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strategic report

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Gilead

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TEAM MEMBERS

Max Kroloff, Lead

John Wick

Charles Sander

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TABLE OF CONTENTS EXECUTIVE SUMMARY………………………...............................…….……………………..….1

PART I: INTRODUCTION COMPANY OVERVIEW…………………….……….………………………….……………..…..…..4

PART II: ANALYSIS FINANCIAL ANALYSIS………………………………………………………………………………….7

Liquidity and Solvency…………………….…………………………………..................7

Profitability and Turnover...……………….………….…………………………………..8

Accruals Analysis.......……………………….……………………………..………………9

Gilead vs. GlaxoSmithKline, Merck, and Bristol-Myers Squibb........................……9

COMPETITIVE ANALYSIS……………….…………………….………….…………………………..10 Internal Rivalry………..…..…………………….………………………………………...11

Entry/Exit Conditions.……………………………………………………………………13

Substitutes and Complements......…………….………………………………………..14

Supplier Power.…………………………………….……………………………………..15

Buyer Power.........…………….……………….….……………………………………….16

SWOT ANALYSIS..…………………………..…………………………………………………………17 Strengths……………………………..……….…………………………………………....17

Weaknesses………………………………….……………………………........................18

Opportunities………..……………………….…………………………………………....19

Threats……………………………………….……………………………........................20

PART III: RECOMMENDATIONS STRATEGIC RECOMMENDATIONS……………………………….……………………………….23

Challenges..............................………….……..………………………..………………..23

Maintain Dominance in HIV Market...……….………………………..……………….23

Narrow Focus on Expanding Drug Portfolio...............................…..……………….25

APPENDICES…………………………………..............................……………………….……….27

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CITATIONS....…………………………………..............................…………………….………...33

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EXECUTIVE SUMMARY Gilead Sciences is a biopharmaceutical company that has grown tremendously over the past decade mainly through its control of the HIV/AIDS market. It was only October 2001, when Gilead officially entered the drug market with its introduction of Vistide. Since then, the firm has commercialized three more HIV/AIDS treatments, which dominate its current drug portfolio consisting of fourteen drugs (see appendix). These treatments contributed over $6.5 billion of its nearly $8 billion in total revenue for 2010 (see appendix).17 Although this HIV/AIDS franchise has been incredibly successful, growth is slowing. As a result, Gilead must find new market segments to spur further growth while minimizing inherent risks to the drug industry such as patent expiration.

Gilead has already attempted to overcome this issue by acquiring smaller drug firms for the rights to their drug knowledge. More specifically, they acquired Myogen, Corus, CV Therapeutics, and CGI Pharmaceuticals in order to enter both the respiratory and cardiovascular areas, but results have been unsatisfactory. Consequently, the company is expanding further as it attempts to develop cancer treatments.

As it stands, Gilead has been unsuccessful in its attempt to expand considering more than 80% of the 2010 revenue was generated through its HIV/AIDS products.17 Meanwhile, they have expanded into a variety of different market segments without any significant success or even signs of future success in these markets. Given their relative failure in the cardiovascular and respiratory markets, the company needs to position itself so that it can focus on high growth areas that also create economies of scope. Since the company became the industry titan it is today through curing unmet needs with HIV/AIDS treatments, it must continue to do so by moving towards the cancer, hepatitis B, and hepatitis C markets. Focusing on these areas will most likely contribute to substantial future revenue generation while avoiding inefficient resource contribution in areas like the cardiovascular or respiratory markets. At the same time,

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diversifying the drug portfolio will distribute the risk of patent expiration and the introduction of generic products into Gilead’s drug markets.

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PART I INTRODUCTION

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COMPANY OVERVIEW Gilead Sciences (GILD) is a biopharmaceutical company involved in the research, development, and marketing of a variety of antiviral medications, although it specializes in combating Human Immunodeficiency Virus (HIV). In fact, since the company was founded, it has concentrated primarily on developing and marketing antiviral drugs to treat patients who have been infected with HIV, hepatitis B, and influenza. Over time, Gilead has acquired multiple companies in order to diversify its product line. Yet, the company’s HIV drugs continue to dominate its inflow of revenue.

Gilead Sciences began in 1987 under the name Oligogen, Inc. until the name was changed to Gilead in the following year. In 1992, it became a publicly traded company as it entered the NASDAQ, but it did not launch its first commercial product until June of 1996. This product, Vistide, treats cytomegalovirus (CMV) retinis in HIV patients. Just one month later, Gilead signed an agreement with Pharmacia & Upjohn to market its first drug in foreign markets.

After its successful development and distribution of Vistide, Gilead quickly prospered and gained reputability as a legitimate drug developer. In 1999, it merged for the first time with Nextstar Pharmaceuticals Inc., which was much larger than Gilead at the time. In fact, Nexstar’s total revenue for that year was three times as large as Gilead’s. As a result of the merger, Gilead acquired Nexstar’s two drugs, AmBisome, a fungal treatment, and DaunoXome, an anti-cancer agent marketed towards AIDS patients.2 As Gilead’s drug portfolio increased in the late 90’s so did its revenue. Vistide and Tamiflu, a treatment for influenza, continued to gain market share.

In 2001, the U.S Food and drug Administration (FDA) approved Viread for the treatment of HIV, which has proved tremendous for Gilead as it continues to generate revenue. In 2010 alone, it generated $732 million.17 2003 proved to be a momentous year as Gilead acquired Triangle Pharmaceuticals and announced its first year of full profitability. Later that year, Hepsera was approved by the FDA for the treatment of hepatitis B and Emtriva was approved for the treatment of HIV. The following year,

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Gilead commercialized Truvada, a combination tablet of Emtriva and Viread, which has become one of the company’s sales leader, with 2010 sales of $2.65 billion.17 In July 2006, the FDA approved Atripla, a once daily single tablet regimen for the treatment of HIV. The drug combines Sustiva, a Bristol-Myers Squibb product, with Gilead’s Truvada, and has become a leader in revenue generation with 2010 sales of $2.93 billion.17

Later that year, Gilead purchased Raylo Chemicals, Myogen, Inc. and Corus Pharma, Inc. in order to further diversify its drug portfolio. These acquisitions allowed Gilead to enter the cardiovascular and respiratory treatment markets. Myogen specifically was completing Phase III trials of Letairis, an oral drug approved for the treatment of pulmonary arterial hypertension (PAH). The drug was approved by the FDA in 2007.5 The acquisition of Corus Pharma provided Gilead with the rights to Corus’ lead product, Cayston, which is an antibiotic used to treat Pseudomona aeruginosa, an illness that can cause lung infection in patients with cystic fibrosis. The drug was approved by the FDA in February of 2010 and has been conditionally approved in Europe, awaiting completion of an ongoing study. In 2009, Gilead acquired CV Therapeutics, which brought Ranexa and Lexiscan into the company’s product collection. Ranexa is a cardiovascular drug treating chronic chest pain related to coronary artery disease.5 The latest merger and acquisition activity involved Calistoga Pharmaceuticals, which signifies Gilead’s attempt to enter the oncology and inflammation areas.

Gilead’s current product pipeline is led by their “Quad Pill” in Phase III clinical trials. The pill is expected to be approved later this year and will be an additional drug used to fight HIV in patients experiencing drug resistance. The Truvada/TMC 278 Fixed-dose Regimen is another Phase III drug, which combines two of Gilead’s currently approved drugs, Viread and Emtriva, along with TMC 278. The rest of the pipeline is also dominated by potential HIV inhibitors although the company hopes to further enter the PAH market along with the hepatitis C market among others.4

While the majority of its drug patents are not set to expire for years to come, the pressure to consistently discover new drug therapies exists. It is this ability to produce new patented drugs that allows Gilead to raise prices

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above marginal cost such that it can operate profitably. In the past, Gilead has been successful in such feats. In fact, it appears that it will continue to do so in the near future since the Truvada and Atripla U.S. patents are not set to expire until 2021.

That said, Gilead has attempted to diversify its drug portfolio through the acquisition of other drug manufacturers such as Myogen, Inc. but has struggled to successfully enter other drug markets. That particular acquisition allowed them to enter the pulmonary treatment market, but Gilead’s HIV drugs continue to dominate their revenue stream. Once again, Truvada and Atripla produced 2010 sales of $2.65 billion and $2.93 billion respectively. In comparison, Letairis, which was acquired when Gilead purchased Myogen, only produced $240 million in 2010 sales.17 Moreover, Gilead treats 86% of all new HIV patients.1 Thus, Gilead’s success currently hinges on its ability to continue to dominate the HIV treatment market. While this strategy has been successful in the firm’s history, it carries a greater risk since there is limited exposure to various areas of the drug market.

Overall, Gilead’s history exemplifies that it has tried to diversify in order to both grow beyond its current levels and attain greater stability. The HIV treatment market is limited in size, and Gilead will have to reach out to other markets if it is to grow substantially in the future. So far, it appears that the company has failed to attain success in comparison to its domination of HIV treatments, but there are positive signs. Because it specializes in antiviral treatments like those used to combat HIV, the previous research for HIV overlaps with other ailments. For example, hepatitis B and hepatitis C are also viral infections that must be treated in a similar manner to HIV. In fact, Viread is used to treat both HIV and hepatitis B. Therefore, the knowledge and patents held on antiviral treatments creates a competitive advantage for Gilead over other drug manufacturers attempting to enter the antiviral market. In a sense, Gilead is taking advantage of economies of scope as the cost of production of multiple drugs is reduced from overlapping technologies.

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FINANCIAL ANALYSIS Gilead’s financial position is relatively strong and it has very low leverage ratios. However, its lack of product diversification makes its continuing profitability much less predictable than other more diversified pharmaceutical companies. Its earnings also tend to be relatively high in accruals, an indicator of lower quality earnings susceptible to management manipulation.

Liquidity and Solvency

As we can see from Table 1, Gilead has a very high current ratio and acid test ratio. However, along with its cash ratio, these have been declining steadily since 2007. Gilead’s cash ratio is currently at less than 40% of its 5-year average. Declining cash reserves can be an indicator of declining business fundamentals, especially when considering that Gilead has had negative total cash flow for the past two years. An analysis of these cash flows shows that Gilead has been using its cash to purchase investments

Table 1 2010 2009 2008 2007 2006 Average

Current Ratio 2.32 2.57 3.50 4.11 3.18 3.14

Acid Test Ratio 1.83 2.01 2.74 3.30 2.44 2.46

Cash Ratio 0.37 0.68 1.20 1.31 1.07 0.93

Total Liabilities/Book Value of Equity

0.98 0.52 0.62 0.69 1.25 0.81

Interest-Bearing Liabilities/Assets

0.30 0.12 0.16 0.22 0.32 0.23

Interest Coverage Ratio 65.72 83.26 45.09 19.71 5.38 41.68

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and repurchase common stock. In fact, Gilead’s cash flow from operating activities has been positive and relatively healthy.

Gilead is relatively unburdened by debt service given its interest coverage ratio is extremely high and the ratio of interest-bearing liabilities to its total assets remains fairly low. However, Gilead’s leverage increased sharply in 2010 as we can see from the large jump in all three solvency ratios presented. On March 23rd, Gilead priced $1 billion of senior unsecured notes at a 4.5% annual interest rate.19 Moody’s and S&P rated the bonds Baa1 and A-, respectively, which indicates that Gilead is considered a medium-risk investment grade issuer. As with many other pharmaceutical companies, Gilead’s financial health is completely reliant on a high-quality product pipeline and very exposed to drug-approval risk. This idiosyncratic risk has raised its risk-profile compared to a company with similarly healthy balance sheet metrics in another industry.

Profitability and Turnover

Gilead’s profitability and product turnover ratios in Table 2 remain healthy and do not exhibit any particularly worrying downward trends. If a company is having business difficulties it often tries to boost earnings by manipulating its accruals accounts such as accounts payable. We can see

Table 2 2010 2009 2008 2007 2006 Average

Gross Margin 76.5% 77.2% 78.9% 81.8% 85.7% 80.0%

ROE 47.4% 49.5% 51.2% 60.1% -65.5% 28.5%

ROA 27.3% 31.7% 31.0% 32.0% -29.1% 18.6%

Asset Turnover 0.75 0.84 0.84 0.85 0.74 0.80

Days' Sales of Inventory 220.14 226.43 247.35 276.35 475.20 289.10

Days' Sales in Cash 50.07 71.12 83.02 76.97 98.42 75.92

Payables Period 293.92 275.99 294.42 333.41 513.25 342.20

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that Gilead’s payables period does not show any significant increases that could be evidence of earnings manipulation

Accruals Analysis

Examining Gilead’s total net accruals and its accruals as a share if its net income in Table 3 shows no evidence of accruals shenanigans and actually indicates a continuing downward trend in its accruals. Overall however, Gilead’s accruals income tends to be a relatively large percentage if its total earnings, an indicator of lower earnings quality.

Gilead vs. GlaxoSmithKline, Merck, and Bristol-Myers Squibb

Gilead is one of the smaller players in its space, but has been expanding and diversifying its product line through acquisitions. Since 2006, Gilead has returned steadily increasing sales, and with the exception of 2010, has reported steadily increasing operating cash flows. The three other players chosen to compare to Gilead managed roughly similar sales and cash flow growth. Merck managed a huge increase in sales and operating cash flow, mostly due to its huge acquisition of Schering-Plough in 2009.

Gilead’s use (or lack thereof) of leverage to boost its returns is about par for the sector. Its leverage levels are similar to Merck’s and Bristol-Myers Squibb’s levels, although GlaxoSmithKline uses leverage far above what these three use.

Table 3 2010 2009 2008 2007 2006 Average

Total Net Accruals

$(868.42)

$1,908.16

$1,303.80

$1,796.35

$1,923.81

$1,212.74

Accruals/Net Inc.

-29.9% 72.4% 65.9% 113.3% -161.7% 12.00%

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COMPETITIVE ANALYSIS Overview

Force Threat Level

Internal Rivalry Low

Entry/Exit Low

Substitutes/Complements Medium

Supplier Power Medium

Buyer Power High

Gilead Sciences is one of the many biotechnology firms that competes in the drug therapy market for viral, fungal, respiratory, and cardiovascular disease. Gilead is primarily classified under SIC Code 2836 (Biological products, except diagnostic).11 Although their full product line of treatments covers a broad variety of diseases, Gilead’s operations are heavily concentrated in the niche market for antivirals, most specifically HIV products. Collectively, antivirals accounted for 80% of Gilead’s total revenue for FY2010.17 The majority of Gilead’s other sales revenue comes from its antifungal infection drug, AmBisome, and pulmonary arterial hypertension treatment, Letairis. The final portion of Gilead’s revenue is in the form of royalties mainly from Tamiflu, an antiviral drug jointly developed with Roche.

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Internal Rivalry

The market for HIV treatment continues to become more competitive and complex as more forms of HIV treatment move through clinical trials and on to the broad market. In the United States alone, there are currently around 32 branded HIV drugs. Gilead’s main competition in this market comes from fixed-dose combination products in the nucleotide/nucleoside reverse transcriptase inhibitors (NRTI) class. Within this class, Gilead enjoys a healthy market share and primarily competes with GlaxoSmithKline (GSK), Bristol-Myers Squibb (BMY), Roche, and Boehringer Ingelheim.12

Billions, Antivirals, $6.54, 80%

Billions, Other Products, $1.08, 13%

Billions, Royalties, $0.56, 7%

Gilead Business Segment Breakdown 2010

Antivirals Other Products Royalties

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Gilead’s AmBisome, used to treat persistent fungal infections in AIDS patients, also holds a significant share of its respective market. Three main companies, Gilead, Merck and Astellas, account for nearly 85% of the total sales in the liposome drug delivery market. Ambisome’s ability to transport drugs into difficult to reach tumors helps it capture 50% of liposome sales in 2010.12

Overall, the pharmaceutical biotechnology industry has a low level of internal rivalry due to the strong presence of patent protection in most primary markets. Although there is vigorous competition in the market for branded treatments for terminal illnesses, the majority of this competition is non-price and takes place in the form of patent races. Due to the huge initial research and development costs associated with drug development, patents are essential in maintaining a competitive marketplace. This has

GlaxoSmithKline, 33.9, 34%

Gilead Sciences, 31.3, 31%

Bristol-Myers Squibb, 13.8,

14%

Roche, 6.6, 6%

Boehringer Ingelheim, 2.7,

3%Others, 11.7,

12%

Nucleotide Analog, Transcriptase Inhibitors and DNA Polymerase Market Projected Market Shares 2011

GlaxoSmithKline Gilead SciencesBristol-Myers Squibb RocheBoehringer Ingelheim Others

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led to fairly consolidated industry where a few main players are able achieve solid long-run profits.

In recent years, Gilead has seen increasing industry-wide sales in all of their markets. According to the United Nations, the number of people infected with HIV has risen in recent years; however, this can be largely attributed to longer survival by HIV patients with anti-retroviral therapy. Furthermore, current health legislation should expand the pool of insured Americans by more than 30 million by 2014. Drug makers should see increased margins as many of the newly insured Americans have pre-existing conditions.

Entry/Exit

The research and development costs required to remain competitive in the highly capital-intensive biotechnology industry keeps the threat of entry relatively low. The majority of competition takes place between the industries main firms who compete in developing, patenting, and marketing new forms of drug therapy. The speed at which a company develops a drug and pushes it through clinical trials to FDA approval is largely dependent on the level of R&D investment. Traditionally, the capital used to cover the R&D costs of a fledgling biotech company would come in the form of venture capital funding. Initial venture funding, called angel investing, causes the investor to take on a significant amount of risk tied directly to the performance of the company’s drug pipeline. The prevalence of venture funding has continued to remain volatile since the 2008 financial crisis. Although interest rates are at historic lows, lenders are very much still obsessed with credit risk and will likely not lend to startup firms. Startup firms may have better access to research grants, but no number of grants can account for the research costs especially in the antiviral market. In the current economic environment, a significantly capitalized company possesses a substantial competitive advantage. However, Gilead still faces competition from other large biotech firms who may move laterally into their market though inorganic growth. Large firms will often bolster their product portfolio by purchasing small companies that have one or two previously competitive products.

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Large biotech firms achieve advantages over smaller companies in other ways that being able to access capital. Gilead Sciences has created a strong global reach that has led to a number of mutually beneficial partnerships. Through its commercial collaboration partnerships with Bristol-Myers Squibb, Merck, and Japan Tobacco, Gilead has opened up distribution channels for its drugs into the European Union, Scandinavia, Japan, Latin America, and the Asian Pacific. As it is often difficult to predict the demand for all of the products in a portfolio across all seasons, it is important for a biotech firm to diversify geographically. Research partnerships and collaborations further benefit established firms through a transmission of information. Large firms stand to benefit most because they will rarely divulge trade secrets unless they stand to make substantial gains.

Considerable economies of scale also exist in research and development. The nature of drug development implies a minimum feasible level of spending on R&D projects. Researchers at Tufts University estimate that drug companies spend over $500 million to successfully take a new drug to market.12 Obviously, once a drug can be successfully commercialized, a firm’s average fixed costs will plummet and the project may become profitable. Research and development also entails economies of scope. Discoveries made on one project can often spill over to other projects creating synergies within the R&D department. Large biotech firms also can exploit learning economies to reduce costs associated with research and manufacturing.

Substitutes and Complements

Gilead’s drug portfolio must compete with other available products based on a variety of things including safety, tolerability, patent protection, reimbursement coverage, and the acceptance by doctors. The existence of process and product patents for drug therapies generally prevents any direct substitutes in the primary branded market. However, in the long run, a biotechnology company may see their patents expire leading to low-cost generic alternatives. Cheap generics quickly and indefinitely erode the market share of existing drugs since producers incur minimal fixed costs. Gilead currently has a strong collection of patents very few of which are set to expire in the upcoming years.

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Although regulators often look favorably on antiviral drugs aimed at combating life-threatening illnesses, generic therapy for AIDS is a looming threat. In 2004, Bristol-Myers Sqibb’s Videx EC became the first generic HIV product in the United States.11 In their annual report, Gilead cites that they have found very little impact from this new generic, but price decreases are always a long-term possibility. It remains clear that certain third party firms will use any new entrances to the generic market to exert pricing pressure on current HIV products.

Complementary drugs are an important part of especially for HIV treatment. Gilead’s blockbuster HIV drug Atripla, developed in a joint venture with Bristol-Myers Squibb, uses the patented active ingredients from drugs originally developed by both companies. These collaborative relationships often create synergies with in the manufacturing and marketing process. Furthermore, combination drugs usually allow both companies to reap the profits due to patent protection until the patents expire on all of the active ingredients.

Supplier Power

Gilead Science’s main strategy is to contract third parties for the majority of their drug manufacturing. Gilead also uses some of their own manufacturing facilities as well as allows some manufacturing by corporate partners. Although Gilead uses multiple third party manufactures for the active ingredients in many of its drugs, the active components of a few of their drugs come from a single manufacturer. Anytime production is concentrated with a single manufacturer there is an opportunity for a

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supplier to exert rent-extracting power. However, a small number of firms in the industry purchase the majority of active ingredients produced by the third party manufacturers, which diminishes their propensity to exert power. Supplier power is further curtailed by the relationship-specific agreements between firms and third party suppliers. For example, Gilead shares their trade-secret liposome manufacturing expertise to obtain lower costs.

The largest source of supplier power comes from the government. The pharmaceutical manufacturing process is highly regulated and can be shut down by regulators at any time. If any of Gilead’s third party suppliers or corporate partners fail perform adequately, Gilead may be significantly impaired in its ability to deliver products in a timely basis. Like for any other manufacturing process, Gilead needs a variety of raw materials to produce their drugs. In the short run, any shortages of these materials could have a significant effect on Gilead’s bottom line.

Buyer Power

The nature of the United States healthcare system curtails any direct buyer power by the patient. Instead, the successful commercialization of a new drug depends on governmental and third party payer reimbursement for the cost of treatment. In the US, buyer power is concentrated most heavily in the hands of government health administration authorities, private insurers, and other social healthcare organizations. In recent years, Gilead has seen an increased attempt by US and EU authorities and private insurers to regulate and limit the prices on various medical services and treatments. This has resulted in lower average selling prices across the board. Imminent regulatory changes pose a large threat to Gilead and all of its competitors.7 US regulators frequently change government prescription drug procurement and reimbursement programs. Impending congressional legislation may decrease coverage and reimbursement for Gilead’s products as well as create additional healthcare reform costs to be borne by the pharmaceutical companies.

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SWOT ANALYSIS Strengths Dominant HIV Market Share

Currently, the brand market accounts for approximately 90% of all antiviral drug therapy sales annually.12 Furthermore, Gilead drug therapies are used to treat 86% of all HIV patients.1 Such figures demonstrate Gilead’s strength within the antiviral market and therefore, their ability to generate increasing revenues by selling therapies at a price above marginal cost. In fact, their market share is expected to reach 31.3% this year, and may even challenge GlaxoSmithKline as the market leader. The nearest competitor to Gilead is Bristol-Myers Squibb, which contains approximately a 12% market share.12

Strong Revenue Growth from HIV Market

The world market for antiviral drugs totaled almost $25 billion. Even more stunning is the fact that since 2004, the market has grown at an annual rate of 9.6%.12 Overall, the antiviral market continues to an increase in revenues each year partially due to the increasing incidence of many viral diseases like HIV, herpes or hepatitis. Included in that market is Gilead’s HIV combating drugs, which have largely contributed to its growth as a firm and will likely continue to do so for some time.

Progress of HIV Drugs in Pipeline

Gilead has dominated the treatment of HIV, and it appears that it will continue to do so as its next generation HIV drugs have showed promised within its pipeline. The firm currently has four HIV drugs in phase three clinical trials. Among these is its Quad pill, which is likely to attain FDA approval later this year before it is introduced to the market. Morever, Gilead owns all four main ingredients contained in the Quad Pill, which will lead to higher profit margins. Thus, it appears that it will be able to extend its HIV franchise and at least maintain its revenue growth within the HIV segment of the antiviral market.

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Weaknesses

Failure to Enter Other Markets (Cardiovascular/ Respiratory Areas)

In 2006, Gilead attempted to enter the cardiovascular and respiratory treatment markets. In order to do so, they acquired Myogen, Inc. which had the rights to a PAH drug in phase III called Letairis.16 While the drug recently received promising news as it no longer is believed to be possibly damaging to the liver, sales have failed to take off as they have for its HIV drugs. Gilead’s other acquisitions have been similarly disappointing. Products such as Ranex and Lexiscan, two cardiovascular drugs, account for a small percentage of Gilead’s sales. For instance, in 2010, Atripla and Truvada, Gilead’s leading HIV treatments accounted for $5.58 billion in revenue, but its total revenue for the year was $7.95 billion.17 Thus, all its other drugs combined have contributed much less than its HIV franchise.

Susceptibility to Supply Shocks

Many of the materials that Gilead uses are made at only one facility. For instance, they depend on single suppliers for amphotericin B, daunorubicin HCl, and high quality cholesterol. Each of these is used to manufacture its liposome products, which are essential vectors for drug delivery. If supplies were to be interrupted for any reason it could not ship some of its products like Vistide or DaunoXome. Because these products are manufactured at a factory in San Dimas, California, something as simple as an earthquake could severely inhibit Gilead’s ability to manufacture and distribute these drugs.7

Cost and Funding for HIV/AIDS Treatment Globally

The economic turndown has affected Gilead as it has affected many other firms around the world. More specifically, international donor budgets have shrunk along and with overall support for HIV treatment internationally. Even the support of the U.S. government has leveled off after increasing substantially for years. Increased funding is essential for ensuring that HIV patients in developing countries gain access to Gilead’s drug therapies.

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Opportunities

Entrance in the Cancer Treatment Market

Gilead recently finalized a deal to purchase Calistoga Pharmaceuticals, Inc. for $375 million. Calistoga Pharma focuses on developing therapies to combat cancer as well as inflammatory diseases. The deal exemplifies Gilead’s attempt to enter the oncology market despite its previous inability to successfully enter the cardiovascular and respiratory markets. Calistoga’s lead pipeline candidate is CAL-101, which will ideally become Gilead’s first successful cancer treatment. The entrance into the oncology area is especially promising given that it is an area of relatively unmet needs similar to HIV/AIDS a decade ago. Such a market has the potential for substantial growth if Gilead is able to capitalize on Calistoga’s previous research and development.

Decreased Costs for “Biosimilar Drugs”

Under the U.S. health reform legislation, a new pathway for FDA approval of next-generation biopharmaceuticals modeled on the original, chemically similar drugs will likely lead to decreased costs for Gilead. Essentially, many of its future drugs will enter an abbreviated pathway to FDA approval, which will allow them to enter the market faster while lowering R&D costs. Still, there is uncertainty what the effect of this particular legislation will be given that this section of the bill has been criticized as being vague. Moreover, the transition will likely take years to make.

Increase in the Number of Patients with Health Insurance

Recent health reform will also introduce an estimated 30 million insured Americans in 2014.11 Given adverse selection, it is likely that many of these people suffer from chronic illnesses and will now have increased access to Gilead’s treatments. As a result, it is likely that Gilead could see a boom in demand in the near future, especially for its HIV treatments.

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Threats

Expiration of Drug Patents/Generic Competition

Gilead’s main revenue generating drug patents are not set to expire until 2021, but if it is unable to produce new drug patents, eventually its current one’s will expire. When the patents expire, other generic drugs using the same chemical formula will enter the market, driving the price of its drugs down along with its profit. The generic drug manufacturer Teva has already filed abbreviated new drug applications challenging an active ingredient in Truvada, Atripla and Viread.18 Such activity signifies that generic versions of these drugs are constantly a threat although generic versions have failed to exert significant price pressure so far.

Changes in regulatory and commercial environment

Like other pharmaceutical firms, Gilead is highly susceptible to the rules and regulation of the governments in the countries it operates. For instance, Gilead spends hundreds of millions of dollars each year on R&D as it attempts to advance products through its pipeline and attain FDA approval. Any changes in FDA regulations could thus significantly affect Gilead’s costs. Recently, U.S. health reform introduced a bill to fill the “donut hole” in Medicare Part D. The government’s solution requires drug manufacturers like Gilead to provide a 50% rebate to patients in this coverage gap, which proves another example of how regulations can immediately affect the firm.7

Antiviral Drug Resistance

HIV is an RNA retrovirus meaning that it replicates using a reverse transcriptase, which makes a DNA copy of the viral RNA. This DNA copy is integrated into the genome of the host cell where it can then undergo transcription and translation to create viral proteins. This process continues throughout the human body making these viruses harmful, but it is there drug resistance that is amazing. Retroviruses like HIV mutate at much higher rates than other viruses, which allows them to build resistance to drug therapies more quickly. Consequently, drug manufacturers such as Gilead must constantly be adapting drug therapies to maintain effectiveness, but it is possible that Gilead simply becomes unable to produce new drug

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combinations that prove effective. If this were the case, Gilead could potentially lose the majority of its revenue, which would prove devastating for the company.

Failure to advance next-generation HIV drugs

In addition to a failure to treat HIV effectively at all, it may be that Gilead is unable to advance its next-generation HIV drugs. In other words, its current drugs may continue to prove effective, but if it does find new drug combinations that are more effective, they will not advance past clinical trials. Consequently, Gilead would not be able to establish patents for these drugs, and eventually, its current patents would expire, giving way to generic drugs.

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PART III RECOMMENDATIONS

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STRATEGIC RECOMMENDATIONS Challenges

In the past decade, Gilead has established itself as a leader in the drug industry through its developments of HIV/AIDS treatments. Now, it appears to be in transition from a high growth stock to a value stock as it attempts to diversify away from HIV/AIDS treatments. While these treatments have provided tremendous growth for Gilead, there is much less growth left in this particular market segment. As a result, Gilead has attempted to diversify its drug portfolio and drug pipeline by buying up other external companies for the rights to their patents. By buying up their R & D, Gilead has began diversifying as a company to help manage some of the risks inherent to the drug industry and simultaneously create growth opportunities. Specifically, the firm has targeted the $2 billion hepatitis C market and more recently, the oncology market.18 In 2011, they purchased Calistoga Pharmaceuticals for their early-stage progress in the areas of oncology and inflammation in addition to announcing a partnership with Yale in cancer research.

As a pharmaceutical company, Gilead faces the constant threat of patent expiration, and therefore, the introduction of generic products that will drive down the prices of their current treatments. The generic drug manufacturer Teva has already filed abbreviated new drug applications challenging an active ingredient in Truvada, Atripla and Viread.18 As a result, generic versions of these drugs could actually enter the market before their patents are set to expire in roughly a decade. With this looming threat, Gilead has taken measures to diversify their drug portfolio, but has failed to generate any success comparable to its HIV/AIDS products.

Maintain Dominance in HIV Market

Once again, Gilead’s HIV/AIDS products drive its revenue. While growth is slowing within that market segment, Gilead needs to ensure that it maintains its dominance within that market. Currently, the firm treats 86% of all new HIV/AIDS patients, but because Gilead’s exposure to this market

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is so high, it must maintain it in order to maintain the health of its company.1 Both generic drugs and cost pressures are continuing to slow market growth. However, thus far, neither has significantly hindered the company’s revenue stream

On a positive note, the HIV/AIDS segment of the product pipeline is promising. The phase III quad-pill is definitely a step in the right direction, as Gilead owns all of the ingredients to the drug. Therefore, the pill will generate better gross margins than those of Atripla, which currently generates the largest share of the firm’s revenue with $2.93 billion.17 Simultaneously, there are three other HIV/AIDS drugs in phase III trials that will likely enter the market in the near future. With a variety of potential products in the pipeline, it seems Gilead is positioned well to overcome the price pressure associated with generic drugs in the short term.

In the long term, the company will need to continue to maintain this dominance as patents expire, but the fact that HIV/AIDS is such a devastating illness actually works in their favor as a drug product. The HIV/AIDS virus replicates using a reverse transcriptase, which is highly susceptible to mutations. This high mutation rate characteristic to HIV/AIDS allows the virus to develop resistance much quicker than most other ailments. As a result, patients will need new versions of their drugs each year. Gilead can help fulfill this need and because of their current patents, it has a head start on its competitors. Thus, it is able to maintain its market share and simultaneously avoid the price pressures from generic drugs.

Finally, it is necessary to address the potential of curing HIV/AIDS. As mentioned, the way in which the HIV/AIDS virus replicates makes it nearly impossible to cure. At best, firms like Gilead will only be able to treat the illness more effectively in the future. For example, instead of having to take the daily Atripla pill, patients in the future will hopefully need treatment less frequently. Also, some of the side effects of the drugs will be minimized. The fact that the virus cannot be prevented or cured like the small pox virus means that there will be a market in the future. As grim as it sounds, Gilead needs to take advantage of this and maintain its dominance through a successful pipeline.

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Narrow Focus on Expanding Drug Portfolio

Gilead’s current drug portfolio is heavily focused on HIV and hepatitis treatments, as is its pipeline (see appendix). It has attempted to diversify this pipeline through the acquisition of Myogen, Corus, CV Therapeutics, and CGI Pharmaceuticals, but results have been relatively disappointing. Gilead has bought many more external

companies contributing to other market segments such as the cardiovascular and respiratory areas. Both of these areas have produced unsatisfactory results. For instance, Myogen was acquired for the rights to the once promising PAH drug Letairis, but sales have failed to take off. Furthermore, Ranex and Lexiscan are cardiovascular drugs acquired through external companies that continue to account for a small percentage of Gilead’s sales.18

While Gilead has clearly expanded its drug portfolio, it has failed to do so efficiently. Its HIV/AIDS products still clearly dominate its revenue stream, and as a result, any sort of setback in the market could be devastating for the company. Instead of buying up so many companies with such varying specialties, Gilead should focus on a few segments that have high growth potential and/or have synergies with Gilead’s current drug portfolio.

One of the most logical areas for Gilead to expand is in the hepatitis C market. Not only is it potentially a $2 billion market, but Gilead can effectively carry out its own research without relying on external companies because there are various synergies from the work done with HIV/AIDS. Because the HIV/AIDS and hepatitis C viruses are both single-stranded RNA viruses and replicate similarly, the treatments created to inhibit them are similar as well. As a result, Gilead can use its prior knowledge of treating HIV/AIDS and apply it to treating hepatitis C. Additionally, approximately 35% of HIV/AIDS patients are coinfected with hepatitis C mainly because both diseases are transmitted in the same way and present in similar populations. Therefore, it would be easier for the drug company to distribute drugs to patients they treat for both illnesses, and maybe even establish a combined therapy. Bearing these synergies in mind, Gilead’s current pipeline boasts five promising hepatitis C drugs although it has yet to commercialize any of these drugs.

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Additionally, Gilead should pursue the oncology treatment, which presents a unique opportunity for growth. The firm has already made a push in that direction through the acquisition of Calistoga and its partnership with Yale, but it should be careful not to overextend itself in diversifying. As it pursues cancer treatment therapies, it should shy away from treating some of the chronic illnesses it currently combats. The cardiovascular unit or respiratory ailments represent two ideal areas to exit because they have proven unsatisfactory and are unlikely to become successful in the future. Although Gilead needs to diversify given its exposure to the HIV/AIDS market, it must do so methodically. Cancer treatment presents a promising opportunity, but attempting to enter too many segments at the same time may be difficult to manage. Simultaneously, overextending means the company will fail to take advantage of the natural synergies that exist in treating similar ailments.

Cancer treatments present an especially interesting market segment because like HIV/AIDS, it is an area with relatively unmet needs. Gilead is focusing on some of the most devastating forms of cancer like ovarian cancer where the typical treatment involves surgery followed by chemotherapy. Still, many patients with these forms of cancer relapse after initial treatment, and improved therapies are needed. If successful, these treatments could rival the success of Gilead’s HIV/AIDS products because such a large percentage of the population is affected by cancer. Meanwhile, treatments will focus on inhibiting replication as they do with HIV/AIDS. Therefore, the firm will likely be able to apply previous knowledge that it has gained through treating HIV/AIDS.

Generally, Gilead must act as a drug developer and distributor. In the past few years, it has attempted to expand, acting more like an investment company. Such a strategy has proven unsuccessful despite initially promising drug technology. By focusing on HIV/AIDS, hepatitis B and C, and the oncology market, Gilead can take advantage of inherent synergies and continue to grow through its own successful drug development. Concurrently, these markets contain substantial room for growth, and thus, present encouraging opportunities for both expansion and diversification.

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APPENDICES Appendix 1

Table 4. Breakdown of 2010 Revenue by Drug

Product Revenue (millions)

Atripla $2,930.00

Truvada $2,650

Viread $732.20

Letairis $240.30

Ranexa $239.80

Other Products $601.10

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Appendix 2

Product Portfolio

Brand Name

Indication Date Approved

(USA)

U.S. Patent

Expiration

European Patent

Expiration

AmBisome fungal infection, cryptococcal meningitis, Aspergillus, Candida, Cryptococcus infections

1997-08-11 2016 2008

Atripla HIV, AIDS 2006-07-12 2021 2018

Cayston Cystic Fibrosis 2010-02-22 2021 2021

Emtriva HIV, AIDS 2003-07-02 2021 2016

Flolan pulmonary hypertension 1995-09-20 expired expired

Hepsera hepatitis B (HBV) 2002-09-20 2014 2011

Letairis pulmonary arterial hypertension

2007-06-15 2015 2015

Lexiscan myocardial perfusion imaging

2008-04-10 2019 2020

Macugen age-related macular degeneration

2004-12-17 2017 2017

Ranexa angina 2006-01-27 2019 2019

Tamiflu influenza 1999-10-27 2016 2016

Truvada HIV, AIDS 2004-08-02 2021 2018

Viread HIV, AIDS, Hepatitis-B 2001-10-26 2017 2018

Vistide CMV retinitis 1996-06-26 2010 2012

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Appendix 3

Product Pipeline

Drug Name Description Potential

Indication

Testing

Phase

Integrase

Fixed-dose Regimen

"Quad"

elvitegravir/FTC/TDF/cobicistat

HIV/AIDS Phase III

Truvada/T

MC 278

Fixed-dose

Regimen

Viread, Emtriva, and TMC 278

HIV/AIDS Phase III

Elvitegravir integrase inhibitor HIV/AIDS Phase III

Cobicistat

(GS-9350) Pharmacokinetic enhancer HIV/AIDS Phase III

Tegobuvir

(GS 9190) polymerase inhibitor Hepatitis C Phase II

Cicletanine antihypertensive Pulmonary Arterial Hypertension

Phase II

Aztreonam inhalation solution Bronchiectasis Phase II

Ranolazine late sodium current inhibitor

Coronary Artery Disease/Diabetes

Phase II

GS 9256 protease inhibitor Hepatitis C Phase II

GS 9310/11 inhaled fosfomycin/tobramycin

Cystic Fibrosis/Chronic Obstructive

Phase II

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Pulmonary Disease

GS 9667

(formerly CVT-3619)

partial A1 adenosine agonist

Diabetes/Dyslipidemia

terminated

GS 7340 nucleotide HIV/AIDS Phase I

GS 9451 protease inhibitor Hepatitis C Phase I

GS 5885 NS5A inhibitor Hepatitis C Phase I

GS 9620 TLR-7 agonist Hepatitis C/Hepatitis B

Phase I

GS 6201

(formerly

CVT-6883)

A2B adenosine antagonist Pulmonary Diseases

Phase I

GS 6620 nucleotide polymerase inhibitor

Hepatitis C Phase I

GS 9669 non-nucleotide polymerase inhibitor

Hepatitis C pre-clinical

GS 9411 epithelial sodium channel blocker

Pulmonary Diseases

Phase I

CVT-10216 ALDH-2 inhibitor drug addiction pre-clinical

Tecadenoson

selective A1 adenosine receptor

atrial fibrillation terminated

Perfan enoximone heart failure Phase III

GS 9219 nucleotide analogue non-Hodgkin’s lymphoma and chronic lymphocytic

Phase I

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leukemia

GS 8374 protease inhibitor HIV/AIDS pre-clinical

GS 424020 prodrug of desisobutryl-ciclesonide and salmeterol

asthma and chronic obstructive pulmonary disease

pre-clinical

GS 9148 nucleotide analog, phosphonomethoxy-2'-fluoro-2', 3'-dideoxydidehydroadenosine

HIV/AIDS pre-clinical

GS 9131 prodrug of GS 9148 HIV/AIDS pre-clinical

GS 9224 integrase inhibitor HIV/AIDS pre-clinical

GS 6624 humanized monoclonal antibody

idiopathic pulmonary fibrosis and advanced solid tumors

Phase I

CAL-101 PI3K Delta selective inhibitor

Chronic Lymphocytic Leukemia and Non-Hodgkin Lymphoma

Phase I

CAL-263 PI3K Delta selective inhibitor

inflammatory diseases

Preclinical

CAL-120 PI3K Delta selective inhibitor

inflammatory diseases and oncology

Preclinical

CAL-129 PI3K Delta selective inhibitor

inflammatory diseases and oncology

Preclinical

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CAL-253 PI3K Delta selective inhibitor

inflammatory diseases and oncology

Preclinical

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19 “Gilead Prices $1 Billion of Senior Unsecured Notes.” Gilead. March 2011. < http://www.gilead.com/pr_1542377>