Vernalis — Update 11 November 2015

Vernalis is focused on developing and commercialising prescription-only cough cold programmes, in-licensed from Tris Pharma in 2012, which are expected to drive Vernalis to self-sustainability. Vernalis also has an FDA-approved extended release antibiotic Moxatag and a portfolio of early- to mid-stage development projects in CNS and cancer, which are to be developed exclusively through partners. While royalty income from frovatriptan (acute migraine) will fall away along with patent expiry in 2015, it is the cough cold programmes licensed from Tris Pharma in 2012 that are forecast to drive Vernalis to profitability. Under its existing management, installed in 2009, Vernalis has raised c £116.5m net in three fund-raisings (2009, 2010 and 2011), the last of which enabled it to strike the licensing deal with Tris Pharma and to fund the US-based salesforce to commercialise these programmes. The company employs 90 staff at sites in Winnersh and Cambridge, and 10 full-time employees at its US head office in Berwyn, PA.

We have increased our DCF valuation from £406m to £439m, or 99p per share, using a 12.5% WACC across the development pipeline, with Tuzistra XR at our standard 10% commercial-stage WACC. We have made no fundamental changes to our valuation, but we include some revisions to our near-term forecasts. Despite the shifting dynamics of the cough cold market due to Drug Enforcement Administration (DEA) rescheduling of hydrocodone, the aggregate commercial potential across the portfolio based on June 2015 data is unchanged compared to our previous report at c $500m by 2024. As before, we calculate an average peak sales estimate of $65m per product for the remaining four products in the portfolio, as the company has not disclosed the launch order of the remaining cough cold pipeline.

Vernalis has moved its financial year to the 12-months ending 30 June. Despite some near-term adjustments, the company is within reach of self-sustaining profitability. We forecast FY16 group sales of £15.9m, reducing our forecast cough cold revenue forecast to £5.8m from £7.1m owing to our more cautious outlook for Tuzistra XR in the early phases of launch. We add £7.5m from collaborations and £2.6m of Frova royalties, down from our previous estimate of £3.1m due to a lower volume of API and some pricing pressure. We forecast £36.6m of revenue in FY17. The cost structure is shifting as Vernalis moves from development to the commercial phase for the cough cold portfolio. Our forecast sales and marketing expenditure rises from our last published forecast of £22.8m to £26.8m in FY16. Vernalis will leverage its contract salesforce with successive cough cold launches and adding companion product Moxatag, (extended-release amoxicillin tablets). Our estimated R&D costs fall from £22.6m in 18 months to June 2015 to £15m in FY16 and to £14.3m in FY17, as Vernalis will make no further investment into the NCE pipeline. Our model suggests that Vernalis’s year-end cash/equivalents of £61.3m is sufficient to fund it through to profitability.

For Vernalis the key drivers are: ensuring adequate pharmaceutical supply and distribution of Tuzistra XR; gaining broad tier 3 unrestricted formulary coverage; and the speed and efficiency of the sales force in executing its strategy and particularly in converting prescribers from immediate release to extended release formulations. The dynamics of prescription pharmaceuticals are to a large extent determined by government policymakers and by the decisions and strategy of the private insurers, which could influence patient access to products and prescription pricing.

Vernalis has transitioned from a development to a commercial-stage pharmaceutical company, focusing exclusively on its prescription-only US cough cold franchise. Vernalis focuses on the prescription market segment, valued at up to $3.5bn at brand pricing given that there are around 35m cough cold prescriptions per year at an estimated net price per scrip of $100. The first product out of the blocks is Tuzistra XR, an extended release, adult codeine-based treatment launched in September. Vernalis is developing extended release reformulated cough cold medicines that offer greater convenience and patient compliance than the immediate release (IR) counterparts. Meanwhile, Tris’s patented LiquiXR sustained-release liquid reformulation technology is a key factor in creating high barriers to entry given the difficulty in creating a liquid formula that the FDA will approve. Vernalis is developing four other extended release products in collaboration with licensee Tris Pharma, which are due to reach key development milestones in the near term. Our collective peak sales estimate across the portfolio is for $500m by 2024.

In April 2015, Vernalis received FDA approval of Tuzistra XR, an ER or 12-hourly dosed product. Tuzistra XR is a prescription-only, adult cough cold treatment with US regulatory clearance, indicated for the relief of cough and symptoms associated with upper respiratory tract allergies or the common cold. Its active pharmaceutical ingredients (APIs) are codeine polistirex, to suppress the cough reflex, and chlorpheniramine polistirex, an antihistamine to relieve allergic symptoms. The ER formulation means that the recommended dosing for patients aged 18 years and above is one 10ml dose per 12 hours, not exceeding 20ml in 24 hours, while an immediate release (IR) product may require four to six doses per day. Tuzistra XR carries a standard black box warning against paediatric use as a result of its codeine content.

The US-branded prescription-only cough-cold market offers significant commercial prospects, given that there around 35m prescriptions per year across the narcotic and non-narcotic segments of the market, and the company’s planned target of $100 per scrip. The LiquiXR technology, in-licensed from partner Tris Pharma, provides high barriers to entry given the difficulty in producing an FDA-approved sustained release liquid formulation notably due to the challenges in maintaining the stability of the formulation. The primary competitive advantages of the product include its more convenient administration than IR treatments, and its deemed equivalent efficacy based on bioequivalence data. Vernalis launched Tuzistra XR in the US Rx cough cold market on 8 September via its dedicated US salesforce.

The US prescription-only cough cold treatment market is divided broadly into its narcotic and non-narcotic segments with c 34.7m prescriptions pa (based on the June 2015 market data from IMS). Targeted US Tuzistra XR pricing is estimated at $100 per scrip, based on the price of Tussionex, a 12-hour liquid combination product containing hydrocodone and chlorpheniramine. Tuzistra XR’s primary market segment is codeine plus antihistamine treatments by virtue of its APIs. This segment is valued at $470m at current or $305m at historical Tussionex brand pricing. We estimate aggregate peak sales of $500m across the portfolio of cough cold products, including $240m for Tuzistra.

Physician market research conducted by Vernalis’ partners1 suggests that prescribers are driven more by their preference for the primary active ingredient (e.g. codeine) in the product than the secondary ingredient (e.g. antihistamine or expectorant). The research showed a willingness to prescribe Tuzistra XR among prescribers in the broader $1.6bn narcotics segment, which also includes codeine plus expectorants, as well as the hydrocodone segment, albeit at lower penetration in the hydrocodone segment than in the primary market.

The dynamics of the prescription market have shifted since hydrocodone DEA reclassification from Schedule III into the more restrictive Schedule II, which took place in September 2014. Reclassification is likely to have caused it to be more restrictive and more costly for suppliers and distributors to handle, and for physicians to prescribe hydrocodone-based products. The tightening has caused a contraction of the supply of hydrocodone-based cough cold products; market share has fallen from 16% in June 2014 to 11% in June 2015. This translates to prescription volume falling from 4.9m in 2014 to around 3.7m per year in 2015. To date, the main beneficiaries of the DEA scheduling switch have been codeine- and benzonatate-based products. Codeine’s market share has increased from 32% in September 2014 to 36% in June 2015 (to 12.4m prescriptions). Benzonatate-based products increased market share from 27% to 29% (to 9.4m scrips) over the same period. In the 12-months to June 2015, prescriptions for codeine-based products increased from 11.4m to 12.4m.2

Vernalis has launched a concerted sales effort given the considerable commercial potential of Tuzistra XR in the broader codeine market. The data illustrate that the broader all-codeine segment remains stable, although take-up is likely to be sensitive to the planned marketing effort. Tuzistra XR is positioned as a convenient ER formulation both in its primary segment codeine + antihistamines, and in the broader all codeine segment; we forecast peak sales of $240m. Meanwhile, hydrocodone prescribers may also find it easier and less costly and restrictive to prescribe Tuzistra XR than Tussionex.

Vernalis has a portfolio of four other cough cold products in development. Our estimate of aggregate peak sales across the portfolio is $500m by 2024. This total aggregate value equates to c 14% of the $3.5bn total branded cough cold prescription market for the five products based on June 2015 prescription data using an estimated net price per scrip of $100. The APIs in the remaining four products have not been disclosed, but the company has previously indicated that the portfolio covers the other active ingredients in the cough cold market, with the exception of dextromethorphan. We would therefore assume that the portfolio includes benzonatate, a non-narcotic cough suppressant. The benzonatate segment has an addressable market of c $940m at current pricing. This segment has benefited from the drop in market share of hydrocodone and is likely to be the next largest product alongside Tuzistra XR. Management has inferred that two other products are complementary to Tuzistra XR. However, the launch order of the remaining four cough cold products each with potentially varying peak sales, is undisclosed; hence we have calculated an average peak sales estimate of $65m per product for the remaining four products.

The next most advanced products in the cough cold portfolio are CCP-07 and CCP-08. In June, Tris Pharma initiated 12-month stability testing of CCP-07 and targets NDA filing in 2016. Stability testing provides evidence on how the quality of a pharmaceutical product is maintained over time, in response to varying environmental conditions. It is also used to provide evidence of shelf-life and storage conditions of the product. CCP-08 stability batches are also complete and the NDA filing is targeted for 2016. By way of example, the timeline for approval of Tuzistra XR was a total of c 25 months from proof-of-concept (PoC) to approval. For CCP-05 and CCP-06 the company anticipates that PoC could be achieved during 2016 (previously 2015), leading up to the c 12-month NDA filing preparation process.

Vernalis launched Tuzistra in September ahead of the 2015 US cough season and has an accelerated field salesforce recruitment drive in place through its partner inVentiv. Vernalis has recruited an 80- to 100-strong sales team at the outset to commercialise Tuzistra XR, and has appointed regional business managers and reps to target the high-volume prescribers. The plan is to contact pharmacies and engage the primary care physicians, prescribing c 30% or c 5m codeine and hydrocodone scrips annually. Reps will be aiming to make up to 12 calls per day to pharmacies/physicians. The company anticipates that traction will build over time as call patterns become established, and has implemented a coupon programme to reduce the cost to the patient. Vernalis has identified a combination of strategies to encourage pharmacies to take on inventory of Tuzistra XR, which is critical for launch year success. These activities include offering incentives to wholesalers and pharmacies such as off-invoice discounts on first orders and extended payment terms.

A ‘Stock Now’ campaign is in force, designed to encourage pharmacies to supply Tuzistra XR. Having established pharmacy calls, the field force will subsequently contact physicians, maintaining 12 calls per day. The plan is to locate and concentrate the field force around pockets of high-prescribing doctors. The company is already well-advanced in terms of manufacturing launch stocks of Tuzistra XR and is establishing routine commercial supply of the product. Vernalis has set up third-party logistics through Cardinal SPS as well as securing trade distribution by means of secure fee-for-service contracts with key wholesalers.

Tuzistra XR is targeted at high-value prescribers as opposed to the Medicare and Medicaid sections of the market. A key driver of the company’s ability to garner market share is achieving formulary coverage. Its market access partner, Ashfield, has so far achieved c 52% coverage of commercial lives, privately insured medical patients in tier 3 unrestricted plans, which equates to around 120m lives covered. Formulary coverage enables the inclusion of Tuzistra XR on the list of branded drugs covered by managed care plans. Ultimately, Vernalis targets up to 75-80% of tier 3 unrestricted plans by the end of 2015. The current status of coverage for the larger plans is shown in Exhibit 3 and Vernalis aims to achieve coverage among these key insurers during the 2015/16 cough cold season.

Vernalis aims to achieve tier 3 formulary coverage for Tuzistra XR at brand pricing, targeting a net price per scrip of up to $100. Payer research completed by Ashfield, Vernalis’s market access partner, suggests that tier 3 formulary coverage at brand pricing could be secured and would require a co-pay of $50-75 per scrip by the patient, depending on the insurance policy (vs $10-15 for IR cough cold products). However, the proposed co-pay assistance from Vernalis could reduce the cost to the patient to as little as $25. Co-payment for tier 3 formulary drugs is typically higher than those in the lower tiers. As previously flagged, Vernalis aims to achieve a net price of $100 over time and in the initial launch phase net sale value per Rx to Vernalis is expected to be around $90 per scrip. For illustrative purposes, Exhibit 4 shows the reconciliation of the wholesale acquisition cost (WAC) of $192 per Rx paid by the insurer to Vernalis, to the net sale price per Rx.

A critical factor in commercial success includes minimising the cost to the patient. The model shows that the patient will pay $25 per scrip to the insurer. The company has implemented two co-pay assistance programmes comprising e-vouchers, for pharmacies and co-pay cards, distributed to the physicians. The proposed co-payment of $25 from Vernalis in the example above would reduce the cost per Rx to the patient to $25. The undisclosed payments from Vernalis include year one launch incentives paid to the pharmacies/wholesalers, rebates to the insurer and other undisclosed payments, which in this example collectively amount to $77. To date, physician market research by Vernalis’s partners suggests strong interest from all narcotic cough cold prescribers and confirms that take-up would be based on minimising the cost to the patient through coupons. Research also suggested physicians’ willingness to switch to Tuzistra XR given the changes to DEA scheduling for hydrocodone products. Furthermore, the price precedent set by Tussionex, as well as its achievement of tier 3 formulary coverage, bodes well for commercial potential of Tuzistra XR.

Tuzistra XR faces limited direct competition in the liquid ER market. Tussionex was the only commercialised liquid ER product in the US cough cold market, prior to the approval of Tuzistra XR. It was first launched in 1962, although the current formulation was approved in 1987, with a generic Tussionex formulation launched by Par Pharmaceuticals in 2010 using Tris technology. Tuzistra XR is the only other FDA-approved liquid ER product (as a result of difficulty in formulating products that meet FDA requirements), creating high entry barriers in the long-release liquid formulations market. We note that manufacturing and formulation patents covering Tuzistra XR run until 2029.

Before genericization, Tussionex achieved c 50% of the hydrocodone segment by prescription volume and in 2008 annual peak sales exceeded $200m at an assumed net sales price per prescription of $65 with 85% formulary coverage (reimbursement) at managed care organisations. The wholesale acquisition cost (WAC) of more recently approved prescription cough cold treatments is higher; for example, Zutripro, an IR hydrocodone-based formulation launched in 2011 marketed by Pernix, has an approximate net price per scrip of $140-1823 and the current net price of the Tussionex brand is c $100 per scrip (source: Vernalis).

In October, Vernalis acquired the US rights to Moxatag (amoxicillin extended-release tablets) from Pragma Pharmaceuticals. Moxatag is the only approved once-daily formulation of the antibiotic amoxicillin, and is FDA-approved penicillin for the treatment of tonsillitis and/or pharyngitis secondary to streptococcus pyogenes in adults and paediatric patients 12 years of age or above. The terms of the acquisition included an undisclosed upfront cash payment. Vernalis, which takes on the responsibility for supply chain, will make a further payment to Pragma after manufacturing relaunch supplies of Moxatag, which is planned during 2015. Undisclosed royalties plus milestone payments are payable to Pragma by Vernalis. We base our estimate of the total payment paid to Tris for cough cold NDAs of approximately $14m per product, and considering that Moxatag has lower peak sales potential, we estimate an upfront $5m. The rationale for the acquisition is that Moxatag is an ideal companion product for Tuzistra XR, and for the remainder of the cough cold pipeline. As such, this would enable Vernalis to gain more leverage from its expanding direct salesforce. The marketing message is aligned with Tuzistra XR as Moxatag is also an extended release formulation targeted for the winter cough cold season and will likely have a similar price point to Tuzistra XR. Moxatag has not been actively promoted since 2010; however, it presents a relatively low-risk add-on that could prove highly complementary to Tuzistra XR. We await confirmation that relaunch stock is complete before we add Moxatag sales estimates into our model.

Meanwhile, Vernalis has a marketed product, Frova for acute migraine, and a pipeline of eight NCEs (new chemical entities), which focuses on CNS, oncology and inflammation, five of which are partnered. Vernalis will make no further investment into the NCE pipeline and aims to out-license all products. Frova's composition of matter patent is nearing expiry in December 2015, a factor that has been well-flagged by the company. Correspondingly, our forecast Frova revenues are set to gradually decline from current levels (the product generated £6.6m in the 18 months to June 2015). The pipeline status is outlined in Exhibit 5.

Key newsflow over the past 18 months included cessation of development and return of AUY922 rights to Vernalis by Novartis. Catalysts for the NCE pipeline over the next 12 months could include licensing deals for V158866 (pain) or V158411 (cancer). Vernalis’s NCE pipeline is divided into partnered and un-partnered programmes, with internal efforts directed towards maximising partnering prospects in a timely and cost-effective manner. While timelines and news flow are subject to partner decisions and disclosures for the partnered programme, Vernalis is eligible for downstream economics on development, regulatory and commercial success without incurring any financial cost.

As Vernalis moves into the commercialisation phase for the cough cold portfolio, the near-term sensitivities are shifting towards Tuzistra XR sales growth. The key challenges are: ensuring adequate pharmaceutical supply and distribution of Tuzistra XR; gaining broad tier 3 unrestricted formulary coverage; and the speed and efficiency of the sales force in executing its strategy and particularly in converting prescribers from immediate release to extended release formulations. The cough cold development pipeline is relatively low risk compared with mainstream pharma/biotech, is lower cost and the reformulation technology is proven through market approval for Tuzistra XR. The dynamics of the cough cold market are sensitive to government policy; for example the DEA rescheduling of hydrocodone has caused some shifts in the market, but we note the Vernalis is well placed to cover these shifts through the development of a range of products covering other active ingredients.

We have increased our DCF valuation to £439m from £406m, or 99p per share, using a 12.5% WACC across the development portfolio with the exception of Tuzistra XR at 10% our standard WACC for a commercial-stage product. Our estimate of aggregate peak sales across the cough cold portfolio is for c $500m by 2024, of which Tuzistra is $240m. The aggregate commercial potential across the portfolio based on June 2015 data is the same as in our previous report. As before, we calculate an average peak sales estimate of $65m per product for the remaining four products in the portfolio, as the company has not disclosed the launch order of the remaining cough cold pipeline.

The summary of changes to our valuation includes:

Our valuation assumptions are summarised in Exhibit 6.

Potential catalysts include news on commercial progress of Tuzistra XR at the H116 financial report (estimated in March 2016), further feedback and market data on prescription volumes. For the cough cold pipeline, for the next most advanced product, CCP-07, NDA filing is anticipated during 2016 leading up to estimated launch for the 2017/18 season. In late 2016, achieving POC for CCP-05/CCP-06 could lead us to upgrade the probability of success of these two assets.

Following the change in its accounting reference date from December to June, Vernalis reported financial results for the 12 months to 30 June 2015 in comparison to the previous 12-month period, and also for the 18 months to June 2015. These results are shown in Exhibit 7. Total 12-month revenue to June 2015 increased to £13.7m vs £12.7m in 2014, reaching £19.9m over the 18-months. Revenue for the 12-month period included research collaboration income of £7.9m, up £1.3m or 20% due to an increase in FTE income, with milestone receipts flat at £1.1m (18 months: £2.2m).

Following out-licensing V81444, Vernalis received $1.0m (£0.7m). Frovatriptan royalty income fell 17% to £4.9m vs £5.9m in FY14 (18 months £6.6m) as a result of a combination of factors, notably a drop in volume of active pharmaceutical ingredient supplied, pricing pressure and foreign exchange (Frova revenue per batch is converted from euros to sterling). In line with Tuzistra XR launch preparations, operating costs before exceptional items rose 10% to £21.7m (vs £19.8m in 2014 or £31.2m for the 18-month period). Operating loss for the year before exceptional items was £8.2m vs £8.6m in 2014 or £12.1m over 18 months. Net finance income varies in line with forex gains and losses from US dollar cash reserves into sterling; the 12-month gain was £4.3m vs a £6.9m loss in FY14 (12 months) and a £2.6m gain over 18 months. Pre-exceptional loss fell to £2.0m from £13.9m in FY14 (£6.6m over the 18 month period) and £1.8m (2014: £12.8m, 18 months £6.4m) on a post-exceptional basis.

During the 18-month period, Vernalis made $15.0m of milestone payments to Tris for Tuzistra XR filing and approval milestones and POC for CCP-08/CCP-07, with a £2.6m unrealised foreign exchange gain on the conversion of cash resources held in US dollars into sterling. Consequently, cash and cash equivalents and investments stood at £61.3m at the end of June 2015. Vernalis has switched to a regular 12-month reporting period for the year ending 30 June. We forecast FY16 group sales of £15.9m, reducing our forecast cough cold revenue forecast to £5.8m from £7.1m owing to a slightly more cautious outlook for Tuzistra XR in the early phases of launch. As previously indicated by Vernalis, this could include price discounting and other incentives in year one to gain market traction. We add £7.5m from collaborations and £2.6m of Frova royalties, down from our previous estimate of £3.1m due a lower volume of API being shipped and some pricing pressure. The cost structure is already shifting as the company moves from the development to the commercial phase for the cough cold portfolio. We estimate that Vernalis will need to make additional investment into the salesforce to get things up and running, so we have increased our forecast sales and marketing expenditure from £22.8m to £26.8m in FY16. We estimate that R&D costs will remain lower and steady at £15m in FY16 and £14.3m in FY17 as Vernalis will make no further investment into the NCE pipeline. Therefore, our total forecast operating expenses increase to £41.8m in FY16 and to £41.3m in FY17. Exhibit 8 summarises the changes to our estimates.

After these changes and some minor revisions to our working capital forecasts, our revised end-2016 net cash and equivalents estimate is £33.9m. Our model suggests that the year-end cash and equivalents of £61.3m should be sufficient to fund Vernalis through to profitability, estimated in FY18.