Neutral on Salix

| About: Salix Pharmaceuticals, (SLXP)
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Following the release of fourth quarter and full year 2010 results, we maintained our Neutral recommendation on specialty pharmaceutical company, Salix Pharmaceuticals, Ltd. (NASDAQ:SLXP). Salix posted fourth quarter earnings of 66 cents per share, well above the Zacks Consensus Estimate of 50 cents. The company had reported a loss of 13 cents in the year-ago quarter. Higher revenues and lower research and development costs helped improve earnings.

Although fourth quarter revenues increased 68.7% to $118.5 million, revenues fell short of the Zacks Consensus Estimate of $120 million. Meanwhile, full year 2010 earnings came in at 54 cents per share, well above the year-ago loss of 88 cents and the Zacks Consensus Earnings Estimate of 30 cents. Revenues increased 44.7% to $337 million, short of the Zacks Consensus Estimate of $339 million. Revenues, however, exceeded the company’s guidance of $334 million.

Salix expects product revenues to increase 54% to approximately $520 million in 2011, including $100 million in the first quarter of 2011.

Xifaxan (rifaximin) has taken over the role of primary growth driver following the entry of generic versions of Colazal in December 2007. Xifaxan, a non-systemic selective antibiotic taken orally in a 200 mg tablet, is indicated for the treatment of patients 12 years of age and older with travelers diarrhea caused by non-invasive strains of E coli. We believe that the drug will experience solid, above-market trend growth for traveler’s diarrhea given its safety profile and lack of systemic absorption.

Moreover, Salix has been pretty active in presenting abstracts on Xifaxan at several medical meetings. We believe the results presented in the abstracts will support the development of Xifaxan for additional indications, which in turn should spur sales growth of the product. Price increases together with presentation of additional data on Xifaxan at upcoming medical conferences should help drive growth going forward. Xifaxan sales came in at $250.5 million in 2010, up 112%. We expect Xifaxan sales to cross $300 million in 2011.

Salix has been working on expanding its product portfolio over the past few years through acquisitions and in-licensing of candidates in late stage clinical development. Promising candidates include crofelemer, which is being developed for the treatment of chronic diarrhea in HIV patients. The successful development and approval of crofelemer could allow Salix to establish a strong position in the HIV-associated diarrhea market which could represent incremental opportunity in the range of $300 million. In November 2010, Salix reported positive results from a phase III study (ADVENT). The company held a pre-new drug application meeting with the FDA in January 2011 and intends to file for approval by mid 2011.

Salix boosted its portfolio in February 2011 with the acquisition of worldwide (excluding Japan) rights to Relistor, a subcutaneous injection approved for the treatment of opioid-induced constipation (NYSE:OIC) in patients with advanced illness who are receiving palliative care, when response to laxative therapy has not been sufficient.

Although Salix has been working on expanding its product portfolio, the company has faced several pipeline and regulatory setbacks over the past few quarters. The company first faced a setback in 2008 when the FDA did not grant approval to Giazo, Salix’ tablet formulation of Colazal (1100mg). Salix received another complete response letter for Giazo in April 2010. Another candidate, vapreotide acetate, received a disappointing feedback from an FDA advisory panel that voted against approving the product for the treatment of acute esophageal variceal bleeding.

The company faced a major setback in March 2011 when it received a complete response letter from the FDA for non-constipation irritable bowel syndrome for Xifaxan 550. The IBS opportunity represented significant commercial potential and the delay in gaining approval for this indication is a big disappointment. Salix intends to meet with the FDA to discuss its requirements for approval - the company may even discontinue development for this indication if the agency’s requirements are too stringent.

With Colazal facing generic competition from companies like Mylan (NASDAQ:MYL), Salix’ pipeline needs to deliver in order to drive long-term growth. Moreover, we believe the company needs to diversify its portfolio and reduce its dependence on Xifaxan for growth. While the Relistor deal could help drive long-term growth at Salix, we remain concerned that achievement of the peak sales estimate for the candidate depends on the company’s ability to expand the label and gain approval for the oral formulation.