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Not All Strategic Transformations Are Elite, But This One Is
January 2020 Elite Pharmaceuticals, Inc. (ELTP), Includes: ATNX, LCI
StrategyDoc
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Summary:
An inflection point in the opioid abuse scandal was the basis for Elite Pharma to pivot from pain meds to the development of a newly focused portfolio of generic drugs.
The pivot “changed the game” as it enabled Elite to develop and gain FDA approval for two CNS drugs that compete in markets with annual sales of $2 B.
Elite is on track to become profitable for the first time; a goal unattained by many small pharmaceutical and biotech companies with high-flying share prices untethered to their business realities.
Having once traded on the AMEX at $20 per share and viewed as an innovative company with a novel technology designed to aid in developing controlled release and abuse-resistant opioids, the competitive environment dramatically changed for Elite Pharma (OTCQB:ELTP). Ultimately, their share price dropped into the pennies, as their once-promising future lay in tatters. Relegated to the OTC and its isle of misfit investors, Elite needed more than a comeback, the company needed a strategic transformation.
As long understood in business, the competitive environment is the most powerful driver of the need for strategic transformation, which demands more than a change in senior management, adding a new supplier or customer, or simply improving the way things are done. A strategic transformation is far more complex and requires re-evaluating the entire value chain to better enable a company to engage in new and different approaches to competing in markets. This involves making big, innovation-driven commitments that move the company away from earlier positions towards those that align the business capabilities with competitive opportunities in ways that transform the company from a loss-making business to a profit-making business.
Business transformations are not quick fixes resulting from the discovery of brilliant strategies that emerged spontaneously or overnight. Rather, transforming a business is hard work that takes patience, time, commitment, and leadership.
In understanding these things, I can say Elite Pharma is a transformed company; one that survived the threat of bankruptcy and is now fast approaching the ultimate goal of every business – profitability.
Allow me to elaborate.
Background
In 2013, Elite had managed to avoid bankruptcy and hired a new CEO with more than 30 years of big pharma experience. Nasrat Hakim was brought in to get the company back on track and he added new senior leadership with extensive pharma experience to help take products from the development phase to approval. Mr. Hakim also brought with him 12 approved generics from his private company, Mikah Pharmaceuticals, to add to the growing product portfolio.
Things seemed to be moving in a positive direction, as noted in two articles about the company, one in September and the other in December of that year. The common thread of both articles was that Elite, a small pharmaceutical company with new leadership, was on the verge of entering the then fast-growing opioid pain medication business based on a proprietary technology that would focus on controlled release and abuse-resistance-technology for opioids. This was important given the demographic changes across the U.S. and the globe.
According to the U.S. National Institutes of Health, America’s 65-and-over population is projected to nearly double over the next three decades, from 48 million to 88 million people by 2050. By 2030, one in every eight of the Earth's inhabitants is expected to be 65 years of age or older.
This matters because the elderly, in order to improve their quality of life, are making choices that are, among other things, leading to increased surgical procedures. Since 2011, in the U.S. alone, the number of hips and joint replacements increased 6.2 times and, combined with an increase in oral/dental surgeries, contributed to the demand for pain medications. Further, the number of Americans experiencing chronic pain is estimated to be 11.2% of the adult population because, as people age, they become more likely to have arthritis and other degenerative diseases that are painful but not life-threatening. Subsequently, opioids are commonly prescribed when the pain becomes debilitating.
Based on these realities, it is understandable that Elite might have concluded it was in the right place, with the right technology, to create the right drugs, for the right price, at the right time.
But then, the context changed.
Deaths related to opioid abuse increased eight-fold since 2000, spiking in 2017 to about 49,000 (which is roughly 68% of the 72,000 deaths related to all drug overdoses) and beyond the tragic loss of life are other costs…
Taking into account the staggering costs associated with criminal justice, treatment and loss of productivity, we estimate that the real cost of America’s drug epidemic exceeds $1 Trillion.
Kumar Cidambi, CEO of the Center for Network Therapy, New Jersey’s first licensed outpatient facility for the treatment of all substances of abuse.
As the National Institute for Drug Abuse noted, this led to the socio-political-legal-regulatory pressures on the pain med markets and with it new federal oversight guidelines from the Centers for Disease Control, actions by government law enforcement, and decisions by healthcare providers, all of which were designed to limit opioid prescriptions that might lead to abuse.
Although well-meaning, these actions had an unexpected consequence, as legitimate pain patients have come to feel humiliated, degraded, shamed, and stigmatized by the loss of choice over their physicians and their corresponding program of care. Further, as research by the U.S. National Institutes of Health noted, there have been unfortunate and unintended consequences. In fact, patients struggling with legitimate pain and unable to find prescribers willing to risk sanctions threatened by the government have chosen to end their own lives.
Adding to the external pressures for pharma companies attempting to sell abuse-deterrent opioid pain meds were questions about the cost of abuse-deterrent drugs. As this ICER report concluded, the cost of abuse-deterrent opioids is too high and would need to be cut by at least 40% to make them cost-neutral. In the meantime, the now cautious healthcare providers were not prescribing abuse-deterrent opioids because they do not believe their patients, many on fixed incomes and sensitive to pricing, were at risk of abuse or the diversion of their pain medications.
Fortunately, whether its foray into pain meds was nascent or too small to matter, Elite managed to avoid being caught up in the litigation that is playing its way across the country and has engulfed many notable names: Johnson & Johnson (JNJ), Pfizer (PFE), Teva (TEVA), Mallinckrodt (MNK), Mylan (MYL), as well as distributors like McKesson (MCK); not to mention the biggest producer of opioids, privately-held Purdue Pharma; which finds itself on the precipice of bankruptcy.
Perhaps the “coupe de' grace” for Elite's effort to further pain med development might have been the receipt of the July 2016 FDA complete response letter for their novel immediate release abuse-deterrent opioid, SequestOx, that had been given a Priority Review by the FDA. However crushing at the time, the FDA rejection might have enabled Elite to dodge litigation.
Still, while avoiding litigation was great, the net result appeared to leave Elite with a limited product portfolio and the prospects of continued sunk costs that might achieve nothing; other than to find themselves once again facing potential bankruptcy.
Elite needed to undertake a strategic transformation. The question was how.
Strategic Partnerships
Elite has been a small generic drug company with annual revenues that averaged less than $8 M for a few years. Although possessing manufacturing capabilities, Elite has been selling small-market drugs, assisted by their privately-held partner TAGI, which sells four products for Elite that includes Naltrexone tablets, an opiate antagonist used in the treatment of addiction.
Still, it remains that Elite was steadily losing money. While losing money is not exactly novel for many small and developing drug companies, the impact of the opioid abuse scandal and the incumbent issue of the cost-effectiveness of abuse-deterrent opioids raised questions of the viability of Elite’s product portfolio that made for a simple but compelling choice – transform or die.
While it is often difficult to identify when or if transformation begins in a company, that was not the case with Elite. Unquestionably, Elite’s strategic transformation began with the SunGen Pharma partnership…
August 29, 2016, one month after the FDA complete response letter for SequestOx, Elite announced the inception of the SunGen partnership that was created to develop a range of products, including Central Nervous System stimulants. The two companies would share costs and revenues, with Elite enjoying the benefit from off-the-top fees due to their manufacturing capabilities.
As is true of early transformational steps, the benefits of the agreement were not immediate but unfolded over time.
May 30, 2017, Elite and SunGen announced they had achieved positive top-line results from a pivotal bioequivalence study for an undisclosed generic drug that was expected to be the first of four generics under co-development.
January 10, 2018, Elite and SunGen reported positive topline results from pivotal bioequivalence studies conducted for an undisclosed extended-release generic product with an IQVIA product market of about $1.6 B.
February 8, 2018, Elite and SunGen announced they filed with the FDA an Abbreviated New Drug Application for a generic version of an immediate-release CNS stimulant with a market reflecting annual U.S. sales of about $400 M. This was the first FDA filing for a product co-developed.
May 30, 2018, Elite and SunGen announced they filed with the FDA a generic version of an extended-release CNS stimulant; which represented the second product co-developed with SunGen Pharma and, according to IQVIA, has annual U.S. sales of about $1.6 B.
August 14, 2018, Elite and SunGen reported positive topline results from pivotal bioequivalence studies conducted for an undisclosed generic immediate-release antibiotic with an IQVIA market value of about $110 M.
October 23, 2018, Elite and SunGen reported positive topline results from pivotal bioequivalence studies conducted for a second undisclosed generic immediate-release antibiotic with an IQVIA market value of about $70 M.
December 10, 2018, Elite and SunGen announced they had received FDA approval for immediate-release generic Adderall, the drug filed February 8, 2018, that has an annual U.S. market of about $400 M.
January 3, 2019, Elite and SunGen announced they had filed an Abbreviated New Drug Application for a generic antibiotic product with annual sales of $94 M.
March 11, 2019, Elite and SunGen announced they had entered a strategic alliance with Lannett (LCI) to launch the generic version of immediate-release Adderall approved by the FDA on December 10, 2018.
December 12, 2019, Elite and SunGen announced they had received FDA approval for an extended-release generic of Adderall ER, the drug they had filed May 30, 2018, with IQVIA estimated annual U.S. sales of about $1.3 B. (This drug will also be launched through the Lannett partnership.)
If you are doing the math at home...
Counting the $1.7 B markets for the combined FDA approved CNS generics, as well as the pending approvals for two generic antibiotics, the SunGen partnership will enable Elite to compete in U.S. drug markets totaling about $2 B in annual sales.
Impressive, but that is not all of Elite’s drug development efforts. On its own, Elite has created additional revenue-producing opportunities and has received FDA approvals and launched drugs with prospective markets of more than $40 M.
August 6, 2018, Elite received FDA approval for generic methadone; which is indicated for the management of pain severe enough to require daily, around-the-clock long-term opioid treatment and for which alternative treatment options are inadequate. Methadone can also be used for the maintenance treatment of opioid addiction (heroin or other morphine-like drugs) in conjunction with appropriate social and medical services.
November 5, 2018, Elite announced it had launched its generic Methadone; used for opioid addiction and it will be launched through their partnership with Glenmark (OTC:GLKQY). The drug has a product-market of about $34 M.
June 28, 2019, Elite announced it had launched generic Dantrolene through its partnership with Lannett, which has a U.S. sales market about $6.4 M.
September 12, 2019, Elite announced it had received FDA approval for generic Tylenol with codeine.
However, the development and approval of drugs cannot be translated into revenues without the ability to market and sell the products to a diverse group of consumers. This was a competency that extended beyond Elite’s organizational capabilities and, because developing such a capacity is both costly and time-consuming, the decision was made by Elite to seek partnerships with mature, experienced companies that had a long-standing capacity for commercialization.
Consequently, Elite entered into agreements with Glenmark and Lannett, with whom the commercialization effort began in earnest, as noted in Q1 2020 when Elite reported revenues of $3.4 M; 55%, higher than those of Q1 2019.
Building on the first-quarter results, Elite announced Q2 2020 revenues were $4.6 M, an increase of 240% over Q2 2019; an increase the company attributed to the revenues of the generic immediate-release Adderall and Dantrolene, along with continued growth in Naltrexone sales.
Revenues matter and it is important to recognize that Elite's combined revenues through Q1 & Q2 2020 are more than their entire annual revenues for either fiscal year 2019 or 2018. Moreover, as noted by Elite's CFO on the Q2 2020 conference call, the increase in revenues is largely due to Elite’s off-the-top fees, born of their manufacturing capabilities. However, the CFO indicated the full revenue picture lags some months at the start of commercialization. As a result, Elite expects the next two quarters will show significant increases beyond YOY comparisons and that the increases will result in record annual revenues that will enable Elite to become profitable before the end of fiscal 2020 (March 31, 2020).
What makes this strategic transformation a surprise for some is that Elite was initially denounced for partnering with SunGen, derided as a small "garage pharma” with no track record of success. However, having failed to do the necessary research, the willfully unknowing failed to understand that SunGen had been successful in a partnership with Athenex (ATNX). So, when the Elite-SunGen partnership received FDA approval for generic Adderall XR, it was the eighth FDA approval for SunGen. Hardly a "garage pharma."
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Furthering that partnership and extending the strategic transformation, Elite and SunGen are expected to file in early calendar year 2020 a generic CNS drug with IQVIA estimated U.S. market sales of more than $1.5 B.
Still, Elite’s revenues and the potential for becoming a profitable business needs to be viewed within the lens of how they are funding the company. While there may be hope that, as a profitable firm, Elite can fund their business needs; a mistaken assumption is that all profitable companies pay for R&D, operations and development as they go. This is not true. Most companies view debt as cheaper than equity, so they rather borrow money to fund business development opportunities (as a comparison, it is why consumers finance cars and homes).
So, let’s talk about funding and here is where the revenue increases and the move toward profitability come into sharper focus.
Funding the Business
Let’s get to the interesting part and fast forward to the 2019 Annual Report when Elite reported it had unrestricted cash balances totaling $2.6 M and had incurred losses and negative cash flows from operations, of $1.1 M and $1.9 M, respectively. In addition, overall working capital, defined as current assets minus current liabilities, decreased by approximately $1.1 M during the three months ended June 30, 2019.
Not a pretty sight and, based on the aforementioned, in the annual report Elite’s auditor determined there appeared to be evidence of a substantial doubt of its ability to continue as a going concern. To continue as a going concern and the logic behind the need for transformation, the auditor said Elite needed to do some or all of the following, without limitation: obtain additional financing, increase sales of existing products, bring additional products in the pipeline to market, and/or reduce expenses.
Unsurprisingly, too much debt can handcuff the opportunities for any business. As the 2008 recession highlighted all too well, debt leverage has its limits, as many business failures made clear. But that doesn’t mean all forms of financial leverage are a bad thing. For companies that fail to take advantage of financial leveraging, the ability to grow and compete in the marketplace may be significantly constrained. At the same time, overstepping boundaries of healthy business debt can be lethal. This reflects the yin and yang of business debt, which many companies struggle with on a regular basis.
However, as a small company, Elite's access to borrowed capital is limited and the cost of borrowing a threat. As a result, the decision the company made shortly after Nasrat Hakim become CEO in 2013 was to use Elite’s authorized shares as the means to access capital in a financial leverage process that amounts to self-funding.
In April 2014, Elite secured a funding commitment of up to $40 M from Lincoln Park Capital.
Under the terms of the agreement…
There are no upper limits to the price that Lincoln Park may pay to purchase Elite’s common stock. Elite will control the timing and the amount of shares to be sold. Lincoln Park has no right to require any sales and is obligated to purchase common stock as directed by Elite. Further, under the terms of the agreement, Lincoln Park has agreed not to cause or engage in any manner whatsoever, any direct or indirect short selling or hedging of Elite’s shares of common stock. In consideration for entering into the agreement, Elite has issued shares of common stock to Lincoln Park as a commitment fee and will issue additional commitment fee shares in proportion to the amount of shares purchased by Lincoln Park under the agreement.
Yes, using shares to pay for business operations means dilution. However, over the years, tapping into the authorized shares to access capital for product development and operations has enabled Elite to reach the cusp of profitability, while avoiding onerous debt. This is a business reality that is beyond reproach.
Still, the authorized shares available are not inexhaustible and, as noted in this 8k filed on April 28, 2017, Elite announced it had entered into an exchange agreement with Nasrat Hakim, Chief Executive Officer, under which the company issued to Mr. Hakim 24.0344 shares of their newly designated Series J Convertible Preferred Stock and Warrants in exchange for 158,017,321 shares of common stock owned by Mr. Hakim.
This exchange freed up common shares to enable Elite to fund development and operations through the Lincoln Park agreement.
However, the Series J agreement has an expiration date of April 28, 2020, and an exchange of the Series J for common shares would leave too few authorized shares to fund the company under the Lincoln Park equity agreement; the basis for the auditor’s going concern.
Needless to say, fixing the funding problem has been the primary focus of management and the remedy was to ask shareholders for an increase in Authorized Shares, from the current 995 M to 1.455 B.
As Mr. Hakim noted on the August 2019 Q1 2020 conference call:
In order to raise money, we have communicated with multiple banks and with Wall Street. Raising money through Wall Street is very expensive. The cost is very high. Of all the options we have had on the table, and all that we have experienced, and all the investors we met with, Lincoln Park Capital is the least expensive, least risky, least dilutive method for us to pursue.
Understandably, there was shareholder concern the increase in authorized shares would cause additional dilution. However, merely increasing authorized shares is not dilution; that would only occur when shares were sold to Lincoln Park Capital to raise funds for Elite's business operations. Consequently, for shareholders to consider an increase in authorized shares, the question for approving the increase was whether the shares had been used effectively.
If the past is prologue, the answer is simple. Over the course of the past three years, Elite had substantially transformed its product portfolio and, in so doing, substantially increased revenues and put the company on track for profitability by the end of fiscal 2020. Therefore, the request to increase the authorized share count was approved by Elite’s shareholders and announced at the shareholders meeting on December 4, 2019.
The Lincoln Park Capital agreement remains in place today and, while it may ensure access to additional funding as needed, as a profitable company with multiple products substantially increasing revenues, Elite now has choices not previously available. For example, they might avoid selling shares through the Lincoln Park agreement and find acceptably priced funding from the capital markets. Or, they might fund the business with increasing revenues. Whatever the choice, Elite does not have the financial problems that have sunk other small pharma companies with commercialized products but too much debt.
Whether Elite will remain a standalone company is a question for the future. However, shareholders should be aware that, in the event of Elite merging with another firm or being acquired, having little debt matters.
On any merger, the decision to merge is affected by the debt the merging partners must incur with the joined business. Thus, having very little debt is a factor in consideration for any prospective merger. Moreover, in the event of being acquired by another firm, debt is a consideration in any negotiated buyout, as it must be paid before shareholders receive the benefit of the buyout. It remains true that the price paid for a company is based on the value an acquirer sees in the company being acquired and is unaffected by the number of diluted shares outstanding.
Yes, the blindingly obvious is that the more shares outstanding, the lower the price per share. But the reality is an acquirer will only pay what they perceive to be the value of the targeted firm, in consideration of all debt; fully diluted shares notwithstanding.
In sum, what matters is that Elite’s management has acted as a good steward of its finances and made solid decisions that have enabled new product development and revenue generation, placing the company firmly on track to be profitable.
By the way, adding to its revenue growth, Elite announced on November 13, 2019, they had executed an agreement with privately-held Nostrum Laboratories Inc. to sell Nostrum all of its rights in and to Elite’s approved abbreviated new drug applications (ANDAs) for its generic Norco (hydrocodone bitartrate and acetaminophen tablets, USP CII) and generic Percocet (Oxycodone Hydrochloride and Acetaminophen, USP CII) for $600,000 in cash.
Moreover, Lannett will pay a milestone of $750,000 upon the commercial launch of the generic Adderall XR; which will be shared equally by Elite and SunGen, according to their agreement.
This means Elite will get another $375,000 to go with the $600,000 from Nostrum, adding almost $1 M to its increasing revenues and its march toward profitability.
Summary
No, Elite is not the company many invested in when they thought it would revolutionize the abuse-deterrent opioid market. For that, we can curse the socio-political-legal-regulatory changes that occurred in the external environment. But, under a positive version of the “law of unintended consequences,” Elite completed a strategic transformation for which investors can thank the management decisions that enabled the pivot from a narrowly focused product portfolio to one that is becoming well diversified. When revenues for the newly commercialized drugs begin to show up in the sales column (further enhanced by the recent FDA approval of generic Adderall XR), Elite will be generating an exponential increase in annual revenues expected to continue well into the future.
While management is strategically and operationally responsible for engineering this transformation, a certain amount of credit belongs to those shareholders who believed in the company and approved the increase in authorized shares. They did so because they recognized that self-funding enabled growth while avoiding potentially crippling debt. And, with that revenue growth, Elite is on the path toward profitability in 2020. This is something that did not seem possible in late July 2016.
What remains is for the much-maligned share price to catch up to the business realities made possible by Elite’s strategic transformation into a profitable company.
As was eloquently said by Douglas Adams, The Long Dark Tea-Time of the Soul, and is relevant to Elite…
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