The 10Q Detective: Losing Sleep Over Cephalon

Even as the broader stock market and much of the pharmaceutical sector have clawed their way back from early-year lows, shares of drugmaker Cephalon (CEPH) have dropped around 25% since January. Wall Street jitters are likely due to evidence of slowing growth for Cephalon's flagship product, the sleep disorder drug Provigil. Also, pending litigation could result in the introduction of cheaper, generic copies of the top-selling medicine before its patent expires in 2012.

Of course, big stock-price drops like Cephalon's can awaken value players looking for an opportunity in a beaten-down pharma with an attractive product. But the 10Q Detective thinks investors may wish to hide under the covers on this one. The longer-term value of the company's sleep disorder franchise could come under pressure from efforts by government and businesses to hold down costs of pricey branded drugs. And, it's not certain that Cephalon can beat back the looming generic challenge by successfully switching patients to its next-generation narcoleptic treatment Nuvigil.

The company is also seeking Food & Drug Administration (FDA) approval to promote Nuvigil for new treatments to broaden its commercial appeal beyond narcolepsy. Value investors should note, however, that FDA delays, combined with sooner-than expected generic intrusion, could undermine the company's balance sheet. The 10Q Detective has unearthed a few eye-openers contained deep in recent filings: millions in potential asset writedowns and insufficient cash flow from operations to repay $750 million of convertible notes—if presented for conversion—and other cash obligations coming due in the next 12-18 months.

Price Hikes Boosted Revenue In the event that a significant conversion of convertible debt did occur, management has stated in its second-quarter regulatory filing that the company could obtain the necessary funds through a combination of existing cash ($1.2 billion), a $200 million credit facility, or raising money in the capital markets.

Comparable U.S. revenue from the sale of Provigil tablets (active ingredient, modafinil), indicated for the treatment of sleep disorders such as narcolepsy and sleep apnea, increased 13%, to $485 million, for the six months ended June 30. That's not as impressive as it seems when considering the source of the increase: a price hike of 10% in early 2009 offset a 3% decline in total prescription growth. The same held true for 2008, when domestic price increases totaling 16% masked a 2% decline in total prescriptions written for Provigil. That's even more alarming when one realizes that Provigil accounted for 54% of total U.S. sales in the first half of 2009.

Prescription growth for Provigil started to slide last year after the company reached a $425 million settlement with the U.S. Justice Dept. to stop promoting its pill for non-approved uses, such as general fatigue.

An Atypical Stimulant In a nation of 24-hour shoppers and sleep-deprived coffee gulpers, perhaps it should come as no surprise that Provigil, which was launched in February 1999, witnessed explosive growth in the last decade. U.S. sales jumped from just $28.7 million in 2000 to almost $925 million in 2008, making Provigil a true blockbuster. Provigil, an atypical stimulant that is not as addictive as other drugs, found wide acceptance among stay-awake types like college students and truck drivers. It is also frequently written for non-approved uses like attention deficit hyperactivity disorder, weight loss, and depression.

Cephalon is hoping to reawaken interest in its franchise by exciting doctors about Provigil's new and improved successor Nuvigil. The active ingredient in Nuvigil, armodafinil, is the longer-lasting isomer of modafinil. Nuvigil sustains higher blood concentration levels over a 24-hour period than Provigil, according to company data. Consequently, the company's sales representatives will likely seek, in the opinion of the 10Q Detective, to persuade doctors that this longer-acting version of Provigil translates into meaningful clinical benefits for their patients. The potential selling points: Greater effectiveness in promoting alertness and a truer once-a-day dosing schedule. However, investors should note that the company still cannot promote the drug to a wider audience, such as fatigued Americans just not getting enough sleep.

In addition, Nuvigil has never been studied in head-to-head clinical efficacy trials against Provigil. This is important because Cephalon cannot claim in marketing materials—which must be cleared by the FDA—that patients would be "better off" being switched from Provigil to Nuvigil. Ergo, if a patient is currently responding to Provigil therapy, there is little sense of real urgency for the user and prescriber to jump to the newer drug. There is urgency for Cephalon, of course, to promote the switchover as generic competition looms for Provigil.

Goal May Not Be Attainable Launched on June 1, Nuvigil had sales of $16.8 million (net of promotional discounts or rebates) in its first month. In July, Nuvigil's run-rate was about 6,000 prescriptions a week, split 50-50 between new patients and patient switches from Provigil. Bob Roche, vice-president of global pharmaceutical operations, told analysts on the second-quarter earnings call that the company was looking to hold aggregate prescriptions steady somewhere between 50,000 to 51,000 on a weekly basis.

The 10Q Detective is not as comfortable as Roche that this prescription goal is attainable, as all promotional resources, including field sales activity, shifted from Provigil to Nuvigil last quarter, according to the company. With no advertising muscle behind Provigil, and about 270 less reps selling Cephalon products than last year, total prescriptions for the company's flagship drug are likely to slide at a faster pace than combined new patient starts and refills for Nuvigil.

Understandably, management would prefer that investors measure quarterly success solely on the sales and prescribing trends of Nuvigil, in the belief that expanded labeling will help to drive longer-term growth of the drug. Data compiled by industry researcher IMS shows that "60% of those on Nuvigil are new patients," Cephalon's Flippin tells the 10Q Detective. "We're also encouraged by the extensive clinical program in place to further study the efficacy and safety of Nuvigil in new areas of unmet need," she adds.

Generics Would Hurt Still, it is hard to ignore the market reality: Provigil accounts for 54% of total U.S. sales, which would likely be hit hard within months of generic approvals by the FDA.

With the pill-counters watching the doctors, even a two-year window over generics may not guarantee success: All physicians in managed-care groups receive weekly reports detailing their progress in keeping drug costs for specific illnesses within accepted ceilings. If the doctors ignore suggested cheaper alternatives to Nuvigil, they could be penalized financially, and if that incentive fails, the plan could also hassle the physicians with time-consuming "prior-authorization" requisites.

Meanwhile, generic competitors are lining up. As of early August, Cephalon management was aware of seven applications on file with the FDA.

New Judge Brings Breathing Room The FTC has gone to court seeking a permanent injunction that would allow generic entry prior to April 2012, on the grounds that Cephalon illegally paid several generic drug manufacturers compensation to secure their respective agreements not to compete for a "substantial period" prior to original expiration of a key patent in 2015. Specifically, Cephalon paid some generic companies more than $200 million in exchange for agreements not to flood the market with their cheaper chemical copies of modafinil prior to 2012. The FTC suit alleges that consumers were denied access to lower-priced generic versions of Provigil prior to patent expiration.

On July 28, both the company and investors breathed a collective sigh of relief when a new judge, was assigned the case. The judge issued an order consolidating all of the cases, telling all parties that he needed to be brought up to speed on the case. He then asked all plaintiffs to refile all their motions in concise form before restarting the discovery process. The judicial switch effectively delayed relief sought by the FTC and other plaintiffs, as it will likely take at least two years for any rulings to come down from the bench. The 10Q Detective concurs with analysts at investment banker Natixis Bleichroeder that the delay benefits Cephalon's switchover campaign.

That campaign is in full swing. In addition to promotional efforts by its field sales force to encourage patient switches from Provigil to Nuvigil, the company has initiated and is advertising a free sampling program, a seven-days-free coupon, and an innovative co-pay assistance of up to $50 per prescription.

Optimism About Sampling Program Short term, the company is essentially giving away the drug, as $10.5 million in costs associated with the Nuvigil programs was deducted directly from gross sales in the second quarter. About 40% of new Nuvigil prescriptions in the quarter resulted from coupons, Chief Financial Officer Kevin Buchi reported on the second-quarter earnings call. Nonetheless, management remains optimistic that use of these coupons is a productive means to get new patients onto Nuvigil, and then to covert them into regular Nuvigil users for many years.

Supplementing the coupon efforts: discounted pricing. The prescription cost to the patient for a 30-day supply of daily recommended dosages of Provigil (200 mg) and Nuvigil (150 mg) is $361 and $295, respectively, a savings to cash-paying patients and health-care payers of 23%, according to pharma information site Destination Rx.

Discounted pricing and improved patient compliance (taking a pill once daily versus two-times daily) are incentives to payers (at least for now) to give Nuvigil similar status as Provigil. The current pricing strategy and switchover campaign run the risk of lower revenue per patient, however, as at least 25% of Provigil users need double the dosing, which means the sale of twice as many Provigil tablets, according to Bob Roche. (Offsetting short-term revenue loss, at least in theory: One out of four Provigil users might benefit from switching to once-a-day Nuvigil, potentially providing a source of revenue for many years to come.)

Nuvigil has some breathing room when it comes to generic competition: The patent covering armodafinil does not expire until December 2023. The company has been moving aggressively to expand the use of Nuvigil to a wider audience. An array of clinical programs is under way, including the study of the efficacy and safety of Nuvigil in bipolar depression, the negative symptoms of schizophrenia, cancer treatment-related fatigue, and excessive sleepiness associated with traumatic brain injury.

Lots of Questions Chief Executive Frank Baldino told analysts on the second-quarter conference call that the company's objective is to file four supplemental new drug applications in the next five years. On June 30, the company submitted a Nuvigil application for the treatment of excessive sleepiness associated with jet lag disorder.

With the possibility of a flood of generic competition for Provigil, the uncertain prospects for market acceptance of Nuvigil, and the larger questions swirling around the treatment of its products amid various U.S. health-care reform proposals, the 10Q Detective thinks Cephalon investors may not need any chemical assistance to keep them awake at night.

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