Disappointing Fourth Quarter - Reason to Sell?

Jordo is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Vertex Pharmaceuticals (NASDAQ: VRTX) saw sales of its hepatitis C drug, Incivek, drop sharply in the fourth quarter, year-on-year. This article will address the company's latest earnings release and its future prospects. The company attributes the decrease to patients with hepatitis C opting for alternative treatments through other available medicines. Incivek was approved by the FDA only in May 2011 and the decline emphasizes the cutthroat competitive business environment for hepatitis C. Vertex and several other competitors are all trying to develop an oral drug combination that would do away with the need for interferon injections. Below, I will examine the company's investment potential following its disappointing fourth quarter results.

Financials

Vertex has just reported consolidated financial results for the full year and fourth quarter ended December 31, 2012.  It has also provided financial guidance for 2013. Vertex reported total 2012 revenues of $1.53 billion, including net product revenues of $1.16 billion from Incivek (telaprevir) and $171.6 million from KALYDECO (ivacaftor) and the GAAP net loss attributable to Vertex was $107.0 million, or $0.50 per share, for 2012.

Non-GAAP net income attributable to Vertex was $255.5 million or $1.18 per diluted share, though this figure excludes charges of $362.6 million. For the fourth quarter, total revenues were $334 million compared with $563.3 million for the same quarter of the previous year (which included a one-time milestone payment of $65 million from Mitsubishi Tanabe for the approval and commercialization of Telavic in Japan). Net  revenues generated by Incivek were $222.8 million compared to $456.8 million year on year. The GAAP net loss attributable to the company was $76.1 million, or $0.35 per share while non-GAAP net income was $9.0 million, or $0.04 per diluted share, excluding charges of $85.1 million.

Vertex predicts that full-year 2013 total revenues will be in the range of $1.10 billion to $1.25 billion, including full-year Kalydeco net revenues of $280 million to $320 million. The growth of 2013 Kalydeco revenues, compared to 2012 revenues of $172 million, is mainly dependent on successful completion of reimbursement negotiations outside the U.S.

The company expects total operating expenses to be in the range of $1.09 billion to $1.15 billion for 2013. R&D expenses are expected to be in the range of $750 million to $790 million.  The company has clarified that the R&D expenses “relate to investment in development activities for late-stage CF and hepatitis C programs as well as completion of Phase 2 evaluation of VX-509 in RA and investment in future research programs." Vertex's 2012 R&D investment was $718.7 million.

Pipeline

Early this year, Vertex announced that the combination of VX-809 and ivacaftor for the treatment of people with cystic fibrosis who have two copies of the F508del mutation has been granted Breakthrough Therapy Designation by the FDA.  The company has concluded an end-of-Phase 2 meeting with the FDA and has submitted a proposed design for a crucial Phase 3 program.

The exact implications of the designation cannot be established now, but Vertex says that it is in discussions with the FDA and expects to start Phase 3 development in the first quarter of 2013 subject to regulatory approval for the treatment of hepatitis C, the company has recently submitted a supplemental New Drug Application (sNDA) for a twice a day regimen of telaprevir to the FDA. A similar supplemental New Drug Submission (sNDS) application has been submitted in Canada. In its Phase 2 evaluation of VX-509 in rheumatoid arthritis (RA), a 40 patient study was recently initiated to determine the potential of VX-509 to improve structural joint changes as measured by Magnetic Resonance Imaging (MRI) as well as the markers of inflammation and joint damage in joint fluid. The study will also address a wide range of doses of VX-509.

The Competition

Pfizer (NYSE: PFE) has a drug similar to VX-509 for rheumatoid arthritis by the name Xeljanz, which has already been approved. Timothy Anderson, the pharmaceuticals analyst at Bernstein Research, believes that the drug has the potential to produce annual sales of as much as $2.5 billion.

Gilead Sciences (NASDAQ: GILD) has revealed impressive positive results for an experimental hepatitis C drug, which analysts believe could be best in class. More than 3 million people in the United States suffer from hepatitis C, and the traditional two-drug treatment with negative side effects for the virus is only effective in about 40 percent of people who are afflicted.  More importantly, Gilead's drug does not use ribavirin thus reducing the toxicity of the treatment. Idenix has a drug IDX-184 in development, which has been on clinical hold because it is similar to a drug from Bristol-Myers Squibb that showed extremely poor results in trials. However, the company is trying to establish that its treatment is significantly different.  

Achillion (NASDAQ: ACHN), a development stage biotech, has many candidates in its HCV pipeline. Sovaprevir is the company's lead candidate with a potential for once a day usage and is equally effective against all HCV genotypes. This small company has as many as four HCV candidates of which two are being evaluated in Phase 2 studies.

Conclusion

Vertex has been downgraded by The Street Ratings from hold to sell. For the next year, the market is expecting a reduction of almost 50% in earnings per share (-$0.74 versus -$0.50). The gross profit margin at 26.5% is unsatisfactory and has decreased significantly from the same period of the previous year.  Side by side, the net profit margin of -22.79% is significantly below what one would expect. In view of the poor performance of the existing approved drugs and the high risk of the development pipeline, I am in agreement with the "Sell" rating.


jordobivona has no position in any stocks mentioned. The Motley Fool recommends Gilead Sciences and Vertex Pharmaceuticals. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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