub-lingual formulation that results in about 25% of the dosage being quickly absorbed through the tissues of the mouth, producing a rapid onset of sleep. The remainder of the dose is swallowed and maintains sleep for the rest of the night.

Investor Focus at BioCentury

Many investor questions at BioCentury, not surprisingly, focused on the launch of Intermezzo. I believe that there is a consensus view that it will be slow (I am with the consensus) and many (not me) expect it to be disappointing based on recent experience with Avanir's (NASDAQ:AVNR) Nudexta, Auxilium's (NASDAQ:AUXL) Xiaflex, Cadence's (CADX) Ofirmev, Human Genome Science's (HGSI) Benlysta, NeurogesX's (OTCPK:NGSX) Qutenza and Xenoport's (OTCPK:XPRT) Horizant. Each of these launches was disappointing, at least to this point in time.

There are two issues that have been instrumental in the slow launch phenomenon. Physicians have grown cautious about prescribing new products due to concern about unanticipated side effects that only become apparent post launch. This was most notably the case with Merck's (NYSE:MRK) Vioxx and Glaxo's (NYSE:GSK) Avandia. Moreover, cost conscious formularies trying to keep down drugs costs have put up barriers that slow the process for new products seeking formulary access and then try to limit their use.

There were also questions on the intellectual property position of Intermezzo and whether it is really differentiated from Ambien. A common question asked of Transcept is why a patient would pay $6.45 for a dose of Intermezzo when they can obtain Ambien for $0.10. Another is how can Intermezzo avoid generic competition after the three years of exclusivity granted under Hatch-Waxman expires in 2015.

About the Launch

The national launch of Intermezzo officially began on April 4, 2012 as Purdue began formally detailing. The wholesale acquisition price of Intermezzo is $6.45 per tablet. A prescription is made up of 30 doses and costs $193.50. Based on clinical trials, the company believes that the average MOTN patient will take Intermezzo four times per week for a weekly cost of $25.80 and a yearly cost of $1,340. Only 16% of the patients treated in the clinical trials took Intermezzo every night.

Purdue has stated that it will spend $100 million on the launch of Intermezzo. It has put together a sales force of 275 sales reps who will promote only Intermezzo. This will be separate from their 500 sales reps who promote OxyContin and Butrans. Assuming that each rep costs about $200,000 to keep in the field, the cost of the sales force would account for about $55 million of this $100 million planned spend.

Purdue's formulary strategy is to go for broad formulary acceptance rather than lower tier placement. Intermezzo will probably wind up on tier III which requires a $50 prescription co-pay. For some patients who are not yet cleared for reimbursement or who are subject to high prescription co-pays, Purdue may offer a coupon that will reimburse the patient for perhaps $40. This reduces the co-pay for a patient with drug coverage to about $10 which is in-line with what they pay for generics.

Formulary acceptance is the biggest initial hurdle and it may take until September to get broad formulary acceptance. Mr. Oclassen noted that Purdue has more people in its managed care department than Transcept (with 18) has in the entire company.

The national launch received very widespread media coverage. It was featured in a segment on ABC Evening News with Barbara Sawyer and Good Morning America with Katie Couric. It also was featured in Business Week, Bloomberg and Advertising Age among other publications.

Patent Protection

Investors questioned Mr. Oclassen as to whether the patent protection of Intermezzo can block generic competition. Mr. Oclassen stated that intellectual property protection (patents) was the issue that Purdue spent enormous time on during the due diligence process that led to their in-licensing Intermezzo. Purdue has great expertise in the patent area that was demonstrated in their successful defense of their $2 billion dollar blockbuster OxyContin from generic challenges. From my standpoint, the single most important argument that the patent position for Intermezzo is solid is the action of Purdue. They licensed the product and to date have paid $30 million of milestone fees and are now putting $100 million into the launch.

The current intellectual property protecting Intermezzo is based on two issued patents that relate to formulation, are fairly narrow and offer limited protection. A much more important method of use patent is now being processed by the patent office. It claims the use of zolpidem used in low doses to treat middle of the night awakening. Transcept maintains that this was a unique discovery as the literature on zolpidem teaches that low doses of zolpidem don't work for MOTN. This patent is in process and if issued could block development of new products based on low dose zolpidem as well as generics and extend patent protection into 2029. Purdue obviously has concluded that this patent will be issued and is defendable.

Potential for European Approval

Transcept is in discussions with the EMA in Europe to determine what additional studies, if any, will be needed to gain approval. There was a stumbling block two years ago when the EMA asked for additional clinical studies to determine the effect of Intermezzo in the elderly. At that time they were unwilling to accept pharmacokinetic data. Transcept is hopeful that the data that the data generated in the driving study and the differentiation in the dose as approved by the FDA could possibly satisfy the EMA. If so, the product could be filed in Europe as early as this summer. It is not yet partnered in Europe.

What About Direct to the Consumer Advertising?

When Sepracor launched its insomnia drug Lunesta (remember the butterfly), it was very successful in using DTC advertising to drive sales to over $600 million. It is reasonable to think that DTC could also have a major impact on Intermezzo sales. There is a rule of thumb in the pharmaceutical industry that there should be an interval of six months between the launch and the start of a direct to consumer promotion. This suggests that DTC promotion could start in 4Q, 2012. This timing makes further sense because it may take that long to get broad formulary acceptance.

Co-Marketing

Transcept can exercise an option to co-promote Intermezzo to psychiatrists and receive a royalty of 22% to 40% depending on sales levels obtained and when the option is exercised. If exercised, this would require the company to hire about 50 sales reps at a cost that I estimate of around $10 million. Transcept can exercise this option at various time intervals, but the longer it waits, the lower the royalty.

The R&D Pipeline

There has not been much investor focus on the R&D pipeline, but the company is beginning to talk about TO-2061. It was developed by Transcept for the treatment of obsessive compulsive disorder or OCD, a disease that affects more than 1% U.S. adults. OCD is treated with selective serotonin re-uptake inhibitors or SSRIs such as Prozac and Zoloft and the tricyclic agent, clomipramine. About 50% of patients fail to respond to these first line agents and require the addition of another drug. There are no drugs approved for augmenting first line therapy, but atypical anti-psychotic agents like Risperdal and Zyprexa are frequently used off-label. However, the atypicals come with a host of troubling issues such as weight gain and metabolic disorders.

TO-2061 is a low dosage formulation of ondansetron (now generic) which was approved in 1991 for a different indication, chemotherapy induced nausea and vomiting. In this indication, many millions of doses have been given with no limiting side effects at a dose of 16 to 24 mg per day. It is typically used for five days following a cycle of certain chemotherapy regimens to control nausea and vomiting. Transcept is studying ondansetron at reduced daily doses of 1.0 mg to 1.5 mg, but in a chronic setting.

TO-2061 has been studied in an open label trial of 14 OCD patients treated who had been previously treated for at least 12 weeks with a combination of an SRI and an atypical antipsychotic, but failed to respond adequately to the combination. About two-thirds of these patients showed a meaningful clinical response when T0-2061 was added. A second open label study was conducted in 21 OCD patients who responded poorly to at least 12 weeks of SSRI treatment. Of these, 57% showed a meaningful clinical improvement. None of the treated patients experienced symptom exacerbation or significant adverse effects.

TO-2061 is currently in a phase II proof of concept study that will enroll 150 patients that could report results in the first half of 2013. Patients with a documented history of at least 6 weeks of inadequate response to their current OCD medication will continue to receive the same medication for an additional 6 week run-in phase. If they fail to respond to this course of therapy at the end of this combined 12 weeks of treatment, they will then be eligible to enter a 12 week active treatment phase in which they will receive 0.50 mg of ondansetron twice per day, 0.75 mg of ondansetron 0.75 twice per day or placebo. The primary endpoint of the study is the difference between active and placebo treatment arms as measured by the Yale-Brown Obsessive Compulsive Scale.

Disclosure: I am long TSPT, CADX.

Source: Transcept: The Intermezzo Launch Is Underway