Biotechnology company Trimeris (NASDAQ:TRMS) was popular in early 2003, leading up to the approval of Fuzeon, its drug treatment for HIV. But the past year has not been kind, and the stock is down more than 70% from its high. Considering that most biotech stocks have been soaring, Trimeris' decline is shocking, especially since it just launched a drug.

Pre-approval enthusiasm
Before Fuzeon was approved, the drug was generating considerable excitement. It is the first in a new class of drugs called HIV fusion inhibitors. Since it works by a different mechanism from other approved HIV drugs, it offers new hope to patients who have developed resistance to other therapies. Also, the clinical data on Fuzeon combined with standard drug cocktails was very encouraging. From a scientific and medical standpoint, there was no doubt that Fuzeon was a clear winner.

Given Fuzeon's clinical success and the need for effective HIV drugs, expectations were that the drug was going to quickly turn out to be a blockbuster for Trimeris and its marketing partner, Roche. For example, this article from late 2002 cites sales estimates from a sell-side analyst of $106 million in 2003 and $431 million in 2004. And those estimates were downward revisions. Another estimate came in at $185.8 million for 2003 and $392.5 million for 2004.

With those kinds of sales numbers floating around, it is no wonder Trimeris had a market cap close to $1.2 billion before recording a single sale.

Post-approval disappointment
We can now see that the initial sales estimates are not going to be attained. Worldwide sales in 2003 were just $35.9 million. In the first quarter of this year, sales totaled $24 million. For all of 2004, I estimate sales in the range of $110 million to $130 million. That's not terrible, but since it is a fraction of what was expected, the company's valuation has had to adjust from speculation to hard reality.

One big issue causing a slow uptake has been pricing. At a cost to the patient near $20,000 per year, Fuzeon is three times more expensive than any other HIV drug. Some of the reasons for this high cost are discussed in this article from CBS News. Due to the cost, government-funded health providers such as AIDS Drug Assistance Program simply do not have the budget to cover Fuzeon for all of the patients who need it.

Another difficulty is that Fuzeon is not patient-friendly. Proper use requires subcutaneous injections twice a day. Other HIV drugs are taken orally in pill form.

The relationship with Roche
With strong sequential sales growth in Q1, it appears that Fuzeon is getting on track. However, due to Trimeris' commercialization arrangement with Roche, the benefit to the company may be minimal for some time. Trimeris states in its 2003 10-K that the company expects 2004 revenues from Fuzeon to total $14 million to $17 million. That's not much, and it is worth investigating the difference between the total product sales and how much of that will fall to Trimeris.

In 1999, Trimeris and Roche reached an agreement to develop and market Fuzeon and a follow-up drug, T-1249. Under the terms of this arrangement, the two companies will equally share the profits and losses in the U.S. and Canada. Roche has the marketing rights for the rest of the world and pays Trimeris a royalty.

I'll start with the worldwide sales. I have not seen a specific disclosure of the exact royalty structure in the company's SEC filings, but from looking at the reported ex-U.S. sales and the royalties recorded by Trimeris, it appears that the rate is close to 10%. That's not bad. More important, the payment of a royalty off of net sales means that each dollar in sales makes a direct contribution to revenue growth and decreases Trimeris' losses.

The equal profit sharing in the U.S. and Canada sounds fantastic and seems like a much better deal than the 10% royalty on worldwide sales. There is nothing inherently wrong with profit-sharing arrangements as the upside is potentially higher than the typical royalty-based deals. However, the key word is "potentially."

For a profit-sharing collaboration to be lucrative, there needs to be a profit made on the sales of the drug. In the North American markets, cost of goods and the selling and marketing expenses are subtracted from net sales to arrive at the operating income or loss. If the expenses are greater than the sales, Trimeris and Roche split the loss.

This is the crux of the problem for Trimeris. Despite what appears to be solid growth for Fuzeon this year, Trimeris may receive only a token amount due to the expenses they must bear as part of the collaboration. Even with a profit-sharing arrangement, the company may actually receive less than the 10% they get from worldwide sales.

Profit-sharing arrangements can be great if the drug is profitable. However, below that sales threshold, the company is stuck with nothing. To address this issue, Trimeris does have an agreement with Roche that limits Trimeris' share of the marketing expenses to $10 million this year, with the payment of expenses over that amount deferred to future years. Even so, whether the U.S. sales are cash flow positive for Trimeris this year remains to be seen.

The Foolish bottom line
In January, Trimeris and Roche put a hold on the clinical development of their second HIV fusion inhibitor, T-1249. This leaves Trimeris without a single drug in clinical development and makes the company highly dependent upon Fuzeon to attain profitability. Due to the opaque nature of the expenses within the profit-sharing arrangement, it is difficult to estimate the sales level that will allow for Trimeris to receive enough revenue to turn a profit. At this time, I estimate that total Fuzeon sales of at least $250 million to $300 million would be needed for Trimeris to reach profitability.

Trimeris serves as a valuable lesson to biotech investors. Expected sales for a drug are often priced into a stock prior to approval. This is especially the case if the drug looks to be a clear advance in treatment, as is the case with Fuzeon. If the anticipated sales do not materialize, the stock can get punished severely.

Have your own take on Trimeris' prospects? Let's hear 'em on the Biotechnology discussion board.

Fool contributor Charly Travers does not own shares of any of the companies mentioned in this article.