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Tuesday, July 13, 1999

An Investment Opinion
by Warren Gump

Amgen shouts S-U-C-C-E-S-S

Reaction to excellent news flowed into Amgen (Nasdaq: AMGN) stock today as the stock spliced a $6 gain to $72 5/16. Yesterday after the close, the company announced Q2 earnings per share (EPS) of $0.50, up 22% from the prior year and $0.04 ahead of expectations. In addition to strong revenue and profit growth, the company surprised investors by announcing that it expected to file for approval of IL-1ra, an experimental drug for rheumatoid arthritis, prior to the end of the year. With this product moved to late-stage development, Amgen has increased the likelihood for more rapid growth and a broadening of its two major-product portfolio.

Before discussing the important research and development (R&D) announcement, let's take a look at operating results for the quarter. Amgen's strong R&D pipeline is, in part, attributable to the fact that current products have generated lots of cash, which has been plowed into new pursuits.

Revenue from anemia drug Epogen, Amgen's top seller, increased 27% to $428 million as more patients used the drug and average doses increased. Sales growth for the rest of the year will likely slow down a bit, since this figure has been boosted over the past four quarters by the recision of some restrictive government reimbursement policies. Despite facing tougher comparisons, Amgen still looks for sales to increase in the mid-20% range for the whole year. Last April, the company forecasted growth somewhere in the low-20% area.

Neupogen, a chemotherapy treatment, also had a robust quarter. Revenues reached $304 million, a 12% increase over the similar 1998 period. The sales increase was attributable mostly to higher usage rather than increased prices, indicating that the market for the drug remains fundamentally strong. Amgen now expects Neupogen sales to rise in the high single- to low double-digit range, compared to expectations for high-single digit growth earlier this year.

Including partner and royalty revenues, Amgen's quarterly sales grew 25% to $820 million. Gross product margin increased slightly to 86.6% from 86.3%. Operating margin, what's left in the company's coffers after paying regular business expenses except interest and taxes, increased slightly to an eye-popping 44%. If the company hadn't boosted R&D expenses 27%, that operating margin would have been appreciably higher.

With sales projections for both of its major products raised, you probably won't be surprised to learn that earnings expectations for the entire year were also increased. Amgen now sees earnings falling "at the high end" of $1.90-$1.95, up from a forecast of $1.80-$1.85 three months ago. Assuming the figure ends up being, say, $1.93, the company will experience an earnings improvement of 18% for the year. While impressive in its own right, that growth is even more amazing when you consider that Amgen will boost its research and development spending -- all of which is charged against earnings immediately -- by over 28% to $850 million.

While the earnings news was great, information about the R&D pipeline was even better: Amgen announced that due to the successful results from two large-scale Phase II trials of IL-1ra for rheumatoid arthritis, the company was going to skip Phase III testing and seek Food and Drug Administration (FDA) approval by the end of the year. This decision is based on discussions between Amgen and FDA personnel, who have indicated that Phase III trails are unnecessary.

Most people weren't paying much attention to IL-1ra since it appeared to be far away from approval. (Phase III testing usually takes well over a year, after which a drug faces the sometimes-lengthy FDA approval process.) Besides still being in the middle testing stage, the IL-1ra compound also had bad karma since it didn't successfully make it through sepsis trials several years ago. From what I understand, the testing done for sepsis turned out to be a hidden benefit, since results form those tests reinforce data from the recent Phase II trials that IL-1ra has minimal side effects.

The potential market size for IL-1ra is difficult to ascertain since Amgen won't release data from its second Phase II trial until November. We do, however, know that Enbrel, Immunex's (Nasdaq: IMNX) rheumatoid arthritis drug, is projected to reach sales of $1-$2 billion in the next few years. As more studies are released and likely approved uses become clearer, estimates about market size for IL-1ra should become clearer. CS First Boston analyst Alex To guessed that the drug could have sales of $300- $500 million.

Of course, in the drug business, you can never count your eggs before they hatch. Problems that emerge in late-stage testing or the FDA approval process can quickly derail even the best laid plans. That being said, Amgen now has four drugs for which it might be able to seek approval in the next couple of years. In addition to IL-1ra, the company is testing NESP, an extended-release version of Epogen; Abarelix, a potential prostate cancer treatment; and SD-01, a sustained duration form of Neupogen.

Demonstrating the uncertainty associated with developmental drugs, Amgen yesterday announced that it was going to expand the number of patients in Phase III trials for Abarelix, which will push back the expected FDA filing date to late 2000. When Amgen acquired rights to this drug earlier in the year, the company expected to make such a filing late this year. Setbacks like these are normal and should be expected to occur occasionally when dealing with drug research. One benefit (some would say drawback) of investing in a company with a broad pipeline is that each individual drug has somewhat less importance to the health of the overall company.

Amgen seems to be in the sweet-spot of the prosperity cycle. The success of its existing drugs is enabling it to spend more on new drug development. These new compounds, in turn, should lead to even more revenue that can allow even higher R&D expenditures, starting the cycle once again. What a nice place to be.

While it is impossible to predict the ultimate outcome of a drug development pipeline, Amgen now has the most promising group of experimental drugs in its history. At the same time, its core business continues to successfully climb the challenging mountain of continually increasing sales and earnings. The combination of these two forces will likely lead to more good news in the years ahead. Although Amgen stock will be volatile as information on lawsuits, drug sales, and research and development issues is promulgated, I personally think it is hard to find a stock with better long-term prospects.

Call Your Boss a Fool.

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