Generic Pharmaceuticals
Finance & Investment Club
Healthcare Sector
Summer 2012
Senior Analyst: Roy Tong

• Growth in revenue outpaces that of GDP
• Acceptance of Generics evident in growing domination of sales mix at the expense of brand names
• Lower cost to manufacture than brand names
• Sales further driven by patent expiry of brand names
• Increased government Medicare and Medicaid spending leading to more consumer access to prescription drugs as opposed to OTC
• Most insurances (both private and public such as Medicare) do not cover brand names when generics are available
• Large aging population increasing – elderly more vulnerable to diseases that require medication to treat
• Unhealthy American lifestyle, too much fat and calories, inadequate exercise and fiber, breed obesity and other diseases
2

• Generic pharmaceutical and medicine manufacturers develop prescription drug products that are used to prevent or treat illnesses in humans or animals
• Generic drugs are produced, marketed and distributed without patent protection, yet at the same time comparable to brand listed drug products (if existent) in dosage, strength, administration, quality, performance and intended use
• Firms are allowed to manufacture generics of brand name drugs AFTER the expiration of patents protecting the branded drugs, and are able to do so at a much lower cost due to the bypassing of discovery costs
Ligand Pharmaceuticals
NASDAQ: (LGND)
Avanir Pharmaceuticals
NASDAQ: (AVNR)
Catalyst Pharmaceuticals
NASDAQ: (CPRX)
Sagent Pharmaceuticals
NASDAQ: (SGNT)
Source: Yahoo Finance Industry Center, Various Firms’ 10K & IBISWorld Analysis
Hi Tech Pharmaceuticals
NASDAQ: (HITK)
3

Industry Breakdown by Market Cap ($BLN) Breakdown by Market Cap
28,5%
20,1%
Health Care
$2,384.26B
(100%) 25,3%
23,1%
Drug Manufacturers and Related
$1,423B
(61.23%)
3,1%
Selected Companies Market Cap
Generic Drug
Manufacturer
$45B
(1.89%)
LGND $317.78M
AVNR
CPRX
Source: Yahoo Finance Industry Center & Various Firms’ 10K Analysis
$399.33M
$48.57M
SGNT $364.84M
HITK
Total
$450.88M
$15.81B
4

Revenue
Profit
Exports
$52.8B
$7.8B (14.7%)
$19.6B
Annual Growth
(07-12)
Expected Growth
(12-17)
Businesses
5.4%
6.3%
1,103
Breakdown by LTM Revenue (Total: $427.28M)
54,38%
7,10% 2,48%
36,03%
Pharmaceutical Prep for
Psychotherapeutic Drugs
6%
Medicinal and Botanical
Products
10%
Biological Products
6%
In-Vitro Diagnostic
Substances Products
6%
Pharmaceutical Prep for
Central Nervous System
Drugs
11%
Product
Segmentation
0,00%
Pharmaceutical Prep for
Cardiovascular Drugs
12%
Pharmaceutical Prep for
Metabolic Drugs
14%
Source: Yahoo Finance Industry Center, Various Firms’ 10K and IBISworld Analysis
Pharmaceutical Prep for
Other Drugs
35%
5

Manufacturers Research and Development Partners
Pipeline
Pre Clinical
Trials
Royalties or
Licenses
Pass
Marketed and Sold
Stage I
FDA
Approval
Pass
Stage II
FDA
Review
Pass
Stage III
New Drug
Application
(NDA)
Through
Partner
Sales Team or Retailers
Direct through
Sales Team
Institutions
Retailers
3 rd Party
End User
Pass
Source: Various Firms’ 10K and Firms’ Website Analysis
6

• Mid-Atlantic and West regions with most manufacturers but sales branches typically located close to end market
• Advantage of locating near other manufacturers include local specialize workforce, experienced business services & availability of facilities that are specialized and expensive to build
• Sales of generics follow population trends –
Southeast, home to significant portion of elderly, accounts for largest region in terms of revenue
Source: IBISworld Analysis
7

9%
42% 20% 40%
58%
31%
Health Care
Products (OTC)
8%
ECR
Pharmaceuticals
(Branded)
6%
100%
Source: Various Firms’ 10K Analysis
100%
Hi-Tech Generics
86%
8

11,61%
21,58%
30,14%
78,42% 58,25%
8,57%
19,67%
71,75%
24,46%
21,58%
53,96%
44,36%
* No selling
Source: Various Firms’ 10K and Firms’ Website Analysis
55,64%
9

2
(29%)
(71%)
5
8
(22%)
(78%)
28
0
(61%)
51
33
(39%)
33
(34%)
(66%)
63
Source: Various Firms’ 10K and Firms’ Website Analysis
(100%)
8
10

80
70
60
50
40
30
20
10
200
100
0 0
2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013(est) 2014(est) 2015(est) 2016(est) 2017(est)
Generic Drugs Revenue Medicare Spending Medicaid Spending
• Revenue – Medicare Spending Correlation: 0.98 • Revenue – Medicaid Spending Correlation: 0.86
• Based off anticipated US government spending on Medicare and Medicaid (which can be found from records and projections from the US Government Office of Budget and Administration), we can reason that a comparable growth rate will be found in projected revenue of the generic drugs industry
• Projected Revenue (Billion $) = 6.601 + 0.112*Medicare – 0.68*Medicaid Spending (Billion $)
• Accurate within +/- 3 Billion $
800
700
600
500
400
300
Source: Office of Management and Budget, IBISworld & BUFC Analysis
11

125%
• Generic pharmaceutical manufacturing shows key features of an industry in its Growth stage
• The value that industry (revenue) adds to the US economy is growing at a much faster pace than US
GDP
• Rapid introduction of products and brands coincides with growing customer acceptance of products
• This is seen in how market share has grown substantially at CAGR of
5.4% for past 15 years compared to brand name drugs’ decline
Source: US Census Bureau, Mintel & IBISworld Analysis
Generics Revenue
120%
115%
110%
105%
100%
95%
US GDP
90%
2007 2008 2009 2010
% Distribution of Brand vs Generic Sales Mix
2011
80
70
60
50
40
30
20
10
0
CAGR: 5.4%
1995 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
12

Top Selling Drugs to Lose Patent by End of 2012
Brand Name Generic Name
US Sales
(billions)
Company
% of
Revenue
Plavix Clopidogrel 6.1
Bristol-Myers (BMY) 48%
Actos Pioglitazone 3.5
AstraZeneca (AZN) 53%
Advair Flucticansone 4.03
GlaxoSmithKline (GSK) 34%
• Patent expirations have huge impact on sales, as brand name drugs quickly lose market share once generic versions are on the market
• Drugs representing more than $140 billion in sales will lose patent protection between
2012 and 2017
• The patent expiry of “blockbuster” drugs would continue to stimulate sales in the generic industry
Source: Mintel, IBISworld & Frost and Sullivan Analysis
13

180,00
Average Retail Prices of Brands vs Generic ($)
• Lure of generics are obvious, with a
74% difference in average retail prices as of 2010
160,00
140,00
120,00
100,00
• Virtually all major pharmacy chains offer generics at extremely inexpensive prices, leading to price wars
80,00
60,00
40,00
20,00
0,00
• Result of this has been an increase in sales of generics, often at the expense of brand names
1995 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Pharmacy
Chain
Offer Price
Walmart 30 Day $4 • In 2010, 93% of physicians prescribed generics when they were available – compared to 83% in 2003
• Some 75% of prescriptions dispensed in
2011 were generic drugs – compared to
40% in 2000
CVS
Kroger
United
Healthcare
90 Day
30/90 Day
Provides for co-payments for Medicare
Part D
$9.99
$4/$10
$2
Source: US Census Bureau, Mintel & IBISworld Analysis
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Does Not Cover
Prescription Drugs
7%
I Don’t Know
3%
Prescription Drugs
Covered but Doctor Will
Not Prescibe It (i.e. Xanax for Anxiety)
12%
Doctor Willing to
Prescribe Drug, But Not
Covered (i.e. Viagra for
Sexual Dysfunction)
16%
Covers
Prescription Drugs
90%
Will Pay for Certain Brand
Names, Does Not Cover
Generics
13%
Wil Not Pay for Brand
Name if Generic is
Available
59%
• Of the pool of respondents in a Mintel study, 90% of the total indicated that their insurance covers prescription drugs
• Furthermore, close to 60% of respondents indicated that their insurance would not pay for Brand Name drugs should a Generic be available
Source: Mintel & IBISworld Analysis
15

Federal Medicare & Medicaid Spending
• When Medicare and Medicaid receive more funding from the government, more consumers gain prescription drug coverage
800
700
600
500
400
CAGR: 6.7%
300
• As a result, industry demand increases with the population’s ability to afford the industry’s products
200
100
0
CAGR: 8.7%
2006 2007 2008 2009 2010 2011 2012
(est)
2013
(est)
2014
(est)
Medicare
Medicaid
2015
(est)
• Coverage by these government aids usually will not cover the cost of brand name drugs if generics are available
• Health Care reform in 2010 expected to benefit generic pharmaceutical manufacturers - PPACA
Patient Protection and Affordable Care Act
(PPACA)
Section 10609
Prevents brand-name manufacturers from making label changes to the brand-name or listed drugs, thereby delaying generic products
Source: Office of Management and Budget, Mintel & IBISworld Analysis
16

100 000
90 000
80 000
70 000
60 000
50 000
40 000
30 000
20 000
10 000
0
2006 2011 2016(Est)
>55 >55 % of Total Population
• American population is an aging one, with Americans aged 65-74 estimated to see the greatest hike from 2011-2016, followed by 55-64s
28%
27%
26%
25%
24%
23%
22%
21%
20%
• This means that the 2 fastest growing demographics are at or approaching the age when the aging process will place them at greater risk for a variety of age-related ailments
• The elderly are more vulnerable to certain diseases, including Alzheimer’s, heart disease, diabetes, cancer etc, which require preventive or treatment measures provided by pharmaceuticals
Source: Mintel & IBISworld Analysis
17

Unhealthy American Lifestyle
• Lack of exercise and poor diet primarily responsible for increase in number of diseases
Insufficient Exercise
70% of Population is inactive, 12% of respondents in CDC survey meet weekly recommended amount of 150 mins of moderate-intense exercise
• 67% of population is overweight/obese, with cancer and stroke strongly associated with obesity
Too Many Calories
Daily caloric consumption up from 2172 a day to 2775 over past 30 years
Too Much Fat
Not Enough Fiber
Average American diet is
34% fat, 12% being saturated, above AHA recommendations of no more than 7% saturated fat
Adult Americans consume only 50% of optimum amount of fiber
• Some 81 million Americans (34%) have heart disease, and 92.7% have at least 1 risk factor for the disease
(obesity, high blood pressure, high cholesterol, diabetes, smoking)
• According to NIH, diets high in fat result in higher mortality rates and incidences of colon, breast and prostate cancer
Source: Mintel & IBISworld Analysis
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Leading Causes of Death
Diabetes 71 382
Alzheimer's Disease
Accidents
Respiratory Diseases
74 632
123 706
Stroke
Cancer
Heart disease
127 924
135 952
562 875
616 067
0 100 000 200 000 300 000 400 000 500 000 600 000 700 000
• A result of high disease counts has been an increase in the number of prescriptions dispensed, up 3.2% from 2007 to 2009, almost double the increase in US population in the same time period
• Those affected by chronic disease and require chronic medication, a large portion of which are older adults, resort to skipping/reducing doses when faced with increased medication costs which can lead to expensive hospitalizations and adverse health outcomes
• However, patients who initiate therapy with lower cost generic medications have higher rates of adherence, making generics appealing to health care providers who want to ensure treatment compliance and avoid unnecessary spending
Source: Mintel & IBISworld Analysis
19

Company
Ligand (LGND)
Avanir (AVNR)
Catalyst (CPRX)
Sagent (SGNT)
Hi Tech (HITK)
Industry
Market Cap
(In Millions)
326.17
403.1
46.73
233.69
460.14
45,000
Closing
Price
(Aug 28)
16.36
2.96
1.52
14.68
35.26
-
% of 52 wk High
P/E
Ratio
EV/EBIT
DA
EPS
Debt/Eq uity
LTM
ROE
Quick
Ratio
82% 32.08 85.3x
0.51
3.31
60% 0.71
73% (5.8) (4.8x) (0.51) 0 (85%) 5.93
77% (7.24) 7.6x (0.21) 0 (170%) 7.47
55% (15.29) (17.9x) (0.96) 0.03
(19%) 1.89
79% 9.82
4.5x
3.59
0.01
20% 4.74
50.1
7.6% -
High
Low
460.14
46.73
Median 326.17
Mean 293.97
*does not include industry values
35.26
1.52
14.68
14.17
82%
55%
77%
73%
32.08 85.3x
(5.8)
2.71
14.9x
Source: Yahoo Finance Industry Center, Google Finance, MacroAxis & Various Firms’ 10K Analysis
3.59
(15.29) (17.9x) (0.96)
0.48
3.31
0
4.5x (0.21) 0.01
0.67
60% 7.47
(170%) 0.71
(19%) 4.74
(39%) 4.15
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Risk 1 – OTC, Complementary & Alternative Medicine
• Greater motivation to self-treat in order to save time and money with a trip to the doctor
• Greater Availability of OTC remedies that were once available only with a prescription to treat minor illnesses such as colds, allergies, headaches or coughs
• Desire for natural healing (CAM) to avoid potential side effects from prescription drugs
Risk 2 – External Competition from Brand Names
• Many brand competitors try to prevent or delay approval of generic equivalents by attempting to extend patent protection
• Brand competitors sometimes launch authorized generics concurrent with 1 st generic launch
• Brand competitors also seek to lower prices of brand name drugs after patent expiry to compete with generic equivalents
Risk 3 – Other Health Care Reforms or Changes to Current Policies
• “Evergreen” loophole in health care regulation that allows innovator drug companies can extend market exclusivity for branded drugs through strategies like authorized generics
• Branded-Generic patent settlements paid to firms to compensate generic producers for keeping generics off the market
• Changes to current policies with elections coming up and potentially new directions could adversely affect the generic drug industry
Source: IBISworld, Mintel & Various Firms’ 10K Analysis
21

• Growth stage industry fuelled by continual acceptance of products, low prices of goods and federal health care spending
• State and behavior of American population set to have positive effects on prescription drugs and therefore generic industry in the next 5 years
• Competition from brand name manufacturers that attempt to keep generics off the market for a longer period of time
• Must stay responsive to potentially new government regulations and health care reforms, especially during election years
• HITK is profitable, with 4.7 Quick Ratio showing good financial health and liquidity in addition to having minimal debt (0.01 Debt-Equity Ratio)
• LGND with diverse revenue generation, yet could mean complicated business model
• Both with ROE well above industry average and poised to take advantage of trends
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• Executive Summary
• Industry Definition
• Health Care Sector Breakdown
• Industry at a Glance
• Revenue Generation
• Geographical Distribution
• Revenue Generation Segments
• Operating Expenses Segments
• Product Development Segments
• Time – Series Analysis
• Trend 1 – Growth of Generics
• Trend 1 – Patent Expiry
• Trend 2 – Generics’ Prices
• Trend 3 – Insurance Coverage
• Trend 3 – Government Spending
• Trend 4 – Aging Population
• Trend 4 – Unhealthy Lifestyles
• Trend 4 – Leading Causes of Death
• Comps
• Risks
• Conclusion and Recommendation
• How to Calculate Patent Expiry
• What are CAMs?
23

For Patents filed before 08/06/1995 (INID Code 22)
• Add 17 years to patent issue date shown on front page of patent (INID code 45) to obtain 1 st date
• Add 20 years to the application date of the earliest related application shown on the front page of patent (INID codes 62 or 63) to obtain 2 nd date
• Later of the two dates is the expiry date
• Add any applicable extensions of adjustments to the patent term, and then account for any terminal disclaimers to obtain the full-term expiry
For Patents filed on or after 08/06/1995 (INID Code 22)
• Add 20 years to the date of the earliest related application show on front page of patent (INID codes 62 or 63) to obtain the expiry date
• Account for any terminal disclaimers to obtain full-term expiry
Source: http://www.genericsweb.com/
24

Complementary & Alternative Medicines
• A group of diverse medical and health care systems, practices, and products that are not generally considered part of conventional medicine
• Complementary medicine refers to the use of CAM together with conventional medicine, such as using acupuncture in addition to usual care to help lessen pain
• Alternative medicine refers to the use of CAM in place of conventional medicine
Categories of CAM
• Natural Products – “natural products”, many sold OTC as dietary supplements, include probiotics
• Mind & Body Medicine – focus on interaction among brain, mind, body. Techniques include meditation, postures, yoga, acupuncture, breathing exercises, tai chi etc
• Manipulative & Body Based – focus on the structure and systems of the body including bones and joints, soft tissues etc, such as spinal manipulation or massage therapy
• Other CAM – these include movement therapies such as pilates etc to promote physical, mental, emotional and spiritual well-being. These also include manipulation of energy i.e. magnet therapy
Source: http://nccam.nih.gov/health/whatiscam
25