small-cap researchs1.q4cdn.com/460208960/files/jan 30, 2013_depo_serada...if this adjustment in...

© Copyright 2013, Zacks Investment Research. All Rights Reserved.

Current Recommendation Outperform

Prior Recommendation Neutral

Date of Last Change 08/09/2011

Current Price (01/30/12) $6.29

Target Price $9.00

Update

SUMMARY DATA

Risk Level Average,

Type of Stock Small-Blend

Industry Med-Drugs

Depomed Inc. (DEPO-NASDAQ)

We continue to be positive on the Depomed story. Recent prescriptions of Gralise show a potential uptrend in sales coming in the fourth quarter 2012. Likewise, we see some stabilization in the Zipsor product and believe it could be a nice contributor to the top-line in 2013.

Upside to the story comes from potentially monetizing the Glumetza royalties, the approval of Serada, or another Acuform licensing deal that brings a handsome upfront payment.

Our rating is Outperform with a $9 price target.

52-Week High $7.06

52-Week Low $4.97

One-Year Return (%) 4.83

Beta 1.48

Average Daily Volume (sh) 236,154

Shares Outstanding (mil) 56

Market Capitalization ($mil) $353

Short Interest Ratio (days) 24.66

Institutional Ownership (%) 55

Insider Ownership (%) 3

Annual Cash Dividend $0.00

Dividend Yield (%) 0.00

5-Yr. Historical Growth Rates

Sales (%) 7.9

Earnings Per Share (%) N/A

Dividend (%) N/A

P/E using TTM EPS N/M

P/E using 2012 Estimate N/A

P/E using 2013 Estimate N/A

ZACKS ESTIMATES

Revenue (in millions of $)

Q1 Q2 Q3 Q4 Year (Mar) (Jun) (Sep) (Dec) (Dec)

2011 83.1 A 21.2 A 16.5 A 12.1 A 133.0 A 2012 16.8 A 14.1 A 33.3 A 26.8 E 91.1 E 2013 142.3 E 2014 197.3 E

Earnings per Share

Q1 Q2 Q3 Q4 Year (Mar) (Jun) (Sep) (Dec) (Dec)

2011

$1.77 A -$0.11 A -$0.15 A -$0.25 A $1.26 A 2012

-$0.16 A -$0.28 A -$0.03 A -$0.09 E -$0.56 E 2013

$0.07 E 2014

$0.77 E

Small-Cap Research

scr.zacks.com 111 North Canal Street, Chicago, IL 60606

January 30, 2013 Jason Napodano, CFA

312-265-9421 [email protected]

DEPO: Serada Approval Presents Big Upside To Depomed

Zacks Investment Research scr.zacks.com

WHAT S NEW

Gralise Update

On January 8, 2013, we sat down with Jim Schoeneck (CEO) and August Moretti (CFO). Topics for discussion were the steady growth in prescriptions for flagship product, Gralise, and the pending FDA Reproductive Health Drugs Advisory Committee meeting to be held on March 4, 2013, and subsequent Prescription Drug User Fee Act (PDUFA) action date for Serada on May 31, 2013. We note two important takeaways from my meeting with respect to Gralise.

The first is that management took a 12% price increase on Gralise on December 14, 2012. Gralise now costs $2.52 per pill, or a $7.56 per day. Surprisingly, thanks to Pfizer raising the price of Lyrica by 9% on January 1, 2013, Gralise is still around 10% cheaper than Lyrica. For the purpose of my model, we ve been using a blended price per prescription of around $150. I note the blended price includes the lower-price titration pack for new prescriptions and some couponing and sampling to drive awareness and uptake. Given the new price increase, we have raised our revenue forecasts for 2013 and beyond. We note that Pfizer did $4,158 million (+13%) in sales of Lyrica in 2012. Clearly this is a huge market for Depomed.

The second key takeaway is that management continues to make progress on the formulary front, winning its first Medicare Part-D listing with CVS Caremark for broad Tier-2 reimbursement. This is an important win because the majority of PHN patients are of Medicare age, and Medicare does not allow discount coupons. The listing of Gralise as Tier-2 with CVS 6+ million lives opens up a meaningful opportunity for management. In total, there are roughly 30 million lives covered under Medicare Part D that have been disadvantaged to Gralise due to lack of coverage. If Depomed can follow this up with additional Medicare wins in 2014, Gralise prescriptions (and sales) are set to soar.

According to IMS data, Gralise did just over 46k prescriptions in the fourth quarter 2012. Using a blended price of around $135-140 per script, we project sales in the fourth quarter of $6.3 million. We note this figure does not include any of the potential booking of deferred revenues for product returns. As of September 30, 2012, the company listed $4.5 million in deferred product sales related to Gralise on the balance sheet. Depomed recognizes revenues on Gralise when prescriptions are written (a conservative approach). However, management expects to transition to recognizing revenue when shipped to the wholesaler at some point in the near-future. If this adjustment in accounting is made, we would expect a one-time bump of around $2.5 million in recorded sales.

For the week ending January 18, 2013, Gralise total prescriptions were 4,086, which annualizes to a run-rate of approximately $31 million using a blended price of around $150 per script. Gralise current holds 0.4% of the total gaba-molecule market. To date, over 8,500 physicians have written prescriptions for Gralise, with the majority coming from pain specialists (~41% of the total), primary-care physicians (~28% of the total), and neurologists (~16% of the total). Roughly 55% of the Gralise scripts are coming from users switching from generic gabapentin TID, with Cymbalta (~21%), Lyrica (~12%), and Lidoderm (~11%) rounding out the bulk of the rest of patient switches.

Source: Depomed, Inc.


What The Future Holds

Depomed also recently published the data from its phase 3 program with Gralise in the Clinical Journal of Pain. The data shows that once-daily Gralise significantly reduces intensity of pain (-2.12 vs. -1.63, p=0.013) in patients with postherpetic neuralgia (PHN). The results also highlight the improvement in tolerability and side-effect profile of the drug, when compared to known issues with generic gabapentin. With the data now published for peer-review, the sales force can begin to use the article as marketing material when detailing the product to high PHN prescribers. Depomed also recently began a post-approval (phase IV) study looking at the real-world use of Gralise. The study should provide valuable information on Gralise titration and tolerability, and improve the dosing issues noted above.

With respect to the sales force, in September 2012, Depomed made the decision to convert all of their full-time reps contracted from Ventiv Commercial Services (in June 2011) to direct employees. The move results in minor upfront costs (conversion fee, health insurance, stock options, vacation, etc ) but in turn should improve efficiency in the future. There was some minor attrition and realignment due to managed-care reimbursement. The company now has 155 full-time territories, down from 164 at the end of the second quarter. Additionally, the 78 flex reps added in July 2012 are now actively targeting primary care physicians. Management expects to see the impact of the flex reps beginning here in the fourth quarter.

For the full year 2013, we are modeling sales of Gralise at $47.8 million (does not include the accounting adjustment). We expect Gralise sales to grow to $86.0 million in 2014. Gralise remains the key value driver for Depomed in our view. Below is a graphical representation of our forecasts vs. weekly TRx. To date, Gralise TRx has been remarkably consistent in its slow and steady growth.

Lawsuit, ANDAs, and the FDA

On September 25, 2012, Depomed announced it had filed action in federal court against the U.S. FDA seeking an order requiring the FDA to grant Gralise Orphan Drug exclusivity for the management of postherpetic neuralgia (PHN). As a reminder, the FDA previously granted Orphan Drug designation (ODD) to Depomed, but has not granted the exclusivity associated with the claim. ODD would protect Gralise from generic alternatives until January 2018. This would clearly be nice protection to have considering five (was six by Impax has withdrawn) companies have filed paragraph IV - abbreviated new drug applications (ANDA) on Gralise seeking to bring generics to the market following the 30-month Hatch-Waxman exclusivity in July 2014. As of today, the FDA has not yet filed an answer in the case. Depomed views this issue as a matter of interpretation to the relevant statute and regulation. Both sides will present their case in front of a federal judge. We expect a summary judgment in 7-10 months, well before the Hatch-Waxman period expires.

Management continues to believe it has strong intellectual property protecting Gralise. The company has added to the patent portfolio throughout 2012 with the addition of four new patents, and now has eight Orange Book listed patents for Gralise, many not expiring until 2022 or 2024. In late December 2012, Depomed noted that Watson has withdrawn its Gralise ANDA. We really cannot read much into this move because Watson acquired Activis Elizabeth in November 2012, and the Activis ANDA remains active and was first-to-file . Par Pharma also amended its ANDA and is no longer seeking to bring a generic Gralise to the market prior to the patent expirations (change from paragraph IV filing to a paragraph III filing).


Zipsor Update

Zipsor is now being promoted in the second position behind Gralise by the Depomed sales force. We note at the time of the acquisition, Zipsor was annualizing at around $19 million per year. Depomed recorded a total of $4.9 million in Zipsor sales in the third quarter 2012. In our conversations with management in early January 2013, management noted that Zipsor prescriptions have been flat the past several weeks. We are expecting around $4.5 million in the fourth quarter 2012. For all of 2013, we think Zipsor does between $19 and $21 million. We see Zipsor as having $30 million peak potential as long as it stays in the number two position for Depomed behind Gralise.


Glumetza Update

Glumetza contributed $11.6 million in royalties in the third quarter 2012 off of sales at Santarus at around $39 million. Santarus recently took a price increase on Glumetza and increase the number of reps promoting the product. As a result, Depomed management now sees full year 2012 royalties from Glumetza eclipsing $40 million. Depomed receives 29.5% royalty on sales of Glumetza at Santarus. We note the royalty rate is set to jump up in 2013 to 32% and to 34.5% in 2015.

We expect the first generic Glumetza tablets will start to show up in early 2016. Glumetza is a nice cash-cow for Depomed. It lowers the quarterly burn and provides meaningful growth to the top-line. However, Glumetza has a shelf life, and royalties are going to start to decline in early 2016 on the launch of generic alternatives. We think that Depomed could monetize this royalty stream in an effort to secure additional cash beyond 2013. We believe if the company can secure north of $100 million, it would be wise to sell the royalty stream and look to acquire another late-stage or commercialized product in the pain / neurology market that Depomed can promote along with Gralise and Zipsor. Glumetza is no longer a core-asset and its life is coming to an end. We believe that shareholders would react favorably to cashing-out on Glumetza and securing another core-asset to add to the existing pain and neurology model the company has worked so hard to create over the past year. That being said, we do not expect Depomed to enter into such a transaction unless they already have identified a pain / neurology product to acquire.


Serada Presents Big Upside To The Story

On July 31, 2012, Depomed submitted a New Drug Application (NDA) for Serada to the U.S. FDA. Serada is Depomed's proprietary extended release formulation of gabapentin in development for the treatment of moderate to severe vasomotor symptoms ("hot flashes"). We remind investors that management at Depomed met with the U.S. FDA in a Type-B "pre-NDA" meeting in April 2012. Following that meeting, management believed the data from the BREEZE-1, -2, and -3 trials, "Warrants submission of an NDA for the FDA's review and consideration." The FDA formally accepted the application on October 15, 2012 and established a Prescription Drug User Fee Act (PDUFA) action date of May 31, 2013.

However, investors may not have to wait until the last day of May to get a sense on whether or not the FDA will approve Serada. The agency's Reproductive Health Drugs Advisory Committee will discuss the Serada NDA at an Advisory Committee meeting scheduled for March 4, 2013. Below we discuss the data from the three phase 3 trials studying Serada for the treatment of menopausal hot flashes. But before we get into the data, investors should note the FDA's guidance on study considerations for a menopausal hot flashes therapy. First, since this is a new indication for gabapentin extended release, the agency requires two placebo-controlled phase 3 clinical trials to establish safety and efficacy. The FDA encourages study participants be enrolled who have a minimum of 7 to 8 moderate to severe hot flashes per day, or 50 to 60 per week at baseline. The primary endpoints should be as follows:

Mean change in frequency of moderate to severe vasomotor symptoms from baseline to week 4.

Mean change in frequency of moderate to severe vasomotor symptoms from baseline to week 12.

Mean change in severity of moderate to severe vasomotor symptoms from baseline to week 4.

Mean change in severity of moderate to severe vasomotor symptoms from baseline to week 12.

The FDA gives leeway with respect to secondary endpoints. Besides the four required primary endpoints noted above, Depomed studied Serada on a mean change in frequency and severity at 24 weeks, as well as incorporated both a patient and clinician global impression of change (P/C-GIC), insomnia severity index (ISI), and sleep interference (S/I) assessment.

The BREEZE-1 / BREEZE-2 Data

In total, Depomed studied Serada in 1,699 post-menopausal women suffering from hot flash. Each trial was a randomized, double-blind, placebo-controlled study of the drug's effectiveness in post-menopausal women experiencing at least seven moderate to severe hot flashes each day.

For BREEZE-1 and BREEZE-2, patients were randomized into one of three treatment arms, receiving either placebo or a total dose of 1200 mg (600 mg AM + 600 mg PM) or 1800 mg (600 mg AM + 1200 mg PM) of Serada. Data from B1 and B2 was analyzed using parametric methods using ANCOVA (analysis of covariance) and mean data, assuming the normal distribution of primary endpoints. The statistical tests were performed at the = 0.025, 2-sided significance level to accommodate two pairwise comparisons between each Serada treatment group (1200 or 1800 mg) and the placebo group.

Depomed reported results from B1 and B2 in October 2009, noting that the trials failed to achieve statistical significance in all sixteen primary endpoints - remember there were two separate trials, each testing two doses on four primary endpoints. There was however, a noticeable trend in dose-response, with a clear bias toward the higher dose. If we focus on only the patients that received the 1800 mg (n=371) dose of Serada, compared to the 1200 mg dose (n=360) vs. the placebo (n=360), at a p-value of 0.025 (per protocol) the trial hit five of eight endpoints. If Depomed had tested only the 1800 mg dose vs. the placebo to begin with, allowing for a 1-sided significance level of = 0.05, then the trial would have hit seven of eight endpoints, missing only frequency at week 12 in B1.

BREEZE-1 Frequency (% Change) Severity (% Change) (n=541)

Serada Placebo p-value Serada Placebo p-value

Week 4: -66% -52% p=0.0001 -28% -16% p=0.0001

Week 12: -67% -62% p=0.20 -32% -28% p=0.0468

BREEZE-2 Frequency (% Change) Severity (% Change) (n=565)


Week 4: -63% -49% p=0.004 -28% -20% p=0.0003

Week 12: -67% -55% p=0.028 -36% -24% p=0.0026



Depomed presented the results from the BREEZE-1 and BREEZE-2 data at the North American Menopause Society (NAMS) annual meeting in October 2010. At the meeting, management discussed the effects of outliers on the data, noting at the time that some women in the study were reporting as many as 99 hot flashes a day. For example, one patient (#37013) on the 1800 mg dose reported an average of 45 hot flashes per day vs. the study average of 11.13 per day for the 1800 mg cohort. At week 12, this patient showed no response to Serada, still averaging 51 hot flashes per day. Another patient (#41006) in the placebo group clocked-in at 44 hot flashes per day vs. 11.34 cohort average at baseline. This same patient reported less than 1 hot flash per day at week 12.

Above we note that the one missed endpoint - using a 1-sided significance level of = 0.05 for B1 and B2 - was the week 12 frequency data in B1 (p=0.20). Removing the two above outliers (patients #37013 & #41006) from the study changes the p-value for week 12 frequency to p=0.026.

Parametric methods of analysis are only valid if assumptions for normal distribution are met. For B1 and B2, management at Depomed assumed a normal and homogeneous distribution of data. Unfortunately, this was not the case. The population in B1 and B2 was skewed due to outliers on the high-end, specifically with respect to frequency of hot flashes per day (as noted above). On the low-end, patients had to have at least seven hot flashes a day to enroll in the study. As such, the distribution of patients was not normal at all. In this regard, a non-parametric analysis (one that focuses more on the equal ranking of responses rather than the degree of response) would have been a superior methodology. In fact, when management re-analyzed the B1 data using a non-parametric analysis, three out of four endpoints for B1 met statistical significance with a p-value less than 0.05. When a similar analysis was performed on the B2 trial, all four endpoints met statistical significance with a p-value less than 0.025.

The BREEZE-3 Data

To confirm the findings from B1 and B2, Depomed initiated a third trial, BREEZE-3, which enrolled 600 women between two arms, 1800 mg Serada (n=302) and placebo (n=298). The primary endpoints were the same as B1 and B2, only because B3 stratified into only two cohorts, the statistical analysis allowed for a significance hurdle of = 0.05.

For B3, management instituted some controls and protocol changes in an attempt to reduce the outliers and control placebo response in the trial. These changes and controls included a two-week run in period prior to randomization, rather than one week to allow for baseline stabilization. The trial also called for fewer patient interactions with the clinical census to minimize caregiver impact on assessment, and a reduction in the electronic diary recording of hot flashes in the 12-week persistent efficacy portion of the trial to improve patient retention (a problem in both B1 and B2). Depomed and the U.S. FDA agreed on these changes through a special protocol assessment (SPA).

Top-line data from BREEZE-3 was released in October 2011. The trial did not meet all four primary endpoints when analyzed using non-parametric analysis, begging the question: Why didn't management's changes to control placebo response work? Perhaps hot flash is just an indication where the placebo response is just too powerful to control?

Nevertheless, using the methodology pre-specified in the SPA (i.e. non-parametric analysis), the trial hit three of four endpoints, missing that pesky frequency endpoint at week 12 (similar to the failure of B1). Besides the four primary endpoints, Depomed looked at signs of persistent efficacy at week 24. The FDA specifically asked Depomed to look at efficacy at week 24 because there were internal questions at the agency of just how effective a non-hormonal treatment could be on a sustained basis. Unfortunately, B3 did not achieve statistical significance when analyzed using non-parametric analysis for either frequency or severity at week 24, begging yet another question on whether or not Serada is truly an effective drug.

BREEZE-3 NON-PARAMETRIC ANALYSIS Frequency (% Change) Severity (% Change) (n=593)


Week 4: -57% -44% p<0.001 -17% -9% p<0.001

Week 12: -65% -58% N/S -26% -18% p<0.01

Week 24: -76% -67% N/S -34% -26% N/S


However, when the company went back and analyzed the data from B3 using the same parametric ANCOVA analysis conducted on B1 and B2, the results were statistically significant for all endpoints tested, including the secondary week 24 endpoints. In fact, management went back and looked at all 67 centers that enrolled patients. Thirty-nine (58%) of the 67 centers enrolled less than 10 patients. In fact, 19 (28%) of the 67 centers enrolled less than 5 patients. The larger number of very small centers indicates that non-parametric Wilcoxon (Van Elteren) analysis (Zhao YD, 2006) was not the appropriate statistical test for B3. When analyzed using ANCOVA, the results below show strong statistical significance in favor of Serada.


BREEZE-3

ANCOVA ANALYSIS

Frequency (% Change) Severity (% Change) (n=593) Serada Placebo p-value Serada Placebo p-value

Week 4: -57% -44% p<0.0001 -17% -9% p<0.0001

Week 12: -65% -58% p=0.0007 -26% -18% p=0.0102

Week 24: -76% -67% p=0.0174 -34% -26% p=0.0457

Numerical Data

Frequency (% Change) Severity (% Change)

Week 4: -1.69 vs. placebo p<0.0001 -0.21 vs. placebo p<0.0001

Week 12: -1.14 vs. placebo p=0.0007 -0.19 vs. placebo p=0.0102

Week 24: -1.08 vs. placebo p=0.0174 -0.22 vs. placebo p=0.0457


Additionally, significantly more women said their symptoms improved with Serada at 12 weeks (68% vs. 54% with placebo; p<0.0036) and 24 weeks (74% vs. 54% with placebo; p<0.0001) on the patient global impression of change (PGIC) scale. Management also conducted an analysis of Serada's impact on sleep. Though not a primary endpoint, the analysis yields some encouraging results.

BREEZE-3 Sleep Impact Insomnia Severity Index (ISI) Sleep Interference (S/I) (n=593)


Baseline: 17.54 17.33 - 7.3 7.4 -

Week 12: -8.7 -6.3 p=0.0044 -3.6 -2.8 p=0.0056

Week 24: -8.6 -6.2 p=0.0056 -3.9 -3.1 p=0.0084


Sleep disturbance in women with menopausal hot flashes is a significant psychological and physiological problem (Howard et al., 2003, Thurston et al., 2006). Gabapentin, the active ingredient in Serada, is known for causing somnolence (sleepiness). Just how much of the improvement in sleep characteristics are a result of improving hot flash symptoms versus a side-effect of gabapentin therapy is unknown, but we are willing to bet women don't care why, as long as it works.

Overall, Serada was well-tolerated. Five percent more patients on Serada than placebo withdrew from the trial due to adverse events (16.7% vs. 11.5%, respectively). The most common adverse events were headache (9% vs. 8% placebo), daytime sleepiness, or somnolence (6% vs. 3% placebo), upper respiratory tract infections (6% vs. 4% placebo), and dizziness (13% vs. 3% placebo), which are the most bothersome side effects commonly associated with gabapentin. Of note, both treatment arms reported minimal changes in weight over the 24-week arm.

Our Thoughts On The Data

We think Serada works, and we say that despite the noticeably high power of the placebo in all three trials. We think B1 and B2 failed because a few outlier patients drastically swayed the magnitude of response (mean) vs. the rank of response (median). Removing just two outliers, one in the 1800 mg group and one in the placebo group makes all endpoints statistically significant at p<0.05. The same can be said for B3. Using the proper ANCOVA analysis, all endpoints, including a secondary analysis at week 24, met statistical significance.

In fact, looking at all the data and using a p-value of less than 0.05 and ANCOVA analysis, we see that Serada hit ten of the required 12 primary endpoints. Remove the two outliers from B1, and Depomed went 12 for 12. And if you think this is data manipulation, then you're right, but it worked for Endeavor Pharma and Barr Pharma, now owned by Teva Pharmaceuticals, back in May 2004 when the FDA granted approval to Enjuvia (synthetic conjugated estrogen B) on the strength of a re-analysis of the data following an approvable letter in April 2003.

As we look at the data from the BREEZE trials, we see that the placebo showed a 58% average (62% in B-1, 55% in B-2, 58% in B3) reduction in hot flash frequency at week 12. Serada showed a 66% reduction in B1 and B2, and 65% in B3 at week 12. That's ~66% vs. ~58%, or around a 14% improvement. Responder analysis from BREEZE-3 showed a 68% improvement in symptoms for Serada vs. 54% for the placebo at week 12. That's a 26% improvement. By week 24, the numbers get more impressive, 74% for Serada vs. 54% for the placebo, or a 37% improvement.


We would not classify any of the above data as a "Home Run." After all, women can expect a greater than 50% improvement in symptoms by simply taking a sugar pill. Nevertheless, the data are interesting enough that we believe some primary-care physicians and Ob/Gyn doctors will prescribe the drug. The sleep data is interesting because nearly all women with hot flash have sleep disturbance. In fact, there is evidence that sleep disturbance is the clear driver of women seeking prescription help for moderate to severe hot flashes, and Serada can be effectively promoted as improving quality of sleep.

The Serada Opportunity

Hormone replacement therapy (HRT) is currently the only FDA-approved single-agent therapy for the treatment of menopausal hot flashes. In 2003, prescriptions for HRT products, specifically Wyeth's Premarin, dropped dramatically following the National Institutes of Health's decision to halt a large-scale clinical study of HRT due to preliminary results suggesting a correlation between HRT and increased risk of breast cancer and cardiovascular disease.

Results from these Women's Health Initiative (WHI) trials in 2002 caused HRT prescriptions to decline by 60% from 2001 levels. Primary-care physicians (PCP) and Ob/Gyn's dramatically reduced their use of HRT products as a result of WHI. That being said, HRT remains the standard of care, physicians are just using lower-effective doses of a combination of estrogen plus progestin therapy (EPT).

At the NAMS meeting in October 2012, results from the Kronos Early Estrogen Prevention Study (KEEPS) were presented. KEEPS was a four year, randomized, double-blind, placebo-controlled clinical trial of low-dose oral or transdermal estrogen and cyclic monthly progesterone given to healthy women (n=727) within three years after menopause.

Results from KEEPS suggest that low-dose EPT treatment, comprised of 0.45 mg a day conjugated equine estrogen (Premarin) plus 200 mg micronized progesterone for only 12 days each month (Prometrium), started soon after menopause appears to be safe; relieves many of the symptoms of menopause; and improves mood, bone density, and several markers of cardiovascular risk. The dose was significantly lower than that tested in the WHI study in 2002, which used 0.625 mg conjugated equine estrogen plus 2.5 mg medroxyprogesterone a day.

NAMS believes that low-dose EPT remains the most effective treatment available for menopausal symptoms, including hot flashes and night sweats that can interrupt sleep and impair quality of life. NAMS believes that the majority of women can take low-dose EPT safely, for periods up to three to five years, with little risk of heart attack, stroke, blood clots, or breast cancer.

The position of NAMS seems in concert with the FDA's updated guidance to use the lowest effective dose, and the approval of Biosante Pharma's (BPAX) Elestrin (estradiol gel 0.06%) in December 2006. The package insert for Elestrin recommends patients start at "one pump per day" (0.52 mg estradiol) even though the clinical data clearly shows (on page 20) that one pump did not meet statistical significance at week 4 for either frequency or severity (instead clinical data showing statistical significance at p<0.01 is presented at week 5). The FDA seemed okay with allowing women to start on one pump of Elestrin in an effort to approve alternative low-dose treatment options and reduce the risk of breast cancer or cardiovascular events. As a result, we expect that these updated guidelines from NAMS, the approval of Elestrin, and data from KEEPS will relegate Serada to a second-line therapy for women where HRT / EPT is either not effective or not desirable due to pre-existing conditions. For women with pre-existing risk, an alternative therapy, like Serada, may be more desirable. Analysis clearly shows a void in the market, but we believe the void is for second-line treatments, not for a new standard of care.

Many physicians have been prescribing off-label anti-depressants, including Paxil, Effexor XR, and Pristiq. In early May 2011, Pfizer released data from a phase 3 trial studying Pristiq (desvenlafaxine) in the treatment of hot flash in postmenopausal women. The data was presented at the 59th Annual Meeting of the American College of Obstetricians and Gynecologists.

Pristiq (desvenlafaxine) Phase 3 Sub-Set Data Frequency (% Change) Severity (% Change) (n=365)

Pristiq Placebo p-value Pristiq Placebo p-value

Week 4: -55% -31% p<0.001 -20% -8% p<0.001

Week 12: -62% -38% p<0.001 -25% -12% p<0.001

Source: Pfizer, Inc.

This data compares very well with a pool analysis of the 1800 mg Serada data from the BREEZE trials. The problem with Pristiq is the side-effect and tolerability profile. According to the Pristiq label, which is currently approved for the treatment of depression, 100 mg / day is associated with 0.7% sustained hypertension, 26% nausea, 17% dry mouth, 9% diarrhea, 9% constipation, 7% fatigue, 8% decreased appetite, 10% dizziness, 9% somnolence, 12% insomnia, 11% hyperhidrosis, and 5% anxiety. The Pristiq clinical trials showed both potential liver and cardiovascular issues, a risk the FDA was willing to take on depression but not for hot flash. Additionally, the drug carries an FDA Black Box warning for potential suicidal thinking and behavior in young adults. We are unsure if this warning would carry over to the label for hot flash (different population), but nevertheless, Pristiq is not an attractive option for patients. Comparing the approved label for Gralise it is clear that Gralise / Serada is a much cleaner drug. Pfizer gave up on Pristiq for hot flash in February 2012 for undisclosed reasons.


According to Breastcancer.org, 80% of the women in the U.S. (~32 million) experience hot flashes of some kind as they approach menopause, and for the first year or two after their periods stop. Between 25% and 50% of women continue to have them for many more years. About 30% (10 million) seek medical treatment. That's a big market, and presents a big opportunity for Depomed, even in a second-line role.

Of the 10 million women seeking medical treatment for hot flashes, we suspect that 65% are eligible and adequately treated by HRT. According to an article published in the Journal of Clinical Oncology (Loprinzi et al, 2009), HRT reduces hot flash symptoms by 80-90%. As noted above, we do not expect Serada to overtake HRT as the first-line treatment. Serada will battle for second-line use in the remaining 3.5 million women with off-label antidepressants, including paroxetine, venlafaxine, fluoxetine, and sertraline. We think Serada data compares well to these drugs (as noted above with Pfizer's Pristiq). Therefore, we believe if Serada could capture just 5% market share in these 3.5 million women seeking alternative treatment options, it would be a commercial success for Depomed. If we assume that Depomed will charge a similar price for Serada to the approved Gralise ($2.52 per 600 mg tablet), we arrive at a peak gross sales estimate of $355 million for Serada.

We expect that Depomed would like to be involved in the promotion of Serada to high-prescribing Ob/Gyn's in the U.S. Management noted that there are about 18,000 of these high-prescribing Ob/Gyns. We estimate this is roughly 50% of the target market noted above, and believe that Depomed will partner the drug for primary-care promotion. It's an interesting market opportunity for Depomed because Ob/Gyn's are clearly the thought-leaders and gate-keepers to the larger primary-care market. However, primary-care physicians are probably less comfortable with HRT, and thus more apt to adopt a new medication like Serada. We suspect that effective promotion to Ob/Gyn's can be accomplished by a small field force of 40 to 60 representatives. Approval will be a nice transformation for Depomed, allowing the company to branch out from its current pain / neurology focus with Gralise and Zipsor to women's health with Serada.

If approved, we suspect that it will take Depomed seven years to achieve peak sales (2020). Depomed is currently trading at 2.5X our projected 2013 revenues of $142 million. Simply using the same multiple on Serada, discounted back to present day at 15% and adjusting for 50% economics to Depomed, yields roughly $3 per share upside to the stock. Therefore, if the U.S. FDA's Reproductive Health Drugs Advisory Committee votes to recommend approval Serada on March 4, 2013, we think Depomed's stock should jump at least $2 per share, with further upside to the final PDUFA decision in late May 2013. We note our modeling assumption does not include any upfront payments, milestones, or royalties for a partnership on Serada to target the primary-care market.

DM-1992 Data In Q4

In January 2012, Depomed announced that it has initiated a phase 2 clinical trial of DM-1992, the company s novel gastric-retentive, extended-release formulation of carbidopa/levodopa, in patients with advanced Parkinson's disease with motor fluctuations (ClinicalTrials.gov Identifier: NCT01515410). In early November 2012, Depomed announced top-line results from the study, noting encouraging results. The phase 2 study was a randomized, active-controlled, open-label, crossover study evaluating DM-1992 dosed twice daily against a generic version of immediate-release carbidopa/levodopa (IR CD/LD) dosed as needed (mean daily dosing frequency = 4.8). A total of 34 patients with advanced Parkinson's disease with motor fluctuations enrolled in the study at eight U.S. clinical centers.

DM-1992 and IR CD/LD were each administered over a ten-day period that included a six-day dose optimization period, followed by a three-day patient self-assessment period and one in-clinic day for clinician evaluation and pharmacokinetic measurements. The primary endpoint for the study is change in percent "off" time during waking hours, as measured by patient self-assessment during the treatment period relative to the baseline period. The top-line data notes that:

All enrolled patients completed the study.

DM-1992 was generally well tolerated in the study. There were no serious adverse events.

Patients' mean baseline "off" time during waking hours was 5.4 hours per day (32.5%), compared to 4.5 hours (27.2%) during the DM-1992 self-assessment period and 5.5 hours (33.5%) for the IR CD/LD comparator.

The reduction in percent "off" time reported during the DM-1992 patient self-assessment period relative to the IR CD/LD comparator was statistically significant (p = 0.047).

Patients took 1.3 mean daily doses of rescue medication (IR CD/LD) during the DM-1992 patient self-assessment period, compared to 0.2 mean daily doses for the IR CD/LD comparator.


As of early January 2013, management continues to evaluate these data. The company is considering partnering opportunities for DM-1992 and monitor competitive developments. With respect to competitive developments, on January 21, 2013, Impax Labs announced that the U.S. FDA issued a complete response letter (CRL) regarding Rytary (formerly IPX066), an extended-release capsule formulation of carbidopa-levodopa. The CRL requires a satisfactory re-inspection of the company s Hayward manufacturing facility.

Rytary would be a direct competitor to DM-1992. Dosing for Rytary in the phase 3 program was three-timers per day. The phase 3 top-line data on Rytary shows patients entered the study with a baseline off time of 36.1% (5.9 hours), and at the end of the randomized IPX066 treatment phase patients had off time of 24.0% (3.8 hours) during waking hours compared to 32.5% (5.2 hours) for carbidopa-levodopa and entacapone (CLE) (p<0.0001). This represents a 33.5% decrease in percent off time for IPX066 from baseline vs. a 10% decrease for CLE.

When we compare Rytary to DM-1992 head-to-head, we see that DM-1992 has superior dosing at twice-daily vs. three-times daily, but that Rytary might have superior reduction in off-time with 3.8 hours vs. 4.5 hours. That being said, the Rytary data is from phase 3 studies where Impax and partner Glaxo had the benefit of a much larger program with well-defined dosing levels. Perhaps Depomed could improve the dosing on DM-1992 to achieve an off-time similar to the 3.8 hours of Rytary. The delay in Rytary approval benefits Depomed. It allows them time to catch-up a little. However, we suspect that Glaxo and Impax will re-submit the NDA shortly and Rytary will be on the market by 2014. Therefore, we have no value assigned to DM-1992 in our model. Upside could come from a potential partnership that provides an upfront payment and the start of a phase 3 program.

Acuform / Licensing Deals

During the third quarter 2012, revenues from licensing and collaborative payments totaled $11.4 million. The company has numerous technology and licensing agreements with other pharmaceutical companies. The company has existing relationships with Merck, Janssen (J&J), Boehringer Ingelheim, Covidien, and Ironwood. These five companies have paid Depomed over $20 million in 2011 and are on par to pay another $20+ million in 2012. On the third quarter call, CEO Jim Schoeneck noted the potential to pull in upwards of $75 million from these agreements in the next several years.

In August 2012, Depomed announced a licensing deal with Janssen Pharmaceuticals (J&J) that paid Depomed an upfront payment of $10 million in cash. Depomed licensed Janssen the non-exclusive right to Acuform gastric retentive drug delivery technology, apparently which is being used in J&J s Nucynta-ER (tapentadol extended-release tablets). Depomed started receiving a low single digit royalty on sales of Nucynta-ER effective July 1, 2012 through December 31, 2032. Depomed can also earn a one-time sales milestone upon achievement of a specified level of quarterly net sales. Prescription tracking services peg Nucynta and Nucynta-ER annualizing at around $85 million in sales. That s up from $50 million at the end of 2011. The ER formulation accounts for 31% of the franchise sales, up from 20% at the end of 2011.

Depomed also receives royalties on Merck s Janumet-XR (sitagliptin and metformin-XR). Merck sold $1,363 million of Janumet in 2011, up a strong 43% YoY. Merck continues to transition patients from Januvia to Janumet. Januvia sales in 2011 were $3,324 million (+39%). Now that Janumet-XR is on the market, we expect Merck to fully-cannibalize Janumet with Janumet-XR. We see peak Janumet-XR sales at $1.5 billion worldwide.

While the J&J and BI deals are smaller than the deal with Merck, they still provide a potential meaningful cash flow stream min the future. Depomed has received $20 million in total payments from J&J and $12.5 million from Boehringer. Likewise, 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 2013. We expect this will be a Vicodin-XR formulation. Covidien expects to follow this up with a second product in 2014. We expect this will be a Percocet-XR formulation. Depomed receives milestone upon delivery of the final formulation, potentially up to $15 million worth, and low single-digit royalty on sales. We are big fans of Depomed s licensing and collaborative business.

We note that on January 29, 2013, Depomed filed a complaint in the United States District Court for the District of New Jersey against Purdue Pharma L.P. for infringement of U.S. Patent Nos. 6,340,475; 6,635,280; and 6,723,340 (collectively, the Depomed Patents ). The complaint alleges infringement of the Depomed Patents arising from Purdue s commercialization of

OxyContin (oxycodone hydrochloride controlled-release) in the U.S. The Depomed Patents relate to Depomed s Acuform drug delivery technology. U.S. Patent Nos. 6,340,475 and 6,635,280 will expire in 2016, and U.S. Patent No. 6,723,340 will expire in 2021. We note that the polymer formulation patients that expire in 2021 are the same patents that Depomed licensed non-exclusively to J&J s for Nucynta-ER. J&J obviously saw an issue and believed it made more sense to settle with Depomed than battle them in court. We will be watching this closely over the next few months. Purdue s OxyContin does around $1.3 billion in sales worldwide. Just 1% royalty could provide $13 million in cash to Depomed per year, and that doesn t include a potential back-pay for damages. This could be a $50 million settlement at the high-end.

We do not think it receives the investor attention it deserves. The company seems to generate at least one major Acuform licensing deal per year. These deals come with no expense or development obligation at Depomed.


VALUATION & RECOMMENDATION

We think Serada represents tremendous upside to the Depomed story, a stock we feel is cheap even without Serada on the market. Case in point, Depomed is currently trading with a market capitalization of $355 million, or roughly 2.5X our projected 2013 revenues of $142 million.

The company exited 2012 with $80 million in cash. In 2012, Depomed booked over $40 million in royalties on Glumetza, sold through partner Santarus. Booking similar amounts over the next three years prior to the patent expiration in 2016 nets a present value of at least $100 million. Prescriptions of Gralise for the week ended January 18, 2013 show the drug annualizing well over $30 million and growing steadily. We think Gralise, the company's flagship pain / neurology product is easily worth another $100 million in present value. Throw in anti-inflammatory pain medication, Zipsor, promoted in the number two position behind Gralise, and some royalties on big pharma drugs like Merck's Janumet-XR and J&J's Nucynta-ER and investors can see that buying Depomed today gets you Serada for free.

We reiterate our Outperform rating on the stock and $9 price target.


PROJECTED INCOME STATEMENT

Income Statement

DEPOMED 2010 A

2011 A

Q1A

Q2A

Q3A

Q4E

2012 E

2013 E

2014 E

Total Product Sales

$45.6

$41.2

$2.1

$3.2

$9.7

$10.8

$25.8

$67.8

$108.0

YOY Growth

30.0%

-9.7%

-86.2%

-80.2%

5.0%

1991.2%

-37.3%

64.6%

59.2%

Total Royalties

$0.3

$10.0

$9.4

$9.6

$12.2

$13.1

$44.3

$61.0

$73.9

YOY Growth

-80.0%

3167.0%

5609.7%

14194.0%

459.9%

73.0%

343.4%

510.4%

21.0%

Total Licenses Revenues

$34.8

$81.8

$5.3

$1.3

$11.4

$3.0

$21.0

$13.5

$15.5

YOY Growth

65.2%

134.9%

-92.2%

-73.3%

121.8%

-25.7%

-74.3%

-83.5%

14.8%

Total Revenues

$80.8

$133.0

$16.8

$14.1

$33.3

$27.0

$91.2

$142.3

$197.3

YOY Growth

39.9%

64.7%

-79.7%

-33.5%

101.4%

122.2%

-31.4%

7.0%

38.6%

Cost of Goods Sold

$8.1

$5.5

$0.5

$1.4

$1.8

$1.3

$5.0

$8.4

$14.2

Gross Margin

90.0%

95.8%

96.9%

89.8%

94.7%

95.3%

94.5%

94.1%

92.8%

SG&A

$17.5

$54.2

$21.8

$25.0

$26.8

$25.5

$99.1

$108.0

$110.0

% SG&A

21.7%

40.8%

129.3%

177.3%

80.6%

94.6%

108.7%

75.9%

55.7%

R&D

$20.1

$15.2

$3.5

$3.5

$5.3

$3.5

$15.8

$15.0

$15.0

% R&D

24.9%

11.4%

20.7%

25.0%

15.8%

13.0%

17.3%

10.5%

7.6%

Santarus Payment

$31.4

$27.3

$0

$0

$0

$0

$0

$0

$0

Amortization $0

$0

$0

$0.1

$1.0

$1.0

$2.1

$4.0

$4.0

Operating Income

$3.6

$30.7

($8.9)

($16.0)

($1.5)

($4.3)

($30.8)

$7.0

$54.1

Operating Margin

4.5%

23.1%

-

-

-

-

-33.7%

4.9%

27.4%

Interest & Other Net

$0.3

$40.4

$0.1

$0.2

$0.0

($0.9)

($0.5)

($3.0)

($3.0)

Pre-Tax Income

$3.9

$71.1

($8.8)

($15.8)

($1.5)

($5.2)

($31.3)

$4.0

$51.1

Taxes $0.0

$0.4

$0.0

$0.0

$0

$0.0

$0.0

$0.0

$5.1

Tax Rate

0%

0%

0%

0%

0%

0%

0%

0%

10%

Net Income

$3.9

$70.7

($8.8)

($15.8)

($1.5)

($5.2)

($31.3)

$4.0

$46.0

Net Margin

4.8%

53.2%

-

-

-

-

-34.3%

2.8%

23.3%

Adjusted EPS

$0.07

$1.26

($0.16)

($0.28)

($0.03)

($0.09)

($0.56)

$0.07

$0.77

YOY Growth

-117.2%

1626.4%

-

-

-

-

-144.3%

-94.6%

1018.9%

Wt. Ave Shares Out

53.3

56.1

55.6

55.8

56.0

56.4

55.9

58.0

60.0

Source: Zacks Investment Research, Inc. Jason Napodano, CFA


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.

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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 1011 companies covered: Buy/Outperform- 14.6%, Hold/Neutral- 77.8%, Sell/Underperform

7.0%. Data is as of midnight on the business day immediately prior to this publication.

small-cap researchs1.q4cdn.com/460208960/files/jan 30, 2013_depo_serada...if this adjustment in...

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