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AUXL Downgraded to Underperform

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We recently downgraded Auxilium Pharmaceuticals, Inc. to Underperform with a price target of $17.00. Auxilium Pharma’s third quarter results were disappointing with the company reporting a loss of 21 cents per share, wider than the year-ago loss of 8 cents and the Zacks Consensus Estimate of a loss of 6 cents.

Lower-than-expected revenues and higher costs led to the disappointing results. Revenues, which increased 6.4% to $71.0 million, were well below the Zacks Consensus Estimate of $80 million.

In addition to reporting weak results, the company cut its sales guidance for Testim and US sales guidance for Xiaflex. The company also announced the termination of its Pfizer (PFE - Free Report) agreement for Xiaflex, effective April 24, 2013.

Performance of lead product, Testim, was weak in the third quarter. Auxilium Pharma attributed the weakness in Testim’s performance to challenges in the managed-care environment and operational disruption resulting from the company’s co-promotion agreement with GlaxoSmithKline (GSK - Free Report) . Glaxo started co-promoting Testim in the US from mid-July.

The testosterone replacement therapy (TRT) gel market is growing at a slower rate and this will affect sales going forward. Moreover, Testim faces stiff competition from AndroGel, a 1% testosterone gel sold by Abbott (ABT - Free Report) worldwide. As of December 31, 2011, the AndroGel franchise (1% and 1.62%) accounted for 73.2% of the gel prescriptions. Testim will have to continue to take market share from the AndroGel franchise in the coming quarters to continue its growth.

Going forward, we see Testim sales slowing given the entry of additional competitors like Endo Pharmaceutical’s (ENDP - Free Report) Fortesta and Eli Lilly/Acrux’ (LLY - Free Report) / Axiron. Meanwhile, the testosterone gel market will become even more competitive when generic versions of AndroGel 1% enter the market.

The availability of a cheaper generic testosterone gel product could impact Testim’s market share as well as its formulary status. Auxilium Pharma cut its 2012 Testim sales guidance by $10 million to $235 - $245 million. We note that Testim is also facing a patent challenge.

With Testim facing a patent challenge, Auxilium Pharma’s future is heavily dependent on Xiaflex. However, Xiaflex’ sales ramp has been disappointing so far. Auxilium Pharma lowered its 2012 Xiaflex US sales guidance to $52 - $60 million (old guidance: $55 - $65 million). The unsuccessful commercialization of Xiaflex and inability to gain approval for additional indications would weigh heavily on the stock.

Although Auxilium Pharma expects Testim sales to improve, we expect some weakness in the shares until Testim shows signs of sustainable improvement.

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