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Executive Summary

Biocraft Labs, buoyed by approvals for four generic drugs and a bulk antibiotic production facility, was the hottest stock in a reviving generic drug sector during the first quarter of 1992. Biocraft closed March 31 at 23, up 6-3/4 (41.5%) since Dec. 31. The stock made the gains in two distinct jumps. When Biocraft announced on Jan. 16 that FDA had approved its Mexico, Missouri plant to manufacture bulk cephalexin (Lilly's Keflex), the stock climbed from 17 to over 20 within a week. The issue hovered at 20 until Biocraft received its first ANDA approvals in two years, with a total of four drugs clearing FDA between Feb. 27 and March 2. Biocraft shares shot as high as 26-1/8 on March 4 before sliding back to 23 by the end of the month. Biocraft was one of just five pharmaceutical firms tracked by the "F-D-C" index of NYSE and AMEX stocks to show gains during the quarter. Two other generic firms, Barr and Pharmaceutical Resources, joined Biocraft on the plus side. Wedbush Morgan, William Blair, and Merrill Lynch all issued "buy" recommendations for Biocraft between Feb. 4 and 6. The analysts estimated that by producing bulk cephalexin in-house, Biocraft could save between $5 mil. and $10 mil. per year in manufacturing costs. Moreover, they suggested the new facility demonstrates that Biocraft will be a major player in the generic Ceclor market. Lilly has maintained that its process patent on Ceclor (cefaclor) should stave off generic competition until 1994; Biocraft said a year ago that it believes that it will be able to market a generic Ceclor upon expiration of the basic patent this year. "Regardless of whether Biocraft chooses to confront Lilly before 1994," Merrill Lynch's R.R. Vietor said, the new plant ensures that cefaclor will "become a very important earnings contributor to Biocraft down the road." Future Biocraft earnings from pending ANDAs for at least 15 drugs, including a generic version of Marion Merrell Dow's Carafate (sucralfate), also generated considerable market enthusiasm. Investors, however, still faced uncertainty regarding Biocraft's manufacturing difficulties which had prevented the company from receiving any ANDA approvals since early 1990. That uncertainty was resolved when Biocraft was informed by FDA in February that its New Jersey facilities were considered to be fully in compliance. The firm reaped four quick approvals: for baclofen (Ciba-Geigy's Lioresal), metaproterenol (Boehringer Ingelheim's Alupent), cinoxacin (Lilly's Cinobac), and minocycline (Lederle's Minocin). Biocraft was not the only company to put compliance problems behind it in the first quarter. Able Labs, Alra, Biopharmaceutics and West-ward all announced resolutions of actions taken against them by FDA. Barr Labs, whose shares dropped sharply at the end of 1991 due in part to concerns about its compliance status, recovered somewhat in the first quarter. Barr was up 2 to 19-5/8 as investors bet that its regulatory difficulties would be satisfactorily resolved. Barr continues to trade well below its 1991 high of 37-1/2, however. Bolar (down 2-1/4 to 11-1/4) and Pharmaceutical Resources (up 1-3/8 to 6-1/4) both maintained relatively high valuations as they continued to deal with outstanding legal actions resulting from fraudulent ANDA submissions. Pharmaceutical Resources, the parent firm of Par, successfully completed the sale of its troubled Quad subsidiary during the quarter. Investors continue to value Bolar's 50% share of the Somerset Pharmaceuticals joint venture with Mylan for Eldepryl. Mylan, one of the firms benefiting the most from accelerating ANDA approvals in the first quarter, ironically closed off 9% on a decline of 3-3/4 to 37-7/8. FDA approved a total of 68 ANDAs in the first quarter, including 28 in March, the best one-month total since 1989 (see related item, p. 4). After trading as high as 43 on Jan. 10, Mylan began a two- month slide in valuation which even the news of an approval for a generic atenolol (ICI's Tenormin) failed to arrest. By Feb. 21, Mylan had lost over 10 points, dipping below 33. Kidder, Peabody's J. E. Flynn issued a "buy" recommendation for Mylan on Feb. 24, arguing that the generic atenolol could fuel 35% sales growth for the quarter. Moreover, new indications for Eldepryl, including early-stage Parkinson's and possibly Alzheimer's, could make sales "pick up substantially" by mid- decade, Flynn suggested. Finally, Mylan's acquisition of Dow B. Hickam in October gives "a third way to win" with Mylan, with additional proprietary products and a hospital sales force, Flynn said. Flynn's comments on the outlook for Mylan's generics typify the Street's attitude toward the industry as a whole: "With the scandal having reduced the number of operational generic drug companies, one third of all drug revenues coming off patent in the next five years, and a managed health care environment led by mail service pharmacies and HMOs sweeping the nation, we don't believe there will be a better time for Mylan's generic business." Mylan rebounded to 35 by March 13. On March 16, Mylan received the first tentative approval for a generic diltiazem (Marion Merrell Dow's Cardizem, which comes off patent in November). The late March approval of Mylan's ANDA for gemfibrozil (Warner- Lambert's Lopid) could help Mylan carry its momentum into the second quarter. Overall, the strength of generics could not substitute for brandname firms: all components of the "F-D-C" index declined for the three months. Beginning in mid-January, investors moved away from the drug stocks that had fueled the market's rally in 1991 and into "cyclical" stocks likely to benefit from the end of the recession. Thus, while stocks in the auto and housing industries boomed, the "F-D-C" index plummeted 12%. The pharmaceutical component dropped 13.7%, diversifieds were down 8%, chains were off 4.2%, and wholesalers declined 2.4%. In contrast, the Dow Jones Industrial Average was up 2.1% for the quarter. The S&P-500 declined 3%. Among brandnames manufacturers, it didn't seem to matter how good the news was during the quarter. Merck, for example, launched its follow-on cholesterol-lowering agent Zocor in January. In February, the company gained an approval recommendation for the benign prostatic hyperplasia treatment Proscar, projected by some analysts to be the company's next billion-dollar-plus product. The stock nevertheless lost 19-3/8 to close down 11.6% for the quarter at 147-1/8. Pfizer launched the antidepressant Zoloft and the azalide antibiotic Zithromax in the first quarter, secured approval for the antihypertensive Minipress XL on Jan. 29, and reported in February that the calcium channel blocker Procardia XL had taken over the number one slot in the U.S. cardiovascular drug market. Pfizer shares declined more than 17%, losing 14-1/2 to close at 69-1/2. Continuing reservations about liability fallout from Pfizer's Bjork-Shiley heart valve problems may have tempered investor enthusiasm for the stock. Oppenheimer & Co. analyst Steven Gerber, MD, summarized the Street's opinion of Pfizer in a Feb. 19 report: "Pfizer's drug business remains highly attractive," he said, but "heart-valve liability concerns remain the principle investment negative...We remain skeptical that settlement will be achieved easily and expect continued negative publicity on this issue throughout 1992." Alza shares fell 7-3/8 (15%) to close at 41-3/4 despite a royalty boost for Procardia XL: the drug delivery company's royalty rate on the drug will increase from 4% to 7% this year. Initial acceptance of the Marion Merrell Dow nicotine patch Nicoderm has also exceeded expectations. Alza is apparently having difficulty keeping up with the accelerating demand.

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