DND Wisdomtree Pacific Ex-Japan Total Dividend Fund

By Jason Napodano, CFA

On May 3, 2013, Cipher Pharmaceuticals (Toronto:DND.TO) reported financial results for the first quarter 2013. Total revenues in the quarter were $3.3 million, up 82% over the first quarter 2012 and nicely ahead of our estimate for revenues of $2.6 million. The revenue up-tick was driven by the strong performance of the launch of Absorica (CIP-Isotretinoin) at Ranbaxy, and continued growth in Lipofen and ConZip / Durela.

…Absorica…

Total net Absorica revenues in the first quarter 2013 were $2.0 million, comprised of $0.5 million in amortization of upfront licensing fee and $1.5 million in royalties and transfer pricing on U.S. sales at Ranbaxy. We note that Cipher receives a “mid-teens” royalty on U.S. sales of Absorica at Ranbaxy, meaning that sales in the first quarter equated to roughly $10 million. This doubled our expectations.

The launch to date has clearly been impressive. Cipher reported that Absorica held roughly 7.5% market share at the end of March 2013, that’s up from 1.9% at the end of December 2012. Market share since December 2012 to March 2013 has been 1.9%, 3.6%, 5.7%, and 7.5%. This is one impressive ramp, and clearly driven by the improved formulation advantages of Absorica over generic isotretinoin.

The market share gains are clearly encouraging, but what’s even more exciting is that the overall isotretinoin market seems to be bouncing as well – perhaps driven by Ranbaxy’s active promotion of Absorica. Management noted that total U.S. isotretinoin prescriptions grew by 12% in 2012, with a surge at the end of the year. Total isotretinoin prescriptions in the first quarter 2013 grew by 13%. Absorica is a differentiated product, promoted by a highly motivated and focused sales force, into a nicely growing market. The trend should continue.

Based on existing prescriptions, the total isotretinoin market, when equated into Absorica (branded) pricing, is around $800 million. Ranbaxy’s 7.5% market share equates to a $60 million annualized rate as of the end of March 2013. We previously believed that Ranbaxy could capture 25% market share at peak, putting sales in the $200 million range. We have now upped that target to 35-40% market share, putting peak sales for Absorica at around $300 million. For 2013, we see Cipher collecting net Absorica revenues of $10.3 million.

…Lipofen…

Net Lipofen revenues in the first quarter 2013 were $0.8 million, slightly below our forecast for $1.0 million. Looking back in our financial model we notice that Lipofen quarterly revenues tend to bounce around at Cipher. We are not overly concerned with the weak first quarter 2013 Lipofen figure. Prescriptions were up 4% year-over-year despite the fact that revenues declined. This leads us to believe that there was some inventory destocking in the quarter. We expect Lipofen revenues to bounce back in the second quarter 2013. For 2013, we see total net Lipofen revenues at $3.8 million.

…ConZip / Durela…

Net revenues from ConZip / Durela in the first quarter 2013 totaled $0.5 million, mostly driven by sales of ConZip by Vertical Pharmaceuticals Inc. in the U.S. We note that Vertical expanded its sales force on ConZip in the fourth quarter 2012 from 60 to 75 representatives. We are expecting to see this increase promotion out of Vertical Pharma reflexed in the ConZip royalty payments coming in the next few quarters. We note that total ConZip prescriptions grew by a solid 15% in the first quarter 2013 year-over-year. Sales of extended release tramadol products totaled roughly $100 million in the U.S. in 2012. Tramadol-ER controls only 2.2% of the total tramadol market. We think that Cipher will benefit not only from Vertical gaining market share from Ultram-ER and Ryzolt in 2013, but all three products picking up market share from generic immediate-release tramadol.

We note that Cipher has the potential to earn an additional $3.8 million in future milestones from Vertical Pharmaceuticals, contingent upon the achievement of certain future net sales targets. We do not include any additional sales milestones for ConZip in our model given the slow ramp to date. However, should Vertical gain traction and pick up meaningful market share, this additional $3.8 million represents upside to our model.

Sales of Durela by Medical Futures in Canada remain underwhelming. Despite efforts by Medical’s 22 sales representatives, the tramadol-ER market in Canada is only around $20-25 million, and Durela has struggled to gain market share against cheaper immediate-release tramadol products.

One area we may see some new growth from the CIP-tramadol-ER franchise is in Latin America. In late April 2013, Cipher entered into an exclusive distribution and supply agreement with Tecnofarma International Ltd. for the right to market and distribute CIP-tramadol-ER in 18 Latin American countries, including Brazil and Mexico. Under the terms of the agreement, Cipher received an upfront payment and is eligible for additional milestones based upon regulatory approval in Brazil and Mexico. Cipher will supply product to Tecnofarma at a fixed-transfer price.

…Tight Cost Control…

One of the things that has impressed us at Cipher over the past year has been management’s ability to control costs despite a surging top-line. Operating expenses for the first quarter 2013 totaled approximately $1.8 million, essentially flat with the $1.7 million spent during the first quarter 2012, and not much above the $1.4 million spent in the first quarter 2011. This is despite the fact that revenues increased 82% year-over-year in the first quarter.

We are impressed that the company can grow its top-line by 82% while keeping expenses essentially flat. Cipher now has 3 products on the market with Lipofen, ConZip/Durela, and the recently launched Absorica. In the past we've written that Absorica is a game-changer for Cipher. Cipher plans to launch Epuris in Canada during the second half of 2013, and should be in position to file for approval of Betesil Patch in Canada by the end of the year. We are expecting operating expenses to increase in the second half of the year, but for now the company is generating pretty impressive profitability metrics.

…Targeting Canada…

Cipher has done an outstanding job over the past few years out-licensing its products to U.S. partners. This has allowed the company to sit back and collect license fees and royalties, growing the top-line nicely while keeping operating overhead low – as noted above. However, in the third quarter 2013, Cipher plans to launch the CIP-Isotretinoin product, to be called Epuris (the same product Ranbaxy launched in November 2012 as Absorica), on its own. This is a big shift in strategy for the company.

During the first quarter 2013, the company hired Joan Chypyha as Vice President of Marketing and Sales. Ms. Chypyha will head up the company’s commercial operations in Canada, and manage the planned 6-person sales force Cipher plans to contract with for the Epuris launch. We note that Ms. Chypyha seems uniquely qualified for this role, having spent more than 25 years in the pharmaceutical industry with an emphasis on marketing, sales and business development in the dermatology area. We note her previous role as for 16 years with Hoffman-La Roche, escalating to Business Unit Director for the Dermatology franchise where she was responsible for the management of a specialty sales force that promoted Accutane, among other brands.

On the first quarter conference call, Cipher management noted that this specialty sales force that promoted Accutane was 6 to 8 representatives and achieved peak sales between $25 and $30 million. The current Canadian isotretinoin market is only around $15 million in size, but it has been fully genericized and there is no active promotion of any branded products. We believe that Epuris can be a $10 to $15 million product for Cipher in Canada based on the early success of Absorica in the U.S.

We remind investors that Cipher plans to file the new drug submission (NDS) for the Betesil Patch in Canada by the end of the year. If approved, we think the Betesil Patch is an excellent complement dermatology product for Cipher’s contract sales force to co-promote along with Epuris. We would also not be surprised to see the company look to in-license or acquire another specialty dermatology product in Canada. We think Cipher can achieve break-even Canadian operations based on the launch of Epuris alone by the end of 2014. This would be sales in the area of $3 million.

…Solid Cash Position…

Cipher exited the first quarter 2013 approximately $16.5 million in cash and investments. The company generated $0.7 million in cash during the first quarter. We find the current balance sufficient to fund operations for the foreseeable future, as we believe that Cipher will continue to report positive cash flow throughout 2013 even in the face of building a specialty dermatology sales force to promote Epuris and Betesil Patch in Canada.

…Stock Still Attractive…

Based on our financial projections, Cipher should report total revenues in 2013 of around $17.1 million, with net income of $7.9 million, or $0.32 per share. This equates to a P/E ratio of only 11.7x our 2013 figure. In 2014, we model growth in revenues to $28.0 million, net income of $14.4 million and EPS of $0.58. A P/E ratio of 12.5x our 2014 estimate for $0.58 in EPS yields a price target of $7.20 per share. A P/S ratio of 5.0x our 2014 projected revenue forecast of $28.0 million yields a price target of $5.70 per share. We note our EPS forecast of $0.58 includes a 0% tax rate given the company held $23.2 million in deferred tax credits as of the end of the first quarter 2013.

This emerging specialty pharmaceutical story remains under-the-radar and under-valued. Our price target, based on averaging our P/E and P/S calculations, is $6.50 per share. Thus, we believe that Cipher Pharmaceuticals remains an attractive investment for investors.
 

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