Expert Financial Analysis and Reporting

Cadence (CADX) announced that the US patent office has issued an initial action on the re-examination of one of two patents covering Ofirmev, the ‘222 patent on formulation. The PTO rejected certain claims in the patent while upholding others. However, all of the claims remain valid and in place until the PTO issues its final action. This is just an initial finding and Cadence has the opportunity to argue its case with the PTO to restore some or all claims before PTO issues its final action. It is likely that this appeal process is a multi-year undertaking as the PTO is swamped with challenges like this or so my legal consultants suggest. They also suggest that it is not uncommon for claims that are rejected to be re-instated.

What is the worst case? In the worst case, the claims in the patent could be narrowed, but the patent would still stand with a narrowed claims structure through February 2018. This might make it easier for a challenger to develop an intravenous formulation of acetaminophen, but this is almost impossible for an outsider to determine. In any event, it would be a different formulation from the one that Cadence uses. This suggests that there would be development time and expense involved.

The PTO is also re-examining the ‘218 patent covering the manufacturing process that expires in December 2021.The most likely outcome would appear to be that the PTO rejects some, but not all claims in the patent. The process would then be the same as just described; Cadence would have the opportunity to re-instate some or all of the claims. The rest of the argument is similar to that for the ‘222 patent.

What does this mean for the trial on the challenge to the patents that concluded in July and in which the judge is now writing his opinion? Because this is an initial action by the PTO, it cannot figure in his deliberations. However, one point that can be taken from this is that the judge’s decision on the validity of the ‘222 patent and the ‘218 patent might not be a binary event in which the patents are ruled valid or invalid. The judge might uphold certain parts and deny others. The implications might be the same as I suggested on the PTO action that the claims of the patent might be narrowed but certain claims would stand as would the duration of the patents.

The primary issue for the stock will be the judge’s ruling on the just completed trial, not this PTO action. It could be one or two years or more before the PTO issues its final action on ‘218 and ‘222 patents. The judge’s decision which should be known in the October to December time frame is the key issue for the stock. This initial action by the PTO is encouraging in that some claims were upheld as opposed to all being rejected. At this point, I don’t know which claims were upheld or rejected.

I can’t predict what the judge will rule on the patent case. In the worst case, he might find all claims invalid on both patents. Cadence would then appeal and it would likely take another two years or longer for the appeals process to run its course. The PTO action suggests the possibility that the most likely outcome will not be binary-the patents are valid or not valid-but rather that some claims are upheld and others are denied. In this case, the scope of the claims in the patent would be narrowed, but the duration of the patent would stand.

I think that the bear case has been based on the belief the patents will be ruled invalid and generics enter the market in 2014. As I have argued, this binary outcome is unlikely. I think that a potential generic competitor will likely have to work around the claims structure to come up with its own process and formulation for injectable acetaminophen. They would then have to build a plant and gain regulatory approval for manufacturing. This is a long drawn out process of several years in my opinion.

If I am right, Cadence will have the opportunity to realize significant profits and cash flow from Ofirmev before sales begin to erode from generic entries. The question is how many years and i think this could be anywhere from 2017 to 2021. Using this cash flow and the competitive advantage of its sales and marketing structure in the hospital market, it can build a diversified product line through licensing of products, acquisition of products or acquisition of companies with products. By the way, the Ofirmev launch can only be described as spectacular as I described in my recent report.

I continue with my buy recommendation on the stock.