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May 18, 2007 Zacks Research Digest Research Analyst: Shilpa Chandak, CA. Sr. Ed: Ian Madsen, CFA, [email protected]; 1-800-767-3771, x9417 111 N. Canal Street, Suite 1101 • Chicago, IL 60606 www.zackspro.com Encysive Pharmaceuticals, Inc. (ENCY - NASDAQ) $3.25 Note: This report contains substantially new material; all subsequent reports will have additions highlighted. Reason for Report: Q1 2007 Earnings Update. Previous Update: March 21, 2007 Recent Events On May 7, 2007, ENCY announced financial results for 1Q07. Overview Encysive Pharmaceuticals, Inc. (ENCY) is a biopharmaceutical company headquartered in Houston, Texas. The company (formerly Texas Biotechnology Corporation) is engaged in the discovery, development, and commercialization of novel, synthetic, and small molecule compounds. Encysive’s first product, Argatroban, is approved for the prophylaxis or treatment of thrombosis in patients with heparininduced thrombocytopenia (HIT). Argatroban is being promoted by GlaxoSmithKline, PLC. ENCY is in Phase II development with the selective antagonist called Bimosiamose, for asthma, psoriasis, and atopic dermatitis. Additionally, ENCY has several other research and development programs for a range of cardiovascular and inflammatory diseases. ENCY has collaboration agreements with Mitsubishi Pharma Corporation, GlaxoSmithKline (GSK), and Encysive L.P. The company’s website is http://www.encysive.com. Brokerage firms have identified the following factors for evaluating the investment merits of Encysive: Key Positive Arguments Key Negative Arguments Encysive is gearing up its sales and marketing resources in anticipation of potential FDA approval of Thelin. Thelin faces a significant risk from Myogen’s Ambrisentan, due to be launched in 2007 or 2008, which has a potentially superior clinical profile, according to analysts. Encysive depends heavily upon intellectual property to protect its patented products from potential infringement by competitors. Encysive has one of the broadest product pipelines in the sector. Note: The company’s fiscal year coincides with the calendar year. © Copyright 2007, Zacks Investment Research. All Rights Reserved. Revenue Argatroban Indication: Treatment of heparin-induced thrombocytopenia (HIT), a serious immune reaction to heparin that causes abnormal clotting and often leads to limb amputation and even death. Stage of development: Mature, widely sold and distributed. Importance: Argatroban is Encysive’s first product, and promoted by GSK. Encysive receives roughly 15% royalty on its sales. As HIT is a relatively small market, brokerage firms believe Argatroban’s peak sales market potential is less than $100 million. Partners: Argatroban (received FDA approval in June 2000) is being marketed by partner GSK. Royalty Income: According to the Zacks Digest report, royalty income in 1Q07 increased 29% to $4.1 million versus $3.2 million earned in 1Q06. Safety Issues: The most serious side effect associated with Argatroban, is an increased danger of a hemorrhagic event in disease states; and other circumstances like severe hypertension, immediately following lumbar puncture, spinal anesthesia, and major surgery, especially involving the brain, spinal cord, or eye; hematological conditions associated with increased bleeding tendencies, such as, cogenital or acquired bleeding disorders; and gastrointestinal lesions, such as, ulcerations. Argatroban Royalty 2006A $16.9M 2007E $19M 2008E $21.6M 2009E $21.7M Est. Growth 18.7% Pipeline Drugs Thelin (Sitaxsentan sodium) Indication: Treatment of pulmonary arterial hypertension (PAH), a condition that involves high blood pressure and structural changes in the walls of pulmonary arteries of the heart. Stage of Development: Thelin was approved in Australia, while Canadian approval is pending. Thelin will be slowly rolled out in Europe, following pricing and reimbursement negotiation with individual EU countries. The PDUFA day for Thelin in the U.S. is June 15, 2007. Importance: Analysts expect Thelin to be the major value driver for Encysive in the future. Safety Issues: In clinical trials, most frequent adverse events that occurred in patients receiving Thelin, which were more common than in placebo-treated patients, were headache, edema, nausea, upper respiratory tract infection, dizziness, insomnia, nasopharyngitis, and nasal congestion. Thelin Launch: Thelin’s launch ex-U.S. remains on track, with new launches in Ireland and the Netherlands. Reimbursement is being sought in Australia after a March approval, and next launches are expected in Spain, Italy, France, and Canada. Early experience showed 40% of Thelin’s use was in “incremental” patients (those new to ETRA therapy, and those returning to ETRAs after prior discontinuation from side effects). ENCY reiterated it expects a slow ramp for Thelin ex-U.S.; Regulatory Issues: On April 16, 2007, ENCY announced the commercial availability of Thelin 100 mg tablets in the Netherlands for the treatment of pulmonary arterial hypertension (PAH). The company received European Union marketing authorization for Thelin from the European Commission in August 2006. Zacks Investment Research Page 2 www.zackspro.com On April 2, 2007, ENCY announced the commercial availability of Thelin 100 mg tablets in the Republic of Ireland for the treatment of pulmonary arterial hypertension (PAH). On March 7, 2007, ENCY announced the Australian Therapeutic Goods Administration (TGA) has granted marketing approval for Thelin 100 mg tablets as a once daily oral treatment for patients with pulmonary arterial hypertension (PAH). Thelin is indicated for the treatment of PAH in patients with New York Heart Association (NYHA)/World Health Organization (WHO) functional class III symptoms to improve exercise ability. Efficacy has been shown in primary pulmonary hypertension and pulmonary hypertension associated with connective tissue disease. On December 28, 2006, ENCY announced the U.S. Food and Drug Administration (FDA) has accepted for review the company's complete response to the July 24, 2006 approvable letter regarding its New Drug Application (NDA) for Thelin. FDA has designated the review as a Class 2 resubmission, and issued a new Prescription Drug User Fee Act (PDUFA) target action date of June 15, 2007. The company has indicated it will work with FDA to schedule a meeting as soon as possible in an effort to clarify the situation, and move the application forward. Additional Studies: Patient enrollment in the Phase II trial of Thelin in diastolic heart failure patients, is roughly 2/3rd completed. This is a randomized, double-blind, placebo-controlled trial examining the efficacy of Thelin to improve exercise tolerance in patients with diastolic heart failure. Patient inclusion criteria include chronic NYHA Class II/III heart failure, LVEF levels greater than or equal to 50%, exercise time in the range of 120-720 seconds, and echocardiographic evidence of concentric remodeling and/or diastolic dysfunction. Competition: Thelin is the major value driver for ENCY, but is likely to face competition from the increasing number of participants in the PAH space, including Actelion, Gilead, Myogen, United Therapeutics, and Pfizer. The Thelin PDUFA date (June 15, 2007) is only three days ahead of that of Ambrisentan. The company believes it could launch Thelin in the U.S. within 30 days of FDA approval, although one firm (J.P. Morgan) remains concerned that Ambrisentan’s apparent best-in-class efficacy and safety profiles will enable Gilead to capture the majority of new patients and switches from Tracleer. Other: The company hired and trained 52 sales representatives for promotion of Thelin in late 2005, but due to uncertainty regarding the launch of Thelin in the U.S., one representative has left till date. Thelin Sales 2006A $0.3M 2007E $19.2M 2008E $83.2M 2009E $143.2M Est. Growth - Bimosiamose Indication: Treatment of asthma and psoriasis. Stage of Development: Phase II trials are underway with Bimosiamose as an inhaled therapy for asthma. All costs to develop the product for asthma and psoriasis are being borne by Revotar Biopharmaceuticals AG, based in Berlin, Germany, and a majority owned affiliate of Encysive. Importance: Bimosiamose inhibits all three selectins known to support the inflammatory process, thereby blocking the inflammatory process at an early stage. TBC3711 Indication: Treatment of pulmonary arterial hypertension (PAH), a condition that involves high blood pressure and structural changes in the walls of the pulmonary arteries of the heart. Stage of Development: Phase II. Zacks Investment Research Page 3 www.zackspro.com On March 21, 2007, ENCY announced the enrollment of the first patient into its Phase II dose-ranging study of oral TBC3711, the company's next-generation, highly selective endothelin receptor antagonist in resistant hypertension. The 12-week, multi-center, randomized, double-blind, placebo-controlled study will evaluate four once-daily oral doses of TBC3711 in approximately 150 patients with diagnosed resistant hypertension. Importance: TBC3711 showed excellent kinetics in Phase I studies. VLA-4 Antagonists Indication: Prevention of inflammation. Mechanism of Action: The compound may block the adhesion of certain cell adhesion molecules, thereby preventing inflammation in a highly specific manner. Stage of development: Pre-clinical. Total Revenue Synopsis The company reported revenue of $5.4 million for the first quarter of 2007, versus $3.6 million in the first quarter of 2006, reflecting approximately $1.0 million in Thelin European sales, and a year- over-year increase in Argatroban royalty income of approximately $0.9 million. 2006A 1Q07A 2Q07E 3Q07E 4Q07E 2007E 2008E 2009E Total Revenue $18.7 $5.4 $7.0 $10.6 $13.4 $39.0 $101.4 $158.0 Digest High $19.0 $5.4 $8.3 $13.3 $18.5 $68.3 $277.4 $400.4 Digest Low $16.4 $5.4 $6.0 $7.1 $8.7 $27.2 $39.1 $70.0 Digest Average $18.7 $5.4 $7.0 $10.6 $13.4 $39.0 $101.4 $158.0 Digest YOY Growth 33.3% 51.8% 90.0% 67.6% 147.1% 108.4% 159.7% 55.8% -0.1% 29.5% 51.1% 26.4% Quarterly Growth Margins Margins Gross 2006A 1Q07A 2Q07E 3Q07E 4Q07E 2007E 2008E 2009E 97.9% 98.4% 96.3% 95.0% 93.9% 95.2% 93.5% 93.5% Operating -585.2% -530.9% -385.0% -238.2% -176.9% -256.7% -50.6% -6.4% Pre tax -585.3% -553.5% -405.6% -254.6% -188.6% -277.6% -60.9% -13.5% Net -579.6% -548.6% -401.7% -251.9% -186.1% -275.0% -60.2% -14.3% Research and development spending of $17.5 million in the first quarter of 2007, was slightly lower than the last year's first quarter R&D spending of $18.4 million, due to a slowdown in clinical spending. Sales and marketing expenses were $10.9 million in the current quarter versus $9.8 million in the first quarter in 2006. General and administrative expenses were $5.6 million in the first quarter of 2007, versus $5.7 million during the same period in 2006. These changes reflect decreased spending in the U.S. due to internal spending controls, offset by increased spending in Europe where we are actively commercializing Thelin. Encysive stated during the earnings call, it will need to raise additional funds in 2007, regardless of whether Thelin is approved in the U.S. Management indicated it has taken down $18 million of the equity Zacks Investment Research Page 4 www.zackspro.com line during the fourth quarter. One firm (C.E. Unterberg) believes Encysive’s U.S. sales force could be downsized over the next quarter. Given the need for experienced sales people in an increasingly competitive PAH market, the firm believes many of ENCY’s sales force can be wooed away by competitors, some of whom already have products in the market. Earnings per Share ENCY reported 1Q07 net loss of $0.49 per share, mainly due to higher than expected R&D expenses and lower than expected Argatroban royalty of $4.1 million. FY Ends December 2006A 1Q07A 2Q07E 3Q07E 4Q07E 2007E 2008E 2009E Digest Average ($1.84) ($0.49) ($0.41) ($0.36) ($0.34) ($1.50) ($0.97) ($0.42) Digest High ($1.72) ($0.49) ($0.36) ($0.29) ($0.27) ($1.21) ($0.65) ($0.05) Digest Low ($1.87) ($0.49) ($0.45) ($0.43) ($0.39) ($1.75) ($1.35) ($0.70) Y/Y Growth -42.8% 4.8% 9.2% 18.5% -748.0% 15.6% 49.3% 71.5% Management refrained from issuing precise sales and cost forecasts, citing the uncertainty surrounding Thelin’s emerging presence in Europe, and pending review by the FDA. Target Price/Valuation According to the Zacks Digest report, the average target price is $4.80 (↑ from the previous target price). The target price ranges from a low of $2.00 (Deutsche Bank.) to a high of $12 (Punk, Ziegel). Rating Distribution Positive 18.2% Neutral 54.5% Negative 27.3% Avg. Target Price $4.80↑ Brokerage firms in the Digest group believe risks to achievement of the target price include financial risk, development risk, competitive risk, the potential for high share price volatility, market risk, and litigation risk. Capital Structure/Solvency/Cash Flow/Governance/Other Cash, cash equivalents, accrued interest and restricted cash at March 31, 2007, was $62.9 million, versus $43.8 million at December 31, 2006. Cash utilization during the first quarter included $4.5 million in debt repayment related to the Argatroban Notes, as well as $1.6 million in interest payments to the 2005 Convertible Note holders. In the quarter, cash balance included $10.2 million of restricted cash related to the Argatroban Notes, which was held in a holdback account, pending resolution of a United Kingdom tax withholding issue. On February 6, 2007, Encysive Pharmaceuticals announced its newly-formed, wholly-owned subsidiary has closed a private placement of $60 million in aggregate principal amount of non-convertible, nonrecourse promissory notes (Notes) to institutional investors. The Notes are secured by royalties to be paid on sales of Argatroban, a drug licensed by Encysive to and sold by GlaxoSmithKline plc (GSK) for the treatment of heparin-induced thrombocytopenia, and by a pledge by Encysive of the stock of the new subsidiary. Zacks Investment Research Page 5 www.zackspro.com Potentially Severe Problems On October 4, 2006, Federman & Sherwood announced a securities class action lawsuit has been filed against Encysive Pharmaceuticals Inc. On October 1, 2006, the law firm of Brower Piven announced a securities class action was commenced on behalf of shareholders who purchased or acquired the common stock of the company between February 19, 2004 and March 24, 2006. The case is pending in the United States District Court for the Southern District of Texas against defendant Encysive, and one or more of its officers and/or directors. The action charges that defendants violated federal security laws by issuing a series of materially false and misleading statements to the market throughout the Class Period, which artificially inflated the market price of the company's securities. On September 29, 2006, Law Offices of Howard G. Smith announced a similar securities class action lawsuit. The complaint alleges Encysive and some of its officers and directors violated federal security laws by issuing a series of materially false statements regarding the success of Sitaxentan, or Thelin, a drug it was developing to treat Pulmonary Arterial Hypertension (PAH). Long-Term Growth None of the brokerage firms in the Digest group has come out with long-term growth rate for ENCY. In November 2000, ENCY began to market its first product, Argatroban, through an agreement with GSK. However, royalties produced by Argatroban have not made it profitable. Most of ENCY’s resources have been dedicated to the research and development of Argatroban, Thelin and other small molecule drugs for certain vascular and related inflammatory diseases. It does not have any drug candidate that is likely to be commercialized in the near future other than Thelin. In March and July of 2005, the company had received approvable letters from the FDA for Thelin, which contained concerns and observations that need to be satisfied prior to achieving approval, including a request for additional clinical trial work. One firm (Needham) continues to be impressed with management’s efforts to resolve the matter, but considering that the nature of the remaining item has not been made public, it prefers to maintain a conservative position, and assumes additional clinical trials will be necessary. Upcoming Events Date Event June 15, 2007 Thelin PDUFA date Individual Analyst Opinions POSITIVE RATINGS Cowen – Outperform – May 7, 2007: INVESTMENT SUMMARY: The brokerage firm expects the stock to outperform as investors gain confidence in Thelin’s worldwide potential. Zacks Investment Research Page 6 www.zackspro.com NEUTRAL RATINGS C.E. Unterberg – Market Perform (Target Price range $3-$4) – May 8, 2007. INVESTMENT SUMMARY: With a lack of catalysts until the June PDUFA date, and dwindling cash resources, which will yield turnover in its salesforce, the firm maintains its rating on ENCY’s shares. Leerink Swann – Market perform – May 7, 2007: INVESTMENT SUMARY: The firm believes an uncertain regulatory picture and truncated competitive advantage period may continue to garner a relatively low revenue/earnings multiple for ENCY. J.P. Morgan – Neutral – May 7, 2007: INVESTMENT SUMMARY: With a slower than expected Thelin launch in the EU and a Thelin PDUFA date concurrent with Gilead’s Ambrisentan, the firm continues to be cautious on ENCY shares, given Ambrisentan’s apparent best-in-class profile. Rodman & Renshaw – Market perform – May 7, 2007: INVESTMENT SUMMARY: Even if Thelin is approved by the FDA, the firm believes it will not garner any significant market traction, and hence, finds the risk-reward profile ahead of the FDA decision to be unattractive. WR Hambrecht – Hold – May 7, 2007. INVESTMENT SUMMARY: Given the lack of clarity regarding the approval of Thelin in the U.S. and the relative importance of Thelin to Encysive, the firm has maintained a Hold rating. NEGATIVE RATINGS Needham – Under Perform – May 7, 2007. INVESTMENT SUMMARY: Based on the uncertainty surrounding the Thelin development schedule, a lack of significant news flow in the near term, and the continuing need for additional financing, the firm has reiterated an Under Perform rating. Appendix-A Analysts’ sales estimates by product, EPS forecasts, and a consensus model can be found in the file ENCY.xls. Research Analyst: Shilpa Chandak Copy Editor: Oindrila Banerjee Zacks Investment Research Page 7 www.zackspro.com