Alkermes (NASDAQ:ALKS) recently surprised investors with disappointing news: the Food and Drug Administration's refusal to review its lead drug candidate. The decision casts a shadow over the future for ALKS-5461, a once-promising drug for major depression. Will Alkermes be able to convince the FDA to change its mind?

In this episode of The Motley Fool's Industry Focus: Healthcare, analyst Kristine Harjes and Motley Fool contributor Todd Campbell break down Alkermes' bad news and offer insight into what could happen next.

A full transcript follows the video.

This video was recorded on April 4, 2018.

Kristine Harjes: A stock that's covered frequently on fool.com but hasn't made its way onto Industry Focus until now, Alkermes, the ticker is ALKS, received a refuse to file letter on Monday regarding their drug ALKS 5461 for major depressive disorder. This is not a good look for the company. A refuse to file letter is not a rejection, but rather the FDA handing back the application to a company and saying that they can't evaluate it in its current state. How did Alkermes mess this one up?

Todd Campbell: It's like a slap on the wrist, really. It's like, "You submitted this to me? I'm not going to look at this. This is not the report that you were supposed to submit." We're talking about an antidepressant drug. And I want to thank Alkermes for not creating some weird crazy generic name we're going to struggle to pronounce. 5461 is so much easier, right, Kristine?

Harjes: Yeah, it's so awkward, though. 5461.

Campbell: [laughs] We're talking about a major depressive disorder drug, MDD drug. It's a multibillion-dollar indication, and there really hasn't been a tremendous amount of innovation in this space. And there's a big unmet need, because frankly, there's a lot of people who suffer from conditions where antidepressants are prescribed, and roughly one-third of those patients don't respond to the existing treatment options that are out there.

So, 5461 was considered in trials for use as adjunctive therapy. So, if you fail to respond to these other existing treatments, maybe you could then go and take 5461. One of the things that I think investors should recognize is, maybe this isn't so surprising, because typically what the FDA likes to see is three trials with two of them succeeding. There's usually a very high placebo effect in depression trials, Kristine, so it's kind of expected that you're not going to get all three to succeed. But in the case of Alkermes' 5461, it actually only passed the efficacy hurdle on one of the three.

Harjes: Right. Back in 2016, it failed to meet the endpoints in two of these Phase III trials. So, for a while, it didn't look like this drug was really going anywhere. But optimism was renewed based on this third trial. I'll also point out, that caused Alkermes' expenses to swell, because they seemed to really anticipate that this one trial would be enough for the FDA to accept the application and then, hopefully, grant approval for this drug. So now, that timeline has completely shattered.

Campbell: Yeah. I think what they were hoping for was, there's a slightly different study design between the first trial that failed and the third trial, which succeeded. And basically, what they did is, if you failed to respond on placebo, you were rerandomized in the trial. The idea was to try and tamp down on the high placebo effect that you sometimes get in these depression trials. And I think maybe that raised some question marks.

It may also be that, despite the fact that this was studied in over 1,000 patients, so they had a pretty robust amount of safety information they could provide to the FDA -- even if they didn't necessarily have the efficacy from all three trials, they had all that safety information -- there could still be some concerns from the FDA regarding the fact that one of the two active compounds in 5461 is buprenorphine, which is an opiate agonist. So, you have some concerns, perhaps, about what the potential is for risk of abuse. Alkermes has to meet with the FDA and sit down and actually talk to them and figure out exactly what the FDA's concerns are. But one of the things they did say in their press release was, it sounds like they want some bioavailability data on buprenorphine in patients. So, perhaps they're just wanting to make sure that there's no concern there. That and, of course, it appears they want an extra trial to back up that efficacy finding.

Harjes: Yeah. Management sounded a little bit incredulous about this. They seemed to not really understand what the FDA was asking of them and why it was coming now. They spoke to the long history of development of this drug and the rest of Alkermes' drugs. And basically what they said, it doesn't make any sense that the FDA would do this now. This management team is clearly a little bit embarrassed by the refuse to file, and rightly so. And they're not really providing a lot of clarity on what exactly the FDA is asking for. And I don't know whether that's because the FDA hasn't provided that clarity yet, or if it's just management reacting a bit harshly to this news. But, all that is to say, it's not quite clear where exactly the company is going with this particular drug from here.

Campbell: Yeah, there's some egg on the face here. I think their expectation was, the FDA has suggested it's more willing to consider novel trial designs and, I don't want to say set the bar lower, because that's not necessarily the case, it's not like they're trying to approve unsafe drugs, but maybe a more willing FDA. And I think maybe they got caught a little bit off guard by that.

One of the things you'll have to remember as a listener is, usually you'll have a type A meeting that follows the refusal to file. That should occur within the next 30 days. So, I would imagine, the next time they have an investor conference or presentation on the website or whatever, you might want to tune in if you're an Alkermes shareholder and see if there's any update on that from that type A meeting.

It's going to be interesting to see what they do now, because these trials are necessarily quick. It's not like they can get this done within three months. And one of the things that is questionable, what do they want to do with this drug? Are they going to continue to spend money on it, hoping for another positive efficacy readout when they had two that failed? The odds seem pretty high for a failure in running another one. And the competitive landscape is going to shift a little bit, too, Kristine, because Johnson & Johnson has a drug for treatment-resistant patients in Phase III trials that should read out data this year and theoretically could go to the FDA this year.

Harjes: Yeah, that could completely change their competitive advantage. One thing that you mentioned that I want to go back to is this broader question of, how lenient should the FDA be, because this refuse to file letter kind of speaks to the way the FDA is thinking about the approval process. I feel like there's been a lot of scrutiny lately, especially with the change in administration, about how the FDA should consider atypical trial designs and stuff like that. You can see that there are other companies other than Alkermes that reacted to this news, because they're maybe considering a somewhat novel trial design, or even just other companies that are working in the same space. For example, Intra-Cellular Therapies sold off about 7%, I think it was, on the news, because they're also working on a central nervous system drug, it's a schizophrenia drug. Because that might be similar to what Alkermes is doing with their drug, there was a little bit of investor fear that maybe the FDA won't be as accommodating as people had previously thought.

Campbell: Yeah. I think, Kristine, another takeaway for listeners might be that, just because you might have one positive Phase III readout, don't assume that's going to be enough to get you across the FDA finish line. I think we sometimes forget that as investors. We see positive Phase III data and we immediately take the leap and think, "Ooh, commercialization opportunity. In 10 months the FDA will say OK, and this will be on the market, bringing all sorts of bucks in for the company." You need to really do your due diligence and do your homework and look back at all the trials that were done, make sure there weren't failures to go alongside with the successes, and take the management's comments with a little bit of a grain of salt, because as you alluded to, management was pretty bullish about their submission to the FDA. And that might have, unfortunately I don't want to say "misled," that's not the right way to phrase it, but it may have informed investors in a way that maybe investors shouldn't have been informed.

Harjes: Exactly. Before we wrap up, I think we should speak a little bit about what else is going on with Alkermes, because this is not a one-drug company. They have several drugs that are already on the market, and they do have a wider pipeline. Todd, I'm curious to get your thoughts on the company as a whole.

Campbell: I've actually been a fan of this company. I like the company. They've shown that they know how to help develop drugs. They get a lot of royalty income. They've been involved in some other really popular multi-billion-dollar drugs and the development of them. I think they'll bounce back from this. I just don't know where they're going to go with 5461 from here.

So, I think, from an investing standpoint, maybe wait on the sidelines here, see how this all washes out, see what happens with the type A meeting, and then make a decision of whether or not the stock has been beat up enough to whether or not it warrants going out and picking up some shares.

Kristine Harjes owns shares of Johnson & Johnson. Todd Campbell has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Alkermes and Johnson & Johnson. The Motley Fool has the following options: short May 2018 $140 calls on Johnson & Johnson. The Motley Fool has a disclosure policy.