Tuesday, May 20, 2008

Salix Pharmaceuticals Gives GI Upset To Investors

Salix Pharmaceuticals, Ltd (SLXP-$7.28) received an approvable letter from the U.S. Food and Drug Administration for balsalazide 1100 mg tablets as a treatment of mild-to-moderate active ulcerative colitis in patients 18 years and older.

As part of its Life Cycle Management Plan, Salix filed the NDA for the new version of its GI ant-inflammatory in spring 2007, looking to mitigate the sales impact of its COLAZAL franchise from The Office of Generic Drugs approval of three generic balsalazide capsule products on December 28, 2007.

Historically, the tummy company derived a majority of its revenue from sales of balsalazide disodium (
COLAZAL), accounting for 39.2 percent, 49.6 percent, and 71.2 percent of net sales in 2007, 2006, and 2005, respectively.

Offsetting the dosing advantage of the new formulation version of the anti-inflammatory—two times a day versus three times a day for the generic—is the size of the pill, which is a 1100 mg tablet formulation (compared with 750 mg for the generic). The patent expiry on the new dose is in 2018.

In our view, sales of the new pill will be limited by restricted Tier formulary access, too.

Financial Checkup

In our view, the combined effect of COLAZAL reduction in sales (to generic competitors) and limited market acceptance of the new balsalazide tablet will have a materially adverse effect on the company’s business and financial condition in FY 2008.

Due to the loss of COLAZAL sales, Salix posted a net loss of $24.0 million, or $0.50 per share, for the first quarter of 2008, on a 43 percent Y/Y drop in total product revenue to $34.3 million.

And the share-price of Salix Pharma nose-dived after losing patent expiry in FY 2007.

As of the first-quarter 2008 ended March 31, Salix had $111.5 million in cash. Nonetheless, the 10Q Detective believes a combined drop in 2008 sales with limited cash flow generated from operations will necessitate management slashing its spend rate—including R&D—in order for the company to limp through 2008—without needing to raise new capital.

Incoming monthly cash flow slowed from $5.8 million in 1Q:07 (excluding purchase of product rights) to $723,000 in the 1Q:08. Improved collections—about $26.4 million in accounts receivables—prevented the company from reporting an operating cash flow loss in 1Q:08. Expect operating losses in coming quarters to flip cash flow to cash burn!

Of concern, too, allowances for product returns in the 1Q:08 increased 43.7% Y/Y to $10.8 million. The returns for the three-months ended March 31, 2008, excluded COLAZAL, resulting from an unexpected large return from a small wholesaler of VISICOL (a bowel evacuant used to clean the colon prior to colonoscopy).

Salix has $12.65 million coming due in FY 2008, primarily for operating leases and fixed purchase commitments.

The company is currently in compliance with loan covenants (which include a leverage test and a fixed charge test). Albeit, net operating losses for 2008 could put Salix out of compliance in coming quarters, unless management obtains a waiver or amendment, the $15.0 million currently outstanding on the credit facility would immediately come due.

Business Strategy

Management opines that it can rebuild top-line growth by expanding the indications for its
current products.

Save for XIFAXAN tablets (rifaximin), we do not believe that any of Salix’s eight other products can replace lost COLAZAL sales, including the new twice-a-day COLAZAL.

Rifaximin Franchise

XIFAXAN, as approved for travelers’ diarrhea, competes with the generic antibiotic ciprofloxacin (preferred agent of choice by the Academy of Family Physicians) and a plethora of OTC products, such as Imodium (loperamide), bismuth subsalicylate (BSS), which is the active ingredient in Pepto-Bismol, and probiotics (such as Lactobacillus GG and Saccharomyces boulardii).

XIFAXAN contributed 49 percent and 26 percent of net product revenues in 1Q:08 and 1Q:07, respectively. XIFAXAN net sales increased only 8.7 percent Y/Y. The increase in percentage resulted from a corresponding 43 percent drop in net product sales due to generic introduction of COLAZAL.

However, total prescription growth from 2005/2006 to 2006/2007 fell from 118 percent to about 35 percent year-over-year.

Nonetheless, management 2008 revenue guidance for XIFAXAN is approximately $71.0 million, a 10.4% increase over 2007 sales.

Studies to assess the utility of rifaximin for the treatment of irritable bowel syndrome (IBS), hepatic encephalopathy (HE), and for the prevention of travelers’ diarrhea (TD) have been completed, are in the planning stages or are underway (markets in the aggregate of more than $4.0 billion per annum).

Based on current timelines—and assuming trial results support NDA submissions, management anticipates submitting applications for the HE and IBS indications in 1H:09 and 2H:2010, respectively.

Prevention of travelers’ diarrhea is a bright spot for the company, for antibiotic prophylaxis is not recommended by the Centers for Disease Control and Prevention—even for high-risk travelers—because it can lead to drug-resistant organisms and may give travelers a false sense of security.

Salix has hurdles to jump before it could market rifaximin for this indication (off-label use excluded). To date, studies have only evaluated the effectiveness of rifaximin in the prevention of travelers' diarrhea against a placebo.

Not good enough, for the FDA would probably require a randomized, double-blind, efficacy trial against a 'gold-standard' option, such as fluoroquinolones—and, preventive treatment with quinolones is up to 90 percent effective!

However, increasing resistance to these agents, initially among Campylobacter species and now among other TD pathogens, may limit their benefit in the future—opening the door for rifaximin.
Sales/EPS Estimates

Management forecasts a loss of about $1.12 a share on total product revenue of $180 million for FY 2008.

In our view, this guidance could prove to be too optimistic, for sales visibility of the 1100 mg tablet formulation of balsalazide is poor. In addition, to ease formulary restrictions, the company may need to offer contract rebates, resulting in net price erosion.

Editor David J. Phillips does not hold a financial interest in any stocks mentioned in this article. The 10Q Detective has a Full Disclosure Policy.

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