VRX: Belt & Braces Analysis of US Rx Price / Volume. Price Still Wins

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Richard Evans / Scott Hinds / Ryan Baum / Hardy Evans

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October 22, 2015

VRX: Belt & Braces Analysis of US Rx Price / Volume. Price Still Wins

  • This note updates and revises the pro forma analysis of net price and volume contributions to VRX’s US net Rx brand sales growth that we published on October 14th. And, this note expands our model with a parallel analysis of VRX’s price / volume trends based entirely on Medicaid prescription data submitted to CMS by the 50 state Medicaid agencies
  • By law, all Medicaid prescriptions must be reported (and corresponding rebates paid) regardless of who dispensed the prescriptions. Accordingly, we can be entirely sure that the VRX’s Medicaid price / volume trends are unaffected by Philidor, or any other outlets controlled or influenced by VRX. Pricing and volume trends observed in the Medicaid data closely reflect, and we believe thereby confirm, the pattern seen in our pro forma analysis of company-wide growth in US Rx brand sales
  • Our October 14th analysis has been revised to include: 1) a more conservative basis for estimating changes to volume (i.e. one which raises estimated growth contributions from volume), 2) a provision for Philidor volume; and 3) a more conservative (i.e. to VRX’s benefit) treatment of contributions from newer products
  • Our original conclusions are re-confirmed, and we believe strengthened:

    • Most importantly, VRX was one of the five largest contributors to sales-weighted US Rx brand net price inflation over the last six quarters (ending 2Q15); ranking as the largest driver of US Rx brand net price inflation in 3 of these quarters. Because of VRX’s contribution to net price inflation, we believe that formulary managers (e.g. PBMs, HMOs) are compelled to take any feasible steps to slow VRX’s aggregate rate of US net pricing growth
    • And, pricing gains are a substantially larger driver of VRX’s US net sales growth than growth in volumes. At the very most, the rate of volume growth has exceeded the rate of net pricing growth in only 2 quarters (2Q10, 3Q10) since 1Q07
  • Finally, in an attempt to be as transparent as possible, this note more thoroughly explains our methods and underlying data. Lists of brands analyzed, including NDC numbers, are included in the appendices. The models and underlying data are available to our subscribers

Where we’re BULLISH: Biopharma companies with undervalued pipelines (e.g. AMGN, BMY, CELG, GILD, SNY, VRTX); Biopharma companies with pending major product approvals (e.g. ABBV, ACAD, ADMA, ALIOF, AZN, BDSI, BIIB, BMY, CHMA, CLVS, CPRX, ENDP, GNMSF, ICPT, JAZZ, LLY, LPCN, MACK, MRK, NVS, PTCT, RLYP, RPRX, SHPG, SRPT, TEVA, UCBJY, ZSPH); SNY on undervalued basal insulin franchise and sales potential for Praluent (alirocumab), in addition to its undervalued pipeline; RAD as an acquisition target as WBA and CVS seek to defend against narrowing retail networks; CFN, BCR, CNMD and TFX on rising hospital patient volumes; XRAY and PDCO on rising dental patient volumes and rising average dollar values of dental products and services consumed per visit; CNC, MOH and WCG on bullish prospects for Medicaid HMOs; and, DVA and FMS for the likely gross margin effects of generic forms of Epogen

Where we’re BEARISH: PBMs facing loss of generic dispensing margin as the AWP pricing benchmark is replaced (e.g. ESRX); Drug Retail as dispensing margins are pressured by narrowing retail networks and replacement of AWP (e.g. WBA, CVS); Research Tools & Services companies as growth expectations and valuations are too high in an environment of falling biopharma R&D spend (e.g. CRL, Q, ICLR); and, suppliers of capital equipment to hospitals on the likelihood hospitals over-invested in capital equipment before the roll-out of the Affordable Care Act (e.g. ISRG, EKTAY, HAE)

In our research note published October 14th we made the assertion that VRX’s contribution to overall US Rx inflation had grown to a level that compels formulary managers’ attention. Specifically, we showed that VRX has been one of the five largest drivers of US brand net price (real) inflation over the last six quarters, ranking first in three of these quarters (Exhibit 1). This fundamental conclusion, and the underlying data and analysis are unchanged

Also in the October 14th note, we provided a pro forma analysis of price and volume contributions to US brand Rx net sales growth for VRX since 1Q07, and reached the conclusion that net price gains have been a substantially larger driver of VRX US brand Rx net sales gains than growth in volume. This fundamental conclusion also remains unchanged; however we have revised our calculation of VRX volumes in an effort to be both more transparent, and more precise

In the original analysis[1], we analyzed changes in US volumes by relying on 3rd party unit (e.g. pills, milligrams, milliliters, IU’s, etc.) data, rather than 3rd party prescription data. Because there are no prescriptions captured (or generated) in non-retail settings, we used units in order to have a volume basis that could be used across both the retail and non-retail settings. The disadvantage of this method is that large disparities in the number of standardized units per month of treatment across products can result in individual products having inordinately large or small impacts on volume calculations. To control for this, and also to control for shifts in the number of units per prescription over time (e.g. as mail order and/or volume limits become more or less important for a given product), we have shifted our volume basis to ‘adjusted prescriptions’. For products with both retail and non-retail distribution, we bring non-retail unit demand into the volume calculation by expressing non-retail units as prescription equivalents. For example we might find that a product that is typically dispensed at retail as 300 milligrams per Rx has 300 grams of non-retail volume in a given period. In this instance we would account for the non-retail unit demand by including an additional 1,000 ‘adjusted’ Rx’s in the Rx total for that product. The shift to adjusted prescriptions also accounts for shifts in the average number of units per retail prescription. We analyzed units / Rx across the entire period for all VRX products; where units / Rx varied only slightly and did not produce a statistically significant rise or fall in units / Rx over time, we made no adjustment. Conversely in the minority of cases where units / Rx varied significantly, and produced a significant change in units / Rx over time, we adjusted in a manner that maintains the validity of the Rx comparison across time. For example, a product with 100 Rx’s and 15 pills / Rx in period 1 might have 100 Rx’s with an average 30 pills / Rx at period 2. In this case we would adjust the Rx count for this product in period 2 to 200 Rx’s

In the original analysis we made no adjustment for the impact of VRX’s shift toward internally controlled distribution (Philidor). Having no firm basis for estimating the effect over time, and believing that it did not exceed 20 percent of volume (and had been spread over time) we were confident that our basic conclusion of strong pricing offsetting weak volumes was robust. Nevertheless we accept that we should have made some provision or at least shown sensitivities to reasonable ranges of assumptions. In the wake of management providing some guidance as to the impact of Philidor we have incorporated corresponding assumptions. For key dermatology and specialty brands we make upward adjustments to adjusted prescription counts (and gross sales and units) for the estimated percent of volume fulfilled through Philidor (and therefore unreported in 3rd party data)[2]. Conservatively, we only adjust figures for the first three quarters of 2015 and leave earlier periods unchanged[3], thereby incorporating the maximum conceivable positive impact from Philidor on VRX’s 2015 volume trend. Although these provisions provide a modest boost to VRX’s YTD volume growth, they are nowhere near significant enough to alter our fundamental conclusions

Finally, in the original analysis we excluded sales, price, and unit contributions for products that had entered or exited the portfolio within the past year. The goal here was to minimize product mix effects, and offer a more precise description of how units and price were trending for typical products. In retrospect we believe this has caused more confusion than not, and can fairly be challenged as putting the VRX volume trend at a disadvantage by excluding Jublia. Because of this, we’ve included virtually[4] all products in the current analysis, including those in their first or last 4 quarters

As before, we estimate that US Rx brands account for just over 50% of VRX’s global net sales (Exhibit 2). In Exhibit 3 we show the company’s pro forma rate of real net sales growth over time (grey area), and the real rates of both net price inflation (green line) and changes in volume (black line). This exhibit uses adjusted Rx’s as the volume basis, includes estimated Philidor volume, and products in their first or last 4 quarters

In Exhibit 4, we show how our pro forma estimates of net price and volume change as a result of shifting from units as defined in the prior analysis (dotted lines) to the use of adjusted prescriptions as a volume basis (solid lines) in the current analysis. The amount of sales growth to be explained is the same in either case; however because the shift to adjusted prescriptions (and the inclusion of Philidor volume, and the inclusion of products’ first or last 4 quarters) raises the calculated unit growth rate, the rate of calculated net pricing gain is correspondingly lower. Nevertheless the fundamental conclusion – that net pricing gains are substantially more important to VRX’s net sales growth than volume – remains unchanged. Recall that we added Philidor units only to 2015, which in the context of testing our hypothesis is maximally conservative, as this amplifies the calculated rate of unit growth for 2015, and dampens the calculated contribution of net pricing in 2015

Finally, undoubtedly the greatest source of confusion from our October 14th note is our illustration of volume and price trends on a CAGR basis in that note’s Exhibit 7. We calculate net sales, volume, and pricing CAGRs off of sequential quarterly pro forma growth rates, because the quarterly basis allows us to incorporate acquisitions more precisely (than calculating off of annual rates). However generating CAGR rates by rolling up sequential quarterly pro forma rates necessarily means expressing volume effects in unfamiliar terms. Specifically, our CAGR analysis of net sales, net pricing, and volume expresses volume in terms of its effect on the change in net sales dollars, rather than in terms of a simple change in units. In the October 14th note our one year CAGR values for net sales, net pricing, and volume were 55.0%, 93.3%, and -39.1% respectively. This means that all else equal, the change in average net price (which includes the impact of a shift in mix of higher and lower priced products) would have increased net sales by 93.3%; or, that all else equal the change in volume (which also includes the mix shift effects) would have decreased net sales by 39.1%; and, that taken together the changes in net selling price and volumes produced a change in net sales of 55%. As the original exhibit is labelled and presented however, it reads as though we measured a 39.1% reduction in unit volume over the last year, which is clearly not the case, as can be seen by referring to the time series depiction of unit volume in the original note’s Exhibits 3 and 4. In retrospect it is plain to us that this exhibit was misleading, and we apologize for the resulting confusion. We have no interest in producing anything other than the best possible independent estimates of pricing and volume contributions, and did not intend to imply that volume had fallen by nearly 40 percent

Because the CAGR calculation necessarily means expressing volume in terms of its effect on net sales dollars, it’s much less confusing to visualizing the historic volume trends in time series charts as we do in this note’s Exhibits 3 and 4. Nevertheless for the record, and to be as transparent as possible about the effects of changes to our method made in this call, we’re re-casting that original CAGR exhibit in two forms. The first (Exhibit 5) calculates CAGR contributions of net pricing and volume to net sales after including Philidor unit volume and products in their first or last 4 quarters, but still using units rather than adjusted prescriptions as a volume basis. The second (Exhibit 6) includes Philidor unit volume and all products (including those in their first or last 4 quarters), but uses adjusted prescriptions as a volume basis. Exhibit 6 is of course the most conservative view, and nonetheless very much supports our conclusion that net pricing gains are far more relevant than volume to VRX’s US brand Rx net sales growth

Another perspective – Medicaid claims

VRX states that Philidor does not dispense to federally funded beneficiaries (e.g. Medicare, Medicaid). And, because states are required to report and manufacturers are required to pay rebates on prescriptions dispensed to Medicaid beneficiaries — regardless of which pharmacy fills the prescription – we can be confident that Medicaid prescription trends for VRX products are in no way affected by Philidor, or any other VRX-controlled or influenced pharmacy

States report data on total prescriptions, total units, and total reimbursement by product, dosage form, and strength for all retail products dispensed to Medicaid beneficiaries. Reimbursement reported by the states is at the ‘patient level’, i.e. these amounts include any dispensing fees and/or ingredient cost mark-ups captured by the retailer. Nevertheless because dispensing fees and/or ingredient cost mark-ups are in the sample at fairly consistent levels over time, we can be confident that changes in reimbursement per prescription (controlling for any changes in units per prescription) closely reflect changes in pricing

Importantly, because rebates are only paid on prescriptions, the Medicaid data do not capture institutional (i.e. non-retail) sales or volumes (which we estimate to be roughly 10% of VRX’s 3Q15 US Rx net sales). And, because reimbursement data provided by the states is gross of rebates paid by the manufacturer, the implied pricing trend reflects gross rather than net price inflation. Nevertheless because of the controversy over specialty dispensing, and because we can be entirely certain that the Medicaid price / volume analysis is unaffected by who is doing the dispensing, it’s worth taking a close look

Medicaid data are organized by products’ NDC codes, the first five digits of which indicate the manufacturer or ‘labeler’ of the product. We compiled Medicaid sales and prescription data for all of VRX’s labeler codes, for all labeler codes used by companies VRX has acquired, and for all NDC codes of products VRX has acquired from other companies. A list of all VRX products used in this (and in the preceding pro forma net) analysis is provided as Appendix 1, and a list of all NDCs captured for these products in the Medicaid analysis is provided as Appendix 2

In the pro forma net sales analysis detailed in the first section of this note, we incorporated sales and volume data for companies and products only during the periods those companies and/or products were owned by VRX. In this analysis of Medicaid data, we’re tracking sales and volume as though the companies and/or products have always been part of VRX. The simple reason is that when products change ownership, states continue to submit Medicaid data under the prior owner’s labeler codes, sometimes for a substantial period of time. We should soon be able to control for this and to show the Medicaid analysis on a pro forma basis, but in the interest of time we’ve chosen to publish the first version of the analysis without controlling for timing of company and/or product acquisitions

Exhibit 7 shows changes in adjusted[5] Rx volumes over time, and in average net reimbursement (a reasonable proxy for change in gross price) per adjusted Rx over time. The relative contributions of pricing and volume to VRX’s Medicaid sales growth follow patterns that closely resemble the pricing and volume contributions derived in our pro forma net analysis (Exhibits 3 and 4, again). The most obvious difference is a greater recent contribution from volume in the Medicaid analysis. This can be from either or a combination of two effects. At a minimum, the recent Medicaid expansion will have accelerated Medicaid Rx demand relative to broader market Rx demand. However it is also possible that more of VRX’s units are being channeled through specialty pharmacies (e.g. Philidor) than the 15% we’ve assumed. Nevertheless even if the less-weak Medicaid Rx trend were in fact representative of the broader VRX Rx demand trend, our fundamental conclusion that net pricing is far more important than volume to VRX’s net sales growth would remain valid

©2015, SSR, LLC, 1055 Washington Blvd, Stamford, CT 06901. All rights reserved. The information contained in this report has been obtained from sources believed to be reliable, and its accuracy and completeness is not guaranteed. No representation or warranty, express or implied, is made as to the fairness, accuracy, completeness or correctness of the information and opinions contained herein. The views and other information provided are subject to change without notice. This report is issued without regard to the specific investment objectives, financial situation or particular needs of any specific recipient and is not construed as a solicitation or an offer to buy or sell any securities or related financial instruments. Past performance is not necessarily a guide to future results. In the past 12 months, through a wholly-owned subsidiary SSR Health LLC has provided paid advisory services to Pfizer Inc (PFE) and to Merck (MKGAY) on both securities-related and non-securities-related topics

  1. In the original analysis, we compared our estimate of US brand Rx net sales to an estimate of unit volume derived from 3rd party data sources. The analysis is pro forma in the sense that it only incorporates net sales, net pricing, and volume growth effects into VRX for the periods during which VRX owned each asset. The analysis extends back to 1Q07, and our estimate of US Rx brand net sales is informed by VRX’s regular disclosures, by their disclosures of acquisition effects on and pro forma adjustments to net sales (and in some cases of product level net sales), and in all possible cases by pre-acquisition disclosures made by companies that VRX acquired

  2. Per VRX guidance we assume 50% of Jublia volume is fulfilled via Philidor and accordingly adjust Jublia figures upward by 50%. Because there is nearly no 3rd party data available for Arestin, we adjust Arestin figures upward by 100%. We adjust Solodyn, Elidel, and Ziana figures upward by the amounts that set each product’s implied YTD net price trend equal to those stated by VRX – these adjustments are 54%, 19%, and 51%, respectively. Generally consistent with VRX guidance we assume 20% of volume is fulfilled via Philidor for Acanya, Onexton, Zyclara, Retin-A Micro, and Atralin. The sum of implied net sales fulfilled via Philidor for the first five products as a percent of estimated total US brand Rx net sales in 3Q15 is 13.0%; adding the latter five products at an assumed 40% gross-to-net discount rate yields an estimated 15.4% of 3Q15 US brand Rx net sales fulfilled via Philidor – VRX stated this figure is “sort of 10%, 20% maybe… probably closer to 10%”

  3. With the exception of Jublia and Arestin, for which all periods’ figures are adjusted upward

  4. We still account for 3 very minor divestitures: Cloderm, Refissa, and Buphenyl, since they are more or less analogous to a “reverse acquisition”

  5. Adjustments to Medicaid Rx’s are done in precisely the same manner as the adjustments for third party Rx’s in the pro forma net sales analysis. Specifically, we control for any significant changes in the number of units per prescription over time, on a product by product basis. As with the pro forma net analysis, the Medicaid analysis includes products in their first or last 4 quarters on-market

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