Note From Edward Hemmelgarn

Notes released from the Fed’s March meeting indicate that interest rates may be raised just one more time in the current tightening cycle. Equity investors, who feared that overtightening might inadvertently prompt a recession, should generally be pleased with this pause: the stock market typically moves higher when the Fed completes its final hike.

Nevertheless, U.S. economic growth will almost certainly decelerate, and the cumulative impact of the Fed’s rate hikes could have a significant impact on the U.S. consumer. Fortunately, an expected slowdown in consumer spending should be offset by a number of favorable economic trends.

First, many foreign economies may show continued or renewed strength, even as U.S. consumers begin to ratchet down their spending. U.S. companies are exceptionally competitive and financially sound, and should flourish in these new growth markets.

Domestically, we expect that the stock market will continue to grow. Among the areas we believe will outperform is the pharmaceutical sector. Our investment in Alkermes, a highly innovative drug company, reflects our desire to stake a claim in this particular arena. In this issue of our newsletter, we’ve included a report by Lynn Laws on the pharmaceutical industry’s efforts to ensure that patients take medication as prescribed, and an interview with James Frates, Alkermes’ Chief Financial Officer.

Medication Compliance is Important to Patient Health and Healthcare Costs
By Lynn Laws, CFA, Research Analyst  

Taking medication as prescribed – referred to as “compliance” in the healthcare industry – is vitally important, especially to patients with chronic health conditions. Failure to be compliant can result in unwanted symptoms, hospitalization, or even death, and also increases total healthcare costs. In the United States, 30- 50% of patients do not take medications as prescribed. The reasons for non-compliance are many, and include an inability to pay for the medication, unwillingness to take it, and forgetfulness.

The way a drug is delivered, and how it is released once it is administered, can have a large impact on patient usage and outcomes. Drugs can be delivered orally, injected, inhaled, absorbed through the skin, and implanted. Newer technologies that facilitate less frequent or more convenient dosing have the potential to revolutionize disease outcomes by allowing patients to achieve compliance more easily.

The antibiotic Zithromax is one example of progress that has been made to increase compliance. When a course of antibiotics is taken for the full seven to ten days as prescribed, the chance of developing resistance is lower than if the antibiotics are only taken for few days. However, compliance is difficult, because patients usually are required to take pills two to four times per day and it becomes harder for patients to remember to take the antibiotics once they feel better. Zithromax is an antibiotic that is unusual in that it stays in the body for quite a while, allowing for once-a-day dosing and for shorter treatment courses for most infections. This results in better compliance. 

Birth control is another example of where compliance is important to prevent an unwanted pregnancy. To be maximally effective, the majority of oral contraceptives need to be taken once per day at the same time each day. If a dose is forgotten or taken too late, the risk of an unwanted pregnancy increases. There are many new birth control options that are making compliance easier, including Depo-Provera, which is a hormone injection that is given once every three months, and the Ortho Evra patch, which is a skin patch that releases hormones over a period of one week.

In this newsletter, we highlight, Alkermes Inc., which targets chronic diseases with large numbers of patients where compliance is critical to good outcomes. Alkermes has injectable controlled/ sustained release drug delivery technologies that it applies to reduce the frequency of dosing of already highly successful drugs. By reducing dosing frequency, improving safety and tolerability, and decreasing the adverse effects associated with peak/trough levels of other (oral) dosage forms, Alkermes technologies can improve patient compliance and convenience.

Alkermes’ AIR pulmonary drug delivery system is a proprietary drug delivery technology composed of dry powders ideally suited for delivery to the lungs. The AIR re-usable inhaler is approximately the size of a magic marker and is breath-activated. Advantages of AIR include the systemic delivery of small molecules and macromolecules, local or targeted delivery to the lung, rapid onset of action, and the potential for prolonged release.

On its own or in collaboration with other companies, Alkermes has drug development programs in place that pursue diseases such as schizophrenia, alcoholism and diabetes among others. The stock has numerous, potential catalysts over the next year and beyond.

Executive Insights
James Frates, Chief Financial Officer
ALKERMES, INC. [NASDAQ: ALKS]

Alkermes is recognized for its innovative drug delivery technologies. Can you describe these?
A: Our technologies enable drugs to be delivered locally to a certain area, like the lungs, or systemically throughout the body via the bloodstream. Each of these technologies involves the stabilization and complex formulation of those drugs into different particles. Our technologies are designed to allow Alkermes to deliver drugs in a novel way to improve therapeutic outcomes.

Q: Why is the drug delivery method so important?
A: You can never completely take the risk out of the movie business. However, any discerning individual who looked at the film slate for 2006 could probably pick most of the films with the greatest potential to record top grosses. For example, Toys from Pixar, The Da Vinci Code from Sony, and both Superman Returns and Harry Potter and the Goblet of Fire from Warner Brothers would probably be on everyone’s list. As a result, there is relatively low risk associated with these films.

Q: What drugs does Alkermes have on the market, or in development?
A: Risperdal Consta, a long-acting antipsychotic, has been on the market for two full years in the U.S. Last year it sold $593 million; the drug is approved in 50 countries. That’s our key drug that has driven much of our recent financial performance. In addition, we have developed Vivitrol, a drug to combat alcoholism. On April 13 it was approved by the FDA, and Vivitrol will be launched by the end of June. A pulmonary insulin drug, which has been a joint effort with Eli Lilly, is in late-stage development or phase III. Lastly, we’re in the earlier stages (between phases two and three) with a long-acting version of Byetta for the treatment of diabetes.

Q: How large are Alkermes’ markets, either in terms of population or dollar figure?
A: Our potential markets are some of the largest in the pharmaceutical world. Diabetes, for instance, is one of the most costly, fastest-growing medical problems worldwide, with 200 million people afflicted. It once was considered to be primarily a western disease, but is spreading across the globe as more cultures are exposed to fast food and sugary drinks. The market for schizophrenia, which is treated with Risperdal Consta, is well over $10 billion – and we’ve hardly scratched the surface. Finally, the alcoholism market is massive, because no one has, as of yet, developed an effective drug to treat alcoholism. In the U.S. alone, 18 million people abuse alcohol and two million people are seeking treatment.

Q: Will Alkermes be impacted if the U.S. moves toward universal healthcare?
A: Probably not much. Legislating universal coverage won’t change the number of people with diabetes, schizophrenia or alcoholism. If we continue to make high-value medications, there will continue to be demand for them. Indeed, our medications may become even more valuable if healthcare coverage is extended across a larger population.

We also safeguard ourselves against universal healthcare by not seeking to develop the twelfth drug to treat heart disease or, say, the eighth drug to fight high blood pressure. Our treatments are wholly unique.

Q: What is your vision for Alkermes 5- 10 years from now?
A: Our goal has always been to build the premier science-based pharmaceutical company. We believe we have a great opportunity to accomplish this by adopting our drug delivery technologies to create new and improved drugs. We’re in this for the long-haul, and our goal is simple and straightforward: to improve outcomes through innovation.

Q: If demand for Risperdal begins to slack, is Alkermes vulnerable?
A: Risperdal is important to us, but we are by no means a one-drug company. As long as we stay diversified, I don’t believe that we’re too vulnerable. We generally have four or five drugs in development at any one time.

Sure, the near term impact can be damaging, but you must look long-term. We not only plan for difficulties, we expect it! You can’t just rest on your laurels and let the popular drugs turn all the profits. If I have any criticism of our industry as a whole, it’s that companies are too complacent when their drugs are doing well. All product life cycles come to an end at some point.

Q: Will any of Alkermes’s cash flows be deployed for acquisitions in the next several years?
A: We have successfully integrated three acquisitions in the last decade, and we remain opportunistic. Like most companies, we try to buy companies that have many underappreciated assets and are worth more than we paid for them. It’s almost a truism, but that’s our standard. However, we’re not considering any acquisitions right now. When we do, however, we have a proven track record: All told, our three acquisitions cost a total of $130 million. Those holdings are now worth well over a $1 billion.

Q: Looking ahead, what are Alkermes’ greatest challenges?
A: In the near-term, we’re focusing on the execution of this year’s agenda. We’re rapidly expanding our manufacturing capacity, not just for Risperdal Consta but also for Vivitrol. Our priorities are, essentially, making the drugs and executing on the sales process. Long term, we will be making decisions for our portfolio about what to develop next. Our ability to make prudent choices will directly drive Alkermes’ growth.