Vernalis — Positive Tuzistra trends

Vernalis’s H117 results provided an update on Tuzistra’s progress mid-way through its second cough cold season post launch. Operational initiatives to address barriers to prescribing that were identified during the launch season (Exhibit 1) are starting to bear fruit. Increased momentum in Tuzistra XR prescriptions (Rx) has been supported by the refined commercial plan and also a more severe cough cold season compared to 2015/16. This has resulted in material growth in Rx rates to 11,586 in H117, up from 1,976 in H116 and c 10,000 for FY16. However, Rx growth has not been matched by similar revenue growth; for H117, Tuzistra XR net revenues (on a delivered-to-wholesaler basis) were £0.8m (vs £0.6m in H116 and £1.1m for FY16). This is in part due to the cost of Rx growth initiatives (eg pharmacy discounts, patient coupons) which decreased the net dollar per Rx to c $60/Rx (vs $65/Rx at end June 2016 and a longer-term target of $80/Rx) and also the relative importance of patient demand and pharmacy/wholesaler stocking to sales growth.

Emerging Rx trends in the first half of the 2016/17 cough cold season bode well for the latter part of the season, especially given its likely classification as a moderately severe season. The first six weeks of H217 have seen c 6,000 Tuzistra XR Rx, and as pharmacy stocking and patient affordability has improved, the unfilled Rx rate (abandonments/rejections) for Tuzistra XR has declined. With an expanded salesforce and realigned territories, the main focus for H217 is on further improving the effectiveness of the salesforce across the entire sales organisation. Commercial execution is a critical driver of Tuzistra XR performance and Exhibit 2 (overleaf) illustrates both the overall steady progress and also the sensitivity of weekly Rx rates to active promotion. Vernalis’s strategy is validated by the presence of high performing sales reps in all US regions; the aim is to improve performance across the 79% of territories which have an annualised run rate <600/Rx.

Continued implementation and execution of Vernalis’s commercial plan through H217 should mean that an anticipated end-of-season operational update from management in June/July, and the Rx exit run rate should provide a more meaningful indicator of potential Tuzistra XR performance. More information on the Rx growth trajectory could prompt us to revise our Tuzistra XR forecasts, and could also provide greater visibility regarding the potential for improvements in net price. A more established and effective salesforce should also benefit next season launches of CCP-07 and CCP-08.

The foundations laid for Tuzistra XR in the current cough cold season should benefit the potential launches of CCP-07 and CCP-08 into the 2017/18 season, assuming approval around their respective PDUFA goal dates. Vernalis’s intention to train the US salesforce on both products at the same time in late summer 2017 should both receive FDA approval. However, due to the need for Tris to manufacture final validation batches, the launch of CCP-08 will be later than CCP-07, which is expected to launch at a similar stage in the season as Tuzistra XR (also an April PDUFA date with launch in September 2015).

Regulatory approval will trigger the disclosure of the active pharmaceutical ingredient(s) (API) in CCP-07 and CCP-08, which will reveal which market segment each drug will target and enable a more meaningful peak sales assessment to be made. Tuzistra XR addresses the narcotic segment of the market, with the rest of the cough cold portfolio (current status summarised in Exhibit 3) understood to cover the other API market segments, excluding dextromethorphan. CCP-05 and CCP-06 remain in active development, in the formulation stage; proof of concept is now targeted before end-December 2017 (CY17) rather than before end-June 2017 (FY17).

Net revenues from once daily amoxicillin tablet Moxatag in the first four months of its US launch were £0.1m, reflecting its restricted promotion due to supply constraints following the liquidation of sole source supplier Suir Pharma in 2016. Vernalis has completed wholesaler launches with inventories available to support sales in a limited number of regions. The main operational focus is on building brand awareness (through product sampling and physician calls) and on securing routine supply from a new manufacturing partner to enable broader promotion by 2018/19.

The recent acquisition of the Suir facility by IQ PharmaTek may represent an opportunity for Vernalis to accelerate this timeline. Vernalis and IQ PharmaTek, who will be re-opening and operating the site under the name AlbyPharma, have had early conversations regarding potential Moxatag supply. While Vernalis is also engaging with other potential manufacturing partner(s), AlbyPharma would likely be the quickest and lowest risk option from a regulatory perspective.

Recent announcement by partners reveal progress with two partnered new chemical entity (NCE) development programmes: CPI-444 (Corvus Pharmaceuticals) and RPL554 (Verona Pharma). Five of Vernalis’s NCE pipeline of eight assets are partnered; for these, development timelines and newsflow are subject to partner decisions and disclosures, but they could also be associated with economic benefit to Vernalis without any further internal investment.

In February 2017, Vernalis received a $3m clinical milestone from Corvus on the expansion of the renal cell carcinoma patient cohort in the ongoing CPI-444 Phase I/Ib trial. This monotherapy trial in advanced cancers has an adaptive design which permits expansion of disease-specific cohorts if specific pre-defined endpoints are achieved. Corvus has indicated that a registration trial could start by end calendar 2017 should the initial promising finding be confirmed with longer follow up in a larger group of patients. Under the license deal with Corvus, Vernalis is eligible for up to c $220m in development, regulatory and sales milestones, and mid-single digit sales royalties across all indications and all territories.

Also in February, Verona Pharma announced the start of a 30-patient Phase IIa study of RPL554 as an add-on therapy to tiotropium (Spiriva) to treat COPD (chronic obstructive pulmonary disease). This trial is expected to render top line data in Q417. A new Phase IIb COPD trial of the nebulised formulation to treat severe COPD exacerbations in hospital is expected to start in 2017. Verona also reiterated plans to commence a NASDAQ listing (potentially raising up to $130m) in the first half of 2017 in its FY16 results statement. RPL554 licensing terms are largely undisclosed but include a milestone payment on first regulatory approval, low-to-mid single digit royalties on sales, and a c 25% share of any sub-licensing revenue. The latter is noteworthy as Verona has stated its intention to partner RPL554 to enable future indication expansion.

Vernalis’s transition to commercialisation has shifted the key near-term sensitivities away from development risk towards execution risk for the cough cold portfolio, particularly in relation to initiatives to support Tuzistra XR sales growth. The success of ongoing investment into supporting patient access (pharmacy stocking, insurance coverage) and affordability (supporting coupons to minimise out-of-pocket expenses), brand awareness and driving salesforce effectiveness will be measured by increased growth in prescription levels. Addressing barriers to increased prescribing is a key determinant of the trajectory of Tuzistra XR uptake and both the level of and the timeframe over which it can achieve peak sales. Management has stated that the rate of Tuzistra XR prescribing on exiting the 2016/17 cough cold season would be a more meaningful predictor of future sales as some operational initiatives are still early in their implementation. This second year post-Tuzistra XR launch is also important for laying the foundations for the cough cold franchise ahead of the potential launch of CCP-07 and CCP-08 into the 2017/18 cough cold season.

A SWOT analysis detailing the dynamics of the US cough cold market, Vernalis’s opportunity and the key challenges to be addressed can be found in our Outlook note Investing in the commercial platform (published October 2016).

We have updated our financial model and valuation, which results in a higher DCF valuation of £427m or 81p/share (previously £377m or 72p/share). Our underlying valuation assumptions are summarised in Exhibit 5, with the following adjustments made since our last note:

We continue to apply a DCF-based rNPV approach to the US cough cold and NCE pipelines, explicitly model costs (R&D, SG&A, capex) and include cash. We do not explicitly value the research business, instead netting off collaborative FTE funding against R&D spending; thus any milestones received from research partners represent pure upside. We use a 12.5% WACC across the R&D portfolio with the exception of the launched products (Tuzistra XR, Moxatag and Frova) where we use 10%, our standard WACC for a commercial-stage product. We also apply a 21% UK corporate tax rate after 2021 to cough cold cash flows only, reflecting accumulated tax losses. Cash flows from the NCE pipeline are untaxed, based on our assumption that these will benefit from the UK patent box, as well as tax loss offset.

The largest component of our valuation is the US cough cold portfolio rNPV which is sensitive to the degree of success achieved by operational initiatives to boost prescribing levels. The Tuzistra XR prescription run rate at the end of the 2016/17 cough cold season will inform the growth trajectory and thus potential sales in subsequent years; which could prompt us to revise Tuzistra XR, CCP-07 and CCP-08 forecasts upwards or downwards. Additionally, disclosure of the API(s) following approval of CCP-07 and CCP-08 will reveal which market segment each drug will be targeting, likely triggering a reassessment of peak sales potential.

We also highlight that unpartnered assets in the NCE pipeline, as well as V2006 (partnered with Juno/Redox) are not included in our current valuation; deal(s) for the former, or clarity on development timelines and strategy for the latter, would unlock potential valuation upside.

Vernalis’s H117 revenues (six months to 31 December 2016) of £5.6m were down 8% on H116 (£6.1m) with increased US commercial net revenues of £0.9m (H115: £0.6m) offset by lower research collaboration income and the expected decline in Frova royalty receipts. US commercial net revenues include sales of Tuzistra XR (£0.8m) and Moxatag (£0.1m) and are reported on the basis of deliveries to wholesalers net of any rebates, discounts and returns provisions. Lower research collaboration income of £3.2m vs £3.8m in H116 was due to reduced FTE income and the absence of milestone receipts. Generic competition has affected frovatriptan in-market sales by Menarini in Europe and Central America in both volume and price terms; sales dropped 31% to €8.7m for H117 (albeit a similar level to H216). Frovatriptan royalties booked by Vernalis correspond to API supply; in both H116 and H117, one 12.5kg batch was delivered although the £0.1m royalty decrease to £1.5m reflected the 18% price reduction offset by positive movement in £/€ FX rates.

US commercial infrastructure costs drove the 14% increase in operating costs to £21.7m (H116: £19.0m pre-exceptional; £16.3m including the £2.65m gain on settlement of an onerous lease obligation). Sales and marketing costs showed the most significant increase (£13.3m vs £10.8m) reflecting salesforce expansion during H117 and only four months of salesforce activity in H116 (following recruitment in August). Broadly flat R&D costs of £5.5m (H116: £5.6m) were mainly associated with internal R&D, while G&A increased modestly to £2.9m (H116: £2.6m).

Increased investment in US commercial infrastructure increased operating losses to £16.9m (H116: loss of £13.5m pre-exceptional, £10.9m post exceptional gain). Net loss of £11.0m (H116: pre-exceptional loss of £10.2m) again benefitted from unrealised FX gains on cash and equivalents (£4.4m) and tax credits (£1.1m, mainly connected to the CCP-07 and CCP-08 regulatory filing milestones). At 31 December 2016, cash and equivalents stood at £74.2m (£84m at end-June 2016). As at the prior period end, c 73% of cash was held in US$ to hedge against US costs and future milestones to Tris; a translational loss/gain is recognised at the end of each period at the prevailing exchange rate.

Revenue guidance for FY17 includes continued Tuzistra XR and Moxatag sales, albeit with a lower net price per prescription ($/Rx) vs FY16 for the former and continued restricted launch for the latter. Delivery of two additional 12.5kg Frova API batches to Menarini is expected in H217 (vs a previous expectation of one batch in each half year period for FY17). We update our FY17 revenue forecasts on the basis of H117 actuals and full-year guidance and also the prevailing $/£ FX rate. We now expect lower Tuzistra XR revenues of £1.8m (previously £3.7m), Moxatag sales of £0.2m, and frovatriptan royalty receipts of £3.5m (previously £2.5m). Fully recognising the $3m Corvus milestone in collaboration income, and the new Servier collaboration (€2m upfront payment), increases our research collaboration income forecast to £10.2m. Consequently, our new revenue forecast for FY17 is £16.0m (previously £12.9m). For FY18 we also moderate our cough cold net revenue forecast for FY18 to £20m (previously £30m) to reflect growth from a lower FY17 revenue base and our expectation of continued lower $/Rx. Our FY18 revenue forecast is now £30m vs £40m at the time of our last note. We expect to re-visit our longer-term forecasts in the summer following Vernalis’s post cough cold season update.

Operating costs for the second half of the financial year are expected to continue at a similar run rate to H117, although any further US$ strengthening will magnify US$-denominated costs when translated back into sterling. We maintain FY17 R&D and G&A forecasts but have moderated our US sales and marketing expectations given lower H117 spend as the increased investment is being phased in more gradually than our earlier assumption. We now model S&M spend of £29m (previously £33m) for FY17, and a total operating cost of £45.9m (vs £49.7m earlier). Changes to our estimates are summarised in Exhibit 5, with updated forecasts presented in Exhibit 6.

On the basis of our new forecasts we now expect sustainable profitability to be reached one year later in FY20), with Vernalis’s cash position reaching a low point of c £10m at end-FY19. However, this is contingent on US cough cold (Tuzistra XR, CCP-07 and CCP-08) sales meeting or exceeding our expectations for FY17-19 and/or the remaining Tris milestones (totalling $43m or c £35m) becoming due in line with, or later than, our estimates. Following latest guidance, we have adjusted our assumptions regarding the timing of payment of milestones to Tris, conservatively delaying CCP-05 and CCP-06 proof of concept milestones ($3m each) into FY18. We now assume the following schedule of payments: in H217 one approval milestone ($7m); in FY18 two POC milestones and one approval milestone, $13m aggregated; in FY19 two NDA acceptance milestones, $6m aggregated, and in FY20 two NDA approval milestones, $14m aggregated.