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Expert Financial Analysis and Reporting

Update on Santarus (SNTS, $1.78)


I recently met with Debbie Crawford, Chief Financial Officer, and Martha Hough, Head of Investor Relations. I continue to feel that the chips are falling into place to make this an exciting investment opportunity. In this meeting we focused on the key components of the Santarus story.


Investment Overview

Santarus is moving close to profitability based on sales of its only product, Zegerid. However, the company will soon begin to benefit from OTC sales of Zegerid by Schering-Plough, international sales of Zegerid by Glaxo and a newly licensed-in product Glumetza. Over the next three to five years, these opportunities could respectively boost pretax profits by $7 to $11 million, $7 to $11 million and $50 million. In addition, a recently signed deal has brought in a product called budesonide MMX that could have sales potential of several hundreds of millions of dollars. Santarus plans to file an NDA on this product in 2H, 2010 and marketing could begin in late 2011.


The stock has been hugely and negatively affected by a generic challenge to Zegerid. The market is expecting generic competition to Zegerid in 2010 that will erode almost all sales. However, as I have detailed in this note there is reason to believe that Santarus and the generic company could enter into a deal that will delay generic entry until 2014 or 2015. This gives Santarus the opportunity to broaden its product line and introduce Budesonide MMX that will allow it to more easily handle the Zegerid patent situation.


I am currently projecting that the pretax loss in 2009 will be $8.6 million and then the company will reach profitability in 2010. My pretax income projections are $9.6 million in 2010, $21.5 million in 2011 and $34.4 million in 2012. I am projecting a 2008 year end cash position of $25 million for Santarus which includes an estimated $15 million payment to Cosmo. Assuming approval of Zegerid in 2009, Santarus will receive a $20 million milestone from Schering-Plough and will have year end cash in 2009 of $39 million. The cash position is a little thin and can be boosted by drawing down another $15 million from their credit facility. Assuming the stock begins to benefit from the items I listed before, the CEFF could be important to Santarus in 2009.


Zegerid for Prescription Use

The company was founded on this product for gastrointestinal reflux disease and ulcers. It is a combination of baking soda and the now generic drug omeprazole, which was sold by Astra Zeneca as Prilosec. Sales have grown nicely since its introduction in 2004 as shown below:



This impressive sales performance has not been accompanied by stock performance. In fact, the stock declined from a trading range of $10 to $15 in 2004 to a current trading range of $1.75 to $2.25. The costs of building a sales infrastructure has led to a string of hefty losses that have discouraged investors.



Even though Santarus appears to be turning the corner of profitability, investors are not willing to reward the stock because of the threat of a generic entry against Zegerid. From day one there has been investor skepticism that the patents covering Zegerid are strong enough to prevent generic entry.


Generics and Zegerid

Both baking soda and omeprazole, the two active ingredients of Zegerid have no composition of matter patent. The novelty of the issued patents covering Zegerid is that the combination allows the immediate uptake of omeprazole in the stomach. Omeprazole belongs to a class of drugs called protein pump inhibitors (PPI). All of the drugs in this class are inactivated by stomach acid making them ineffective. To offset this effect, they are all enteric coated which allows them to pass through the stomach and then to dissolve and be absorbed in the intestine.


The enteric coating is essential for protecting the PPIs from destruction in the stomach, but at the cost of delaying their onset of action by about two hours. Zegerid offers the significant advantage of quick onset of relief as opposed to a two hour delay. Despite the issued patents that recognize this as a novel discovery, investors have always been skeptical of the strength of the patents.


Most pharmaceutical patents are listed in a compendium called the Orange Book. When a generic company chooses to challenge an Orange Book listed patent it issues what is called a “paragraph IV certification”. This affirms that it believes that the patent or patents it is challenging are invalid or that it is not violating the patent and that it intends to launch a generic equivalent to a brand name drug. When this occurs the marketer of the brand name drug has 45 days to sue the generic company for violation of its patent. By law, this prevents the launch of the generic until completion of the trial or for 30 months, whichever is faster. Generally, the 30 month period expires before a trial can be completed.


The issuing of a generic paragraph IV challenge does not necessarily mean that the patent is invalid. By law, the first generic to the market has 6 months of exclusivity before other generics enter the market. During this period the generic may be priced at 60% to 80% of the brand name product and profits can be enormous. When other generics enter the market, the price of the generic can drop to 10% to 15% of the brand name drug. This first to file status is highly coveted by generic drug companies and incents them to challenge drug patents even if their case is weak. The outcome of patent challenges is never certain and this often causes the generic and brand name company to come to an agreement that will delay the entry of the generic, but will allow the generic drug company to enter the market before the expiration of the patents.


In the case of Zegerid, the generic drug company Par Pharmaceuticals issued a paragraph IV certification to Zegerid on August 7, 2007. This caused the price of Santarus to drop from about $5 to about $2. The trial for Zegerid is scheduled to begin in July of 2009 and the expiration of the 30 month stay is on March 7, 2010. This has led most investors to conclude that Zegerid sales will be crushed by generic competition in 2010, even though the patents covering Zegerid expire in 2016.


On November 5, 2008, Santarus won a Markman hearing. This is a pre-trial hearing in which the generic drug company tries to get the judge to narrow the language and claims in the patents. The brand name company originally writes broad language to increase the strength of the patent. Santarus prevailed in the Markman hearing which enhances confidence that the patents may be upheld.


Also on July 7, 2008, a new Orange Book patent issued that builds on prior patents issued to Santarus. The new patent has claims covering methods for treating acid-caused gastrointestinal disorders by administering a solid pharmaceutical composition comprising non-enteric coated omeprazole and certain antacids. A notice of allowance was sent by the US Patent Office in April 2008. The new patent will have a July 2016 expiration date. Before issuing this patent, the Patent Office looks at all of the assertions of invalidity as defined in Par’s paragraph IV challenge and still issued the patent. Again, this is an indicator of the strength of the patents.


The win in the Markman hearing and the issuing of the new patent give more confidence that Santarus will prevail in the patent case. However, nothing is certain and most brand name companies in this situation choose to settle with the generic drug company to keep it from launching its generic product. In the case of Santarus, the company would probably be happy to let the generic drug company launch in 2015 and the generic company would like to launch in 2014. Either way, this is a major positive for Santarus in that it gives Zegerid four to five more years of being proprietary. Generally, these types of settlements occur before the trial begins which is expensive. I think it is possible that such a settlement could be reached in 2Q, 2009 and would be a huge catalyst for the stock.


Over the Counter Zegerid Could Be Meaningful

Santarus has licensed over the counter marketing rights for 20 mg. Zegerid capsules to Schering-Plough. The PDUFA data for the NDA is January of 2009, but given that the FDA is missing almost every PDUFA date, this will probably slip. Upon approval, Santarus is entitled to a $20 million milestone payment.


This could be a meaningful opportunity for Santarus. Proctor & Gamble markets Prilosec OTC in the US and has annual sales of around $400 to $500 million. In the over the counter market, the faster onset of action of Zegerid could be a major advantage over Prilosec as much of usage is acute rather than chronic; people are looking for immediate relief. Proctor and Gamble has filed a Citizen’s petition with the FDA raising questions about the safety of Zegerid. This is a delaying tactic which highlights the concern that P&G has that Zegerid may erode Prilosec sales.


I estimate that Prilosec OTC has US sales of $400 million or more. Based on past product cycles, I would estimate that Zegerid can achieve sales of $100 to $150 million in two to three years. The net royalties to Santarus are probably on the order of 7% so that annual royalties could be $7 million to $11 million. In addition to these royalties, the advertising campaign for Zegerid OTC could boost awareness and sales of the prescription Zegerid product.


Distribution Agreement with GSK

Santarus licensed to Glaxo the exclusive right to develop, manufacture and commercialize prescription and OTC immediate release omeprazole products in up to 114 countries outside of the U.S., Europe, Australia, Japan and Canada, including specified countries in Africa, Asia, the Middle East and Central and South America. Sales of proton pump inhibitors products in these international markets are approximately $2.0 billion annually. Glaxo began marketing in October of 2008. Within three to five years, Glaxo’s Zegerid could achieve sales of $100 to $200 million. I estimate that the royalty on these sales could be 7% leading to annual royalties of $7 million to $11 million.


The Licensing of Glumetza

Adding Glumetza to the salesman’s bag was an extremely important strategic move. All of the current cost burden of the sales organization is now absorbed by sales of Zegerid. Adding a second product requires little increase in costs so that gross profits drop largely to the pretax income.


Glumetza is a sustained release formulation of metformin licensed from Depomed. Metformin is generally the first drug given to type II diabetes patients. While highly effective, it has the disadvantage of causing gastrointestinal side effects when first given which requires physicians to slowly titrate the dose. Glumetza's delivery system allows physicians to rapidly titrate dosing up to 2000 mg a day, which results in a more optimal level of glycemic control without significantly increasing gastrointestinal side effects as compared to a daily dose of 1500 mg of immediate-release metformin.


Glumetza was originally licensed by Depomed to King Pharmaceuticals, but a change in corporate strategy resulted in its being returned to Depomed. Over the last year, sales of the product were handled by a small contract sales organization, which maintained sales at about $20 million. In the hands of Santarus’ large sales force, the product may be capable of reaching $100 million of sales. Under the terms of the licensing agreement, Santarus receives 75% to 80% of gross profits. The gross profit margin for Glumetza is about 83% so that Santarus essentially receives 63% to 66% of Glumetza sales. If Glumetza achieves $100 million of sales, perhaps $50 million could drop to the pretax income line.


Important Strategic Collaboration with Cosmo Gives Santarus U.S. Rights to a Potential Blockbuster with Budesonide MMX and Rifamycin SV MMX

Santarus just announced a strategic collaboration with Cosmo Pharmaceuticals of Italy which grants Santarus exclusive rights to develop and commercialize Budesonide MMX and Rifamycin SV MMX for the U.S. market. Budesonide MMX is an oral corticosteroid currently being investigated in two multi-center Phase III clinical trials involving more than 800 patients in North America and Europe for the induction of remission of mild-to-moderate ulcerative colitis.


If successfully developed, budesonide MMX could record several hundreds of millions of dollars in sales. It is a major opportunity for Santarus. Corticosteroids like budesonide are tremendously effective agents, but systemic absorption causes dangerous side effects. Budesonide MMX is designed to retain the effectiveness of corticosteroids, but with reduced side effects due to its targeted controlled release in the colon that results in minimal systemic absorption.


Santarus will be responsible for overseeing the Phase III U.S. registration clinical trial, and Cosmo and its partner in Europe, Ferring Pharmaceuticals, are overseeing the European Phase III clinical trial. The protocols for both Phase III clinical trials have been reviewed and approved by the FDA, under special protocol assessments, and have been reviewed and approved by two European agencies. Assuming successful completion of the Phase III clinical program and an extended use safety trial, an NDA submission is planned for the second half of 2010.


Rifamycin SV MMX is a broad spectrum, semi-synthetic antibiotic that also has targeted release characteristics when taken orally. The application of MMX technology to Rifamycin SV allows the antibiotic to be delivered directly to the colon, with the goal of minimizing unwanted effects on the bacterial flora in the small intestine. Cosmo has completed a Phase II clinical program in traveler's diarrhea. Santarus will be responsible for the design and execution of a Phase III U.S. registration clinical trial for traveler's diarrhea, while the European Phase III clinical trial in the same indication will be conducted by Cosmo's European partner, Dr. Falk Pharma GmbH. A pre-IND meeting has been requested with the FDA and is expected to take place in the first quarter of 2009.






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