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Expert Financial Analysis and Reporting

A.P. Pharma: Management Change is a Positive for the Stock (APPA.OB, $0.39)


This report deals with the just announced management change at A.P. Pharma (APPA.OB) and the positive impact that I believe it will have on the stock. It does not get into an in-depth discussion of the fundamentals and financial projections for the Company. For those wanting more background, I

would refer you to past reports and blogs that I have posted on my website.


New Management

The Board of Directors of A.P. Pharma (APPA.OB) has brought in the management team that was responsible for founding the biotechnology company Ardea in 2006 and selling it to Astra Zeneca in April 2012 for $1.3 billion. At the time of sale, Ardea, like A.P. Pharma, had one late stage product; this was lesinurad for gout. Barry Quart will join the Company as Chief Executive Officer. He was a co-founder of Ardea along with Kevin Tang in 2006 and held the position of Chief Executive Officer when it was sold. Steve Davis has joined as Chief Operating Officer, a position that he held at Ardea when it was acquired. Robert Rosen, who joined A.P. Pharma in October 2012 as Chief Commercial Officer, will be promoted to the role of President. These announcements were made by the Chairman of the Board Kevin Tang, who interestingly enough was also Chairman at Ardea.

Mr. Quart and Mr. Davis have been serving as members of the board of directors at A.P. Pharma. They are very familiar with the commercialization plans for APF 530 and the issues in regard to Complete Response Letter or CRL received in March 2013 that has delayed the launch of APF 530 and resulted in a 50% drop in the stock price. They are up to speed on the company and the transition should be pretty seamless.

The obvious first question of investors is what prompted this change. I think that the immediate catalyst was the second complete response letter on APF 530. Before then, Mr. Quart and Mr. Davis had been added to the board in an advisory capacity and for expertise in in business development. The CRL may have been the catalyst that prompted the board to decide to just turn the Company over to them. The experience of the previous CEO was as a chief financial officer; he had little experience in business development or product commercialization.


Conversation with New Management

I met Mr. Quart during his days at Ardea and he gained my respect even before the sale of the company. I was able to speak with him and Mr. Davis about the change. My first question was whether this signaled a potential change in the latest guidance that APF 530 that it will be launched in 1H, 2014.They responded forcefully that there has been no change in this guidance. Both expressed strong confidence that the three issues raised by the FDA in the CRL can be addressed relatively quickly. As a reminder, the three points raised were related to supply chain issues, the need to do a human factors study and a reclassification of patients in the phase III study to meet new ASCO guidelines on the classification of emetogenicity of chemotherapy regimens.

The Company has not detailed the supply chain issue other than to say that it is not difficult to answer the FDA's questions. The human factors study is to assure that the device used to administer APF 530 can be used without error by a nurse or other third party. This involves a trial of perhaps 15 to 30 nurses or other medical personnel and would be designed to demonstrate that they can administer the drug without error. On the third and final point, A.P. Pharma was unlucky as after submitted its NDA, there was a change in definition in what constituted moderate emetogenic chemotherapy or MEC and what constituted highly emetogenic chemotherapy or HEC. The classification of patients in the trial as having received either MEC or HEC has to be changed in accordance with this new guidance. Mr. Quart and Mr. Davis said that there are no new issues beyond this that have arisen and are confident that they these three can be resolved in a time frame that will allow a product launch in 1H, 2014.

The Company raised about $50 million in 3Q, 2012 in preparation for the launch. This was a great decision in that A.P. Pharma will probably not be forced to do a new financing at current depressed prices. My analysis suggests that the Company will have about $30 million at the end of 2013. I think that the Company will probably need to raise capital after the approval of APF 530, although perhaps not immediately. I would also point out that new management chose to sell Ardea before it commercialized its lead drug lesinurad and there is a possibility that A.P. Pharma could be sold prior to commercialization of APF 530.


Investment Opinion

This management change bolsters my confidence in my analysis of the Company and my standing buy recommendation. It is encouraging to have two previously successful biotechnology managers validate my analysis of the Company. They are acting on more detailed knowledge than me and are confident that this is a great opportunity. After the Ardea acquisition, neither was desperate to find work. It is also encouraging that they have reinforced the guidance for a launch in 1H, 2014. Previous management has been silent since the Complete Response Letter was received on March 28, 2013.

I wrote a report on January 24, 2013 reiterating my Buy recommendation before the Complete Response Letter was received on March 28. In that report I estimated that APF 530 would be launched in mid-2013 and would reach peak sales of $200 million in 2014 and EPS of $0.22. My price target for late 2013 was arrived at by applying a P/E ratio of 20 to projected 2014 EPS of $0.22 and resulted in a price target of $4.40. The Complete Response Letter has pushed out the launch by about one year, but has not substantially changed the underlying reasoning for the price target. I think that it is consistent for me to set a similar price target of similar magnitude for late 2014.

I think that Mr. Quart's taking over as CEO could be quite positive for the stock in the near term. He could attract investors who made money in Ardea. Also, many investors like to follow managements who have demonstrated that they can make money for shareholders and he has done this in spades. He is a skilled communicator and well-liked and respected by Wall Street, which should also benefit the stock. Before the last CRL, the stock had climbed to $0.70 in anticipation of the approval. I think we could see the stock retrace back to this price level over the balance of 2013.

The receipt of a Complete Response Letter always triggers a sharp and negative response in the stock price, but this can sometimes create a better buying opportunity. I would point out the case of MAP Pharmaceuticals which I was recommending just prior to its receiving a CRL for its lead drug Levadex on April 8, 2012. This caused its stock to drop by 30% from $16.44 to $11.86 over the next few days. Subsequently, Allergan Pharmaceuticals offered to acquire the company for $25 on January 4 at $25 prior to the Company receiving approval of Levadex. This worked out well for MAP shareholders and I hope that this current situation works as well or better for APPA shareholders.

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