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Durect Corporation (DRRX-NASDAQ)

Current Recommendation Buy

Prior Recommendation Neutral

Date of Last Change 09/06/2012

Current Price (08/05/13) $1.26

Target Price $3.00

Update

SUMMARY DATA

Risk Level High,

Type of Stock Small-Growth

Industry Med-Drugs

On August 5, 2013, DURECT reported financial results for the second quarter 2013. Revenues of $3.9 million exceeded expectations on growing sales of Alzet and Lactle. EPS was in-line with expectations and cash remains at over one year based on the current projected burn rate for the next four quarters.

DURECT has two major events approaching. The first is an update this fall from Pfizer on plans for the Remoxy NDA. The second is the FDA PDUFA goal data for Posidur, set for February 12, 2014. We believe the shares are attractive at this level given the recent progression with the pipeline and potential for positive updates on both Remoxy and Posidur in the next several months.

52-Week High $1.66

52-Week Low $0.77

One-Year Return (%) 34.04

Beta 1.27

Average Daily Volume (sh) 469,090

Shares Outstanding (mil) 102

Market Capitalization ($mil) $128

Short Interest Ratio (days) 0.50

Institutional Ownership (%) 43

Insider Ownership (%) 11

Annual Cash Dividend $0.00

Dividend Yield (%) 0.00

5-Yr. Historical Growth Rates

Sales (%) 14.7

Earnings Per Share (%) N/A

Dividend (%) N/A

P/E using TTM EPS N/A

P/E using 2013 Estimate -6.6

P/E using 2014 Estimate -7.6

ZACKS ESTIMATES

Revenue (in millions of $)

Q1 Q2 Q3 Q4 Year (Mar) (Jun) (Sep) (Dec) (Dec)

2012 41.2 A 4.8 A 3.8 A 3.3 A 53.1 A 2013 4.2 A 3.9 A 3.6 E 3.7 E 15.4 E 2014

21.5 E 2015

27.0 E

Earnings per Share (EPS is operating earnings before non recurring items)

Q1 Q2 Q3 Q4 Year (Mar) (Jun) (Sep) (Dec) (Dec)

2012

$0.35 A -$0.05 A -$0.05 A

-$0.06 A

$0.18 A 2013

-$0.05 A -$0.05 E -$0.05 E

-$0.06 E

-$0.21 E 2014

-$0.15 E 2015

-$0.12 E

Small-Cap Research

scr.zacks.com

111 North Canal Street, Chicago, IL 60606

August 5, 2013

Jason Napodano, CFA 312-265-9421

[email protected]

DRRX: Remoxy Update Expect This Fall, Meanwhile The Pipeline Rolls Forward

Zacks Investment Research scr.zacks.com

WHAT S NEW

Recent Financial Results

On August 5, 2013, Durect Corp. reported financial results for the second quarter 2013. The company reported total revenues in the quarter of $3.92 million, consisting of $3.01 million of product and excipient sales, mainly driven by sales of ALZET Pumps and LACTLE polymer, and $0.91 million in collaborative payments. Collaborative payments consisted primarily of ratable recognition of upfront payments from Zogenix and collaborative payments from Pfizer on the Remoxy supply agreement. Net loss for the quarter totaled $5.1 million, or $0.05 per share. DURECT exited the second quarter 2013 with approximately $21.3 million in cash and investments. Cash usage for the second quarter totaled roughly $4.2 million. We find the existing cash balance to be sufficient to fund operations into the third quarter of 2014.

Still Waiting On Remoxy

No real update was provided by Pfizer, Pain Therapeutics, or Durect on the status of the Remoxy NDA re-file on any of the second quarter update calls. We remind investors that back in May 2013, Pfizer provided a brief update on Remoxy in their Form 10Q filing. From page 74 of the filing:

This news was quite a surprise to Durect investors. Only a few days before on their quarterly conference call, Pfizer noted that the meeting with the FDA in March 2013 was productive and that the guidance received at that meeting was helping to inform the next steps and addressing the issues that the FDA had raised previously in the complete response letter. John Young, Pfizer s President and General Manager of the Primary Care Unit concluded his remarks on Remoxy by saying, We believe we have a path forward and we will publicly communicate further details overcoming quarters. For Pfizer to use the words, If we elect to continue development of Remoxy creates doubt in the mind of investors. And the fact that the resubmission is not expected before mid-2015 is very perplexing. We understand that Pfizer has additional clinical studies necessary before they will re-file, including a pivotal bioequivalence study with the modified formulation to bridge to the clinical data conducted with the original formulation, as well as an abuse potential study with the modified Remoxy formulation; however, we are surprised that this work will take roughly 24 months to complete. We note these studies will be similar in design to the previous bioavailability studies completed by Pfizer, only significantly larger in size.

Nevertheless, Remoxy remains an enormous opportunity for Durect. We believe Remoxy has potential peak sales in the $1.5 billion range, and Durect s tiered royalty roughly 9.1% at $1.5 billion in sales would provide significant cash flow to the company. On the second quarter call, management noted they expect an update from Pfizer on Remoxy in the fall of 2013. Perhaps Pfizer s third quarter call scheduled for late October will shed some light on the situation. Until then, we remain in wait-and-see mode.


Posidur NDA Filed

On June 20, 2013, Durect announced that the U.S. FDA had accepted the company's NDA for Posidur (SABER-Bupivacaine) for the treatment of post-operative pain relief. The PDUFA date is February 12, 2014. We believe the market is largely ignoring the opportunity with Posidur. The drug is an injectable sustained release formulation of the local anesthetic bupivacaine. It is administered during surgery to the surgical site, where it continuously releases therapeutic levels of bupivacaine using Durect's SABER controlled release technology. Clinical data on Posidur suggests 72 hours of uninterrupted local analgesia.

Conventional (immediately release) formulations of bupivacaine used in this indication deliver only 6 hours of pain relief. Surgeons will typically inject bupivacaine with epinephrine to prolong the duration of action; however this can create complications and contraindications for patients susceptible to arrhythmias or hypertension. The short duration of action of bupivacaine leads to contaminant use of opioid analgesics, including fentanyl.

As such, patients lacking sufficient pain control from only immediate release bupivacaine have limited options. They can either elect to wear an elastomeric pump that continuously administers bupivacaine or they can elect to administer opioids intravenously via a patient-controlled analgesia (PCA) device. Neither is a good option. Elastomeric pumps cost around $450 per single use. The medical device requires appropriate instillation and removal, as well as patient education. They are cumbersome, have significant non-compliance issues, and major safety concerns. Opioid medications like fentanyl are equally expensive, require additional hospital resources, and carry significant risk of adverse events that tend to lead to longer hospital stays as a result.

Exparel Expands The Market

In April 2012, Pacira Pharmaceuticals launched Exparel, a 1.3% bupivacaine liposome injection suspension designed fill the much needed void between immediate release bupivacaine and dangerous opioids. Exparel utilizes Pacira's proprietary extended-release drug delivery technology called DepoFoam®. DepoFoam is a multivesicular liposomal platform that encapsulates drugs without altering their molecular structure and then releases them over a desired period of time from 1 to 30 days. Pacira's investor presentation and corporate website highlights Exparel as providing postsurgical pain control with reduced opioid requirements for up to 72 hours.

Although, upon a little digging into the actual Exparel prescribing label, we see the half-life of Exparel is 34.1 hours for bunionectomy and 23.8 hours for hemorrhoidectomy. To us, it looks like Pacira is exaggerating the efficacy of Exparel on its website. Note the Clinical Studies section of the label:

- In bunionectomy, Exparel demonstrated significant reduction in pain intensity compared to placebo for up to 24 hours; however, between 24 and 72 hours after there was minimal to no difference between Exparel and placebo on mean pain intensity.

- In hemorrhoidectomy, Exparel demonstrated a significant reduction in pain intensity compared to placebo for up to 24 hours. The difference in mean pain intensity between treatment groups occurred only during the first 24 hours following study drug administration. Between 24 and 72 hours after study drug administration, there was minimal to no difference between Exparel and placebo treatments on mean pain intensity.


Nevertheless, Exparel is an improvement over immediate-release bupivacaine, or bupivacaine with epinephrine. The clinical benefit of a decrease in opioid consumption has not been demonstrated by Pacira, but convincing physicians that less opioid use by their patients is a good thing is not a difficult task. Thus, Exparel, even though it only provides roughly 24 hours of postsurgical pain relief, if off to a good start at Pacira. The chart below is from the June 2013 Pacira investor presentation. It shows the first four quarters of Exparel sales, totaling roughly $25.1 million, with good trajectory.

As of March 31, 2013, Pacira reports access and orders of Exparel in >90% of the top 100 hospitals and 64% of the top 500 hospitals in the U.S. Pacira notes a number of repeat orders and over 1,000 users in only 12 months on the market. Exparel costs $285 WAC per vial. That's a 25x increase over generic bupivacaine. Despite not being a significant leap forward, Pacira is clearly doing well with Exparel. Perhaps this is because drugs like Exparel, and Posidur, represents a very large market opportunity.

According to data published by the CDC, there are approximately 70+ million surgical procedures performed in the U.S. each year, a large majority of which require significant post-operative pain control. The vast majority of these patients are inadequately treated for post-operative pain relief. The current standard of care for post-surgical pain includes oral opiate and non-opiate analgesics, transdermal opiate patches and muscle relaxants. These medications are either ineffective or carry significant tolerability and side-effects issues.

Drugs like Exparel and Posidur are designed to reduce cost through less opioid use (and corresponding opioid-related side effects) and potentially earlier hospital discharge following surgery. Data published from a retrospective analysis on roughly 320,000 patients in 380 hospitals in the Journal of Pain and Palliative Care (Oderda GM, et al, March 2013) shows that patients with opioid-related adverse events (ORAE) were associated with:

- An increase of 3.3 days longer hospitalization than patients without an ORAE (7.6 days vs. 4.2 days, P<0.0001), - A $4,707 mean increase from the baseline hospitalization cost compared to patients without an ORAE ($22,077 vs. $17,370, P<0.0001), - A significantly greater 30-day, all-cause readmission rate (15.8% vs. 9.4%, P<0.0001) compared to patients without an ORAE.

That's why Pacira can charge $285 WAC per vial for Exparel, that's why the company is succeeding in gaining formulary coverage, and that's why the consensus sales forecast for Exparel in 2013 is $62 million, growing to $136 million in 2014, and $246 million in 2015. That's why Pacira currently has a market capitalization of $1.1 billion. This is an attractive market. In fact, the characteristics of Posidur made the product attractive enough that Durect was able to secure two separate development and commercialization deals with larger pharmaceutical companies, the first with Nycomed in November 2006 and the second with Hospira in June 2010.

The Posidur Data

The initial success of Exparel provides a glimpse of what could be for Durect. The market that Exparel has expanded we believe Posidur could dominate. Posidur would offer true 72 hour pain coverage, and thus even greater opioid sparing and cost reduction for patients and physicians.


That is, if the drug gets approved. Although we are pleased to see the U.S. FDA accept the Posidur new drug application, approval remains a wildcard event for Durect given the clinical data.

In July 2007, Durect reported positive results from a multicenter, randomized, double-blind, parallel-group, placebo-controlled phase 2b trial conducted on hernia patients who were randomized into three arms: Posidur 2.5 mL (n=42), Posidur 5 mL (n=47) and placebo (n=31). Patients enrolled in the study (age 18 to 65) received elective open unilateral tension-free Lichtenstein-type inguinal hernia repair under general anesthesia. The primary outcome of the study was pain intensity on movement evaluated using a numerical rating scale (0=no pain; 10=worst pain possible), collected four times a day. Outcome was assessed via two co-primary efficacy endpoints: the mean pain intensity on movement area under the curve (AUC) over the time period 1 to 72 hours post-surgery, and the proportion of patients who received opioid rescue medications during the study.

The results are presented below for the control and the 5 mL arm. They show a 31% reduction in pain and an 80% reduction in opioid use vs. the control.

Statistically significant reduction in both pain intensity and opioid use was observed for the 5 mL Posidur dose. The data above were presented at the American Hernia Society meeting in March 2008. Data from the trial showed no serious adverse events (SAEs) designated related or possibly related to Posidur. SAE s were generally similar between the three arms. Heart rate, blood pressure, respiratory rate, and body temperature were similar at Day 14 to baseline in all three arms. We note Durect required patients to wear a 12-lead ECG for 24 hours post-op to assess the cardiovascular safety of Posidur. The data clearly shows the drug to be safe, effective, and well tolerated in hernia patients. Reduction of opioid rescue dose was also associated with reduction of opioid-related side effects such as constipation, somnolence, dizziness, nausea, and vomiting.


In February 2011, Durect announced results for a second phase 2b trial, this time studying Posidur in 107 patients undergoing shoulder surgery in a randomized, double-blind, design. Data from this study is presented to the right, which shows statistically significant reductions in both pain intensity (-21%) and opioid use (-67%) vs. the control.

Following the impressive results of these phase 2b studies, Durect met with the U.S. FDA to outline a path towards registration. Recognizing that if approved, Posidur could have significant use by surgeons in a wide variety of surgical procedures, the FDA asked Durect to conduct additional clinical trials in a sicker and older patient population, while also incorporating varying types of incisions.

In January 2010, Durect initiated the phase 3 BESST (Bupivacaine Effectiveness and Safety in SABER Trial), a multicenter, double-blind trial that sought to enroll over 300 patients in three cohorts undergoing a variety of abdominal surgical procedures.

- Cohort 1: An active comparator cohort in which patients were randomized to receive either Posidur 5 mL or commercially available Bupivacaine HCl solution after laparotomy (large wound).

- Cohort 2: An active comparator cohort in which patients are randomized to receive either Posidur 5 mL or commercially available Bupivacaine HCl solution after laparoscopic cholecystectomy (small wound).

- Cohort 3: A double blind, placebo controlled cohort in which patients are randomized to receive either Posidur 5 mL or SABER-Placebo after laparoscopically-assisted colectomy (medium wound).

In January 2012, Durect released results from BESST. On the first co-primary endpoint, pain reduction during the 72 hour period (AUC), the Posidur 5 mL group achieved a 7% reduction. This was not statistically significant versus placebo (p=0.1466). The 7% reduction resulted when assessing pain on movement and whenever supplemental opioids were administered. With respect to pain on movement alone, i.e. not subject to request for opioids, the Posidur 5 mL group reported a 10% reduction, which was statistically significant (p=0.0410).

On the second co-primary endpoint, median total morphine-equivalent opioid dose for supplemental analgesia during the period 0-72 hours post-dose, the Posidur 5 mL group reported approximately 16% less opioids consumed versus the placebo. This was not statistically significant (p=0.5897). Data from Cohorts 1 and 2 were pre-specified to be pooled due to their small sample size. For Cohorts 1 and 2 (pooled), the mean reduction in pain on movement was approximately 20% (p=0.0111) for the Posidur 5 mL group compared to the patient group treated with immediate-release bupivacaine. The median total morphine-equivalent opioid dose for supplemental analgesia during the period 0-72 hours post-dose for Cohorts 1 and 2 (pooled), was approximately 18% less opioids consumed compared to the bupivacaine HCl group (p=0.5455).

The failure of Posidur to meet statistical significance in the co-primary endpoint was clearly disappointing. Posidur had worked well in the phase 2b hernia and shoulder trial comprised of generally healthy patients with pain resulting from the surgical wound. However, in sicker patients with a large visceral pain component, the drug proved less effective. This was probably due to the underlying disease (colon cancer, diverticulitis) causing pain beyond the surgical procedure. This is a pain that most likely requires more powerful analgesics than the local-acting bupivacaine. Nevertheless, both Nycomed and Hospira returned all rights to Posidur after the results of BESST.

Not all was lost on BESST however. We believe the safety of Posidur was clearly demonstrated in the trial. Overall,


the Posidur groups showed a similar systemic safety profile as the patient groups treated with placebo and active comparator. All patients in the trial wore a Holter monitor to record cardiac events. There were no signs of systemic safety issues. No negative safety signals were seen in the cardiac and neurologic safety assessments.

Odds Of Approval

Despite the failure of BESST, in April 2013, Durect filed for approval of Posidur through the 505(b)(2) pathway. We note that management met with the U.S. FDA in July 2012 to outline its plans for the application. In total, Durect filed with 13 clinical trials, in multiple surgical models, with 683 patients exposed to drug and no significant systemic safety concerns. Besides the two phase 2b trials, the NDA included data from smaller phase 2 trials in hernia, appendectomy, and hysterectomy. Data from BESST will be included as well.

Investors will probably ask, why bother to file the NDA if both Nycomed and Hospira have walked, and there is a high chance of a CRL given the failure of the phase 3 BESST trial? Management s theory is that the company has demonstrated clear evidence of efficacy in two randomized, well-controlled, clinical trials the phase 2b hernia trial (soft tissue) and the phase 2b shoulder trial (hard tissue). The company has also demonstrated efficacy of Posidur vs. immediate-release bupivacaine (active comparator). The pool analysis does show statistical significance, and it is clear that patients receiving Posidur use less opioids during the first 72 hours post-surgery.

A good friend once told me, "If you torture the data, it will confess to anything!" Thus, despite the pooled analysis showing statistical significance, we are skeptical of approval in February 2014 based on the failure of BESST. The FDA specifically asked Durect to conduct a trial of that nature (i.e. older / sicker patients with visceral pain).

Therefore, we think the FDA will come back and ask Durect to conduct one confirmatory phase 3 trial before it approves the application. Management has said publicly that laparoscopic cholecystectomy (gallbladder) removal surgery would be a potential for such a trial. Data from this cohort in BESST was statistically significant when compared to placebo. That being said:

1) The NDA costs little to file, only time and effort. Management focus is not an issue; and, as the company s first sponsored NDA, the approximate $1.8 million PDUFA fee was waived.

2) Durect owns worldwide rights to Posidur. The drug has four patients granted (2 U.S., 1 EU, 1 Japan) that protect the asset to at least 2025. The company would like to re-partner the drug for commercialization. Given the initial success that Pacira is having with Exparel, we think the company can re-partner on favorable terms.

But that this point, partners are most likely asking Durect the same questions investors are asking

what s necessary to gain approval? Heck, the FDA may surprise us all and approve the drug in February 2014! However, a complete response letter (CRL) on Posidur is not the end of the world for Durect. In fact, it provides valuable information to the company on what is necessary to gain approval. A CRL on Posidur should lay out what Durect has to do before it can re-file. This may include a phase 3 trial in gallbladder in 100 patients at a cost of $10 to $12 million. If that s the case, at least now Durect knows exactly what it needs to do, and can go back out to new potential partners with a plan of action.


There are roughly 70 million surgeries in the U.S. each year. There are approximately 1 million hernia procedures done in the U.S. each year. A 20% share in the U.S. hernia market at approximately $285 per procedure (priced at parity to Exparel) represents a $57 million opportunity. Expanding into gallbladder, hysterectomy, shoulder surgery, etc opens the door to a potential market of 10 to 20 million procedures that are ideally suited for a long-acting local analgesic like Posidur. Just 5% market share in this broader patient population represents at least a $250 million opportunity for Durect and a potential licensing partner. The market opportunity outside the U.S. is comparable. A quick search of the Zacks Database shows six forecasts for Exparel sales in 2013, with an average of $62 million. In 2015, the Zacks Database shows a consensus Exparel sales number of $246 million. In 2016, the number is $378 million, although we note there are only two figures that comprise this estimate. Nevertheless, the market is fairly optimistic on Exparel. We believe Posidur, post-approval, could follow a similar path.

The Overlooked Pipeline

Below we briefly touch on the rest of the pipeline, which we believe offers some downside protection, and even modest upside, albeit at a less predictable rate.

...Relday...

In July 2011, DURECT and Zogenix, Inc. entered into a license agreement to develop and commercialize a proprietary, long-acting injectable formulation of risperidone using DURECT s SABER controlled release formulation technology in combination with Zogenix s DosePro needle-free, subcutaneous drug delivery system. The product is called Relday. Zogenix is handling the clinical work for Relday. DURECT received an upfront fee of $2.25 million, and can earn up to an additional $103 million in total future milestone payments, along with mid-single-digit to low double-digit royalty on annual net sales.

On July 12, 2012, Zogenix announced that it has initiated its first phase 1 clinical trial for Relday. Results were released in early January 2013. The data showed a favorable safety and PK profile demonstrated with the 25 mg and 50 mg once-monthly doses of Relday. In fact, Zogenix elected to continue the current study to include a 100 mg dose of the same formulation. These results were released on May 2, 2013. Top-line data shows the 100 mg dose achieved risperidone blood concentrations in the therapeutic range on the first day of dosing, and maintained throughout the one-month period.

With this trial now complete, dose proportionality has been established across the full dose range that would be anticipated to be used in clinical practice (50 mg to 100 mg). The 100 mg dose was safe and well-tolerated, with no unexpected adverse events, including injection site reactions, as compared to the initial phase 1 clinical trial with the 25 mg and 50 mg doses. We expect that Zogenix will push forward with a phase 1b multi-dose clinical trial, which would provide the required steady-state PK and safety data prior to initiating Phase 3 development studies, sometime during the second half of 2013.

Relday is designed to compete with Johnson & Johnson's (JNJ) long-acting formulation of risperidone called Risperdal-Consta, or Consta for short. The FDA approved Consta in 2007 for both schizophrenia and bipolar I disorder. J&J sold approximately $1.6 billion worth of Risperdal Consta in 2012. Dosing is with a 21 gauge needle every two weeks. A 21 gauge needle is 0.8192 mm thick (outer diameter). Relday would offer both less frequent dosing along with a less painful needle-free injector that utilizes Zogenix DosePro technology. If successful, we see Relday as a potential $500 million product. But even before commercialization, we think it is fair to assume that DURECT will collect another $10 to $20 million in milestone on Relday between now and 2014 (estimated phase 3).

Zogenix has begun partnering activities on Relday. The company has retained Locust Walk Partners of Cambridge, MA, a transaction advisory firm for life sciences companies, to provide exclusive transaction advisory and support services for a Relday commercial deal. On Durect ssecond quarter conference call in early May 2013, management noted the economics of a sub-license payment being in the area of 10-20% of the overall deal. The market is largely ignoring this potential for non-dilutive cash in our view. Relday only further supports our belief that downside in DURECT is limited at today's price.


...ORADUR-Methylphenidate...

DURECT is developing a drug candidate for the treatment of Attention Deficit Hyperactivity Disorder (ADHD) using its ORADUR tamper-resistant technology; this is the same technology used in Remoxy. DURECT is seeking a way to provide once-a-day dosing with added tamper-resistant characteristics to address common methods of abuse and misuse of the most widely used ADHD drug, methylphenidate (previously sold as branded Ritalin).

ADHD drugs act by stimulating chemical neurotransmitters in the brain such as dopamine and epinephrine. However, stimulants such methylphenidates (Concerta and Ritalin), dextroamphentamine (Adderall), and lisdexamfetamine (Vyvanse) are often misused and abused by teenagers as a means to perform better in school.

MonitoringTheFuture.org reports that 6.4% of 10th-graders and 6.8% of 12th-graders used prescription amphetamines non-medically in 2008. In the study, amphetamines ranked 3rd among 12th-graders for illicit drug use. A National Survey on Drug Use and Health (NSDUH) showed that in 2006 and 2007, about 6.4% of full-time college students reported using such stimulants as Adderall or Ritalin non-medically. A 2009 investigation tracking calls to the American Association of Poison Control Centers from 1998 to 2005 showed that teenaged victims of prescription ADHD drug abuse rose by 76% over that eight-year span.

In August 2009, DURECT entered into a development and license agreement with Taiwan-based Orient Pharma Co., Ltd. Under terms of the agreement, DURECT granted to Orient Pharma development and commercialization rights in certain defined Asian and South Pacific countries to ORADUR-ADHD. DURECT retains rights to North America, Europe, Japan and all other countries not specifically licensed to Orient Pharma.

The goal of the collaboration is to generate a clinical data package through a phase 2 study. DURECT is responsible for formulation and study design of the phase 1 and phase 2 clinical trials, which Orient Pharma will fund and execute. Orient Pharma is responsible for all remaining development and commercialization activities in its licensed territory. If commercialized, DURECT will be entitled to receive a royalty on sales of ORADUR- Methylphenidate by Orient Pharma. Orient Pharma has committed to supply a portion of DURECT s commercial requirements for ORADUR-Methylphenidate in all territories other than the U.S.

Methylphenidate is the most commonly used medication for the treatment of ADHD. In 2012, approximately 3.06 million prescriptions of generic methylphenidate were written. The product is cheap, at only roughly $10 per monthly prescription. However, branded competitors such as Concerta (an improved formulation of methylphenidate extended release) sells for as much as $165 per month. Concerta sales peaked at $1.3 billion in 2009 (~$1 billion in the U.S.). Global sales of Concerta in 2012 totaled around $1 billion (~$0.6 million in the U.S.). Generic methylphenidate in branded terms equates to a roughly $500 million opportunity in the U.S., similar to the current run-rate for Concerta.

...Eladur...

DURECT is developing Eladur, a transdermal bupivacaine patch based on the company s proprietary TRANSDUR technology. Eladur provides continuous delivery of bupivacaine for up to three days from a single application. The patch is being designed as a superior alternative to Endo Pharmaceuticals Lidoderm (5% lidocaine patch). The clinical data to date suggests that Eladur provides longer duration of action, faster onset of efficacy, and potentially deeper tissue penetration of bupivacaine versus lidocaine with Lidoderm. Endo sold $948 million of Lidoderm in 2012, up 15% from the $825 million posted in 2011.

DURECT generated impressive phase 2a data with Eladur in post-herpetic neuralgia (PHN). The data was presented at the 27th Annual Meeting of the American Pain Society in May 2008. In fact, the data was strong enough to attack Alpharma to license the patch, which brought $20 million in an upfront payment in September 2008. Unfortunately, when King acquired Alpharma, development plans for Eladur changed, which results in a failed phase 2b study in lower back pain in April 2011. We believe this was a flawed trial and indication, clearly outside the capabilities of a topical pain patch designed for indications like PHN. As a result, the partnership ended and DURECT has been search for a new partner to move Eladur forward ever since.

Pfizer, who acquired King, walking away from Eladur was not a surprise. Eladur should be developed for PHN, and PHN is a niche indication. Lidoderm dominates the market with nearly $1 billion in sales in 2012. NeurogesX capsaicin (8%) patch, Qutenza, for PHN has been a commercial failure due to poor tolerability and reimbursement. Eladur looks clearly superior to Qutenza, but the range in sales of PHN patches creates uncertainty.


Therefore, we believe additional data is necessary head-to-head versus Lidoderm before the true market opportunity for Eladur can be assessed. It is possible that DURECT may look to conduct some of these studies alone, especially if Remoxy is approved. However, ultimately the company is seeking a development partner to move back into a phase 2b for PHN. Management has not given any timeline for a partnership, only saying that discussions are ongoing. We view any deal for Eladur in 2013 as pure upside to investors.

...Sufentanil Patch...

DURECT has successfully completed phase 2b clinical studies with TRANSDUR-Sufentanil patch (TSP). TSP utilizes the same TRANSDUR delivery technology as Eladur, only delivering sufentanil instead of bupivacaine. DURECT designed the product to provide continuous delivery of sufentanil for up to seven days from a single application for the treatment of chronic pain. The product is similar to Johnson & Johnson's (JNJ) former billion-dollar transdermal patch Duragesic, but may offer distinct advantages in terms of size (~1/5th the size of Duragesic) and length of application (7 days vs. 3 days).

DURECT is actively seeking a development partner for TSP on the backs of phase 2b data first reported in March 2009. The data showed that patients currently on Duragesic (transdermal fentanyl patch) can switch over to sufentanil without experiencing any clinically relevant serious adverse events. The product also has demonstrated rapid onset of action and improved pharmacokinetics over generic fentanyl patches. Based on this data, we believe TSP is phase 3 ready.

Securing a partner for TSP remains a challenge for the company. In our view, we see this as only a niche product. Duragesic is available generic and although TSP provides some interesting advantages in terms of size and dosing, we are unconvinced that peak sales are meaningful enough to support an expensive phase 3 program and NDA filing. Still, DURECT reports being in discussion with potential interested parties, and similar to Eladur, any deal would be pure upside for shareholders.

Don t Forget About ALZET Pumps & LACTEL Polymers

DURECT currently manufactures and distributes ALZET miniature, implantable osmotic pumps and accessories used for experimental research in mice, rats and other laboratory animals. The company controls the rights to these products on a worldwide basis. DURECT markets the ALZET product line through a direct sales force in the U.S. and through a network of distributors outside the U.S.

ALZET pumps continuously deliver drugs, hormones and other test agents at controlled rates from one day to four weeks without the need for external connections, frequent handling or repeated dosing. In laboratory research, these infusion pumps can be used for systemic administration when implanted under the skin or in the body. They can be attached to a catheter for intravenous, intracerebral, or intra-arterial infusion or for targeted delivery, where the effects of a drug or test agent are localized in a particular tissue or organ.

DURECT acquired the ALZET product line from ALZA in April 2000. In 2012, we estimate that ALZET contributed $7.5 million in revenues to DURECT. For 2013, we estimate ALZET at $8 million. We model a similar amount for 2014 and 2015.

The company also designs, develops and manufactures a wide range of standard and custom biodegradable polymers based on lactide, glycolide and caprolactone under the LACTLE brand for pharmaceutical and medical device clients for use as raw materials in their products. These materials are manufactured and sold directly from DURECT s facility in Alabama and are used both internally and by third-party customers for a variety of controlled-release and medical-device applications, including several FDA-approved commercial products. All polymer production is in accordance with the International Pharmaceutical Excipients Council (IPEC) Good Manufacturing Practices guidance for Bulk Pharmaceutical Excipients. Production is conducted in ISO 8 clean rooms with controlled temperature and humidity. Both Drug and Device Master Files (DMFs) are maintained with the FDA to support regulatory filings for customers. LACTLE contributed approximately $3.7 million in revenues to DURECT in both 2011 and 2012. We model a similar amount in 2013 and 2014.


What s It Worth

Combined sales of ALZET and LACTLE products have been consistently growing over the past several years. The chart below is taken from the company s historic filings and shows the growth in revenues from ALZET and LACTLE and the gross margin for the business.

2005 2006 2007 2008 2009 2010 2011 2012

Revenue $6.9 $8.1 $8.3 $8.8 $9.1 $10.5 $10.6 $10.6

Gross Profit $4.1 $4.9 $5.0 $5.4 $5.8 $6.6 $6.2 $5.9

Gross Margin 59% 60% 61% 62% 64% 63% 58% 56% Source: DURECT Corp.

These product lines have been pretty steady over the past few quarters. ALZET and LACTLE contribute revenues to the top-line and solid cash flow to help reduce operating burn. We see this business worth approximately $25 to $30 million in value based on 2.5x to 3.0x revenues. Below we have modeled out projected ALZET and LACTLE sales for the next ten years and arrived at a net present value of $30 million based on discounted cash flow. This equates to a value of $0.30 per share.

Stock Attractive

In the past we've written that Remoxy has at least a 50/50 chance at approval. We still believe that to be the case; in fact we think the odds go up substantially after Pfizer files the application. We suspect that Pfizer will provide an update on the potential NDA filing for Remoxy in the next few months (guidance is for this fall ). If all goes well, we should see a re-filing of the NDA at some point around the middle of 2015.

In the meantime, the Posidur PDUFA is scheduled for February 12, 2014. We think the odds of approval are 50/50 given the previously demonstrated efficacy of the drug in shoulder surgery and hernia and the failure of the phase 3 trial BESST. Pacira has done a nice job in carving out the new market for drugs like Exparel and Posidur, so approval would be a major positive event for the company. If Posidur is met with a complete response letter, which seems to be the consensus based on our rudimentary investor poll, we believe the company can quickly move forward with a phase 3 gall bladder removal study in 2014 and re-file in 2015.

The stock is currently trading at $1.26 per share. We value Durect, as we value all biotech companies, based on the risk-adjusted probability of future cash flows. Based on our analysis, Remoxy is worth $2.00 per share and Posidur is worth $0.35 per share. That gets us to $2.35. Adding in the $21.3 million ($0.21 per share) in cash on the books as of June 30, 2013, another $0.30 for ALZET and LACTLE, and another $0.30 for the pipeline, which includes Relday and ORADUR-methylphenidate, that brings us up to roughly $3.00 per share.


PROJECTED INCOME STATEMENT

Durect Corporation - Income Statement

DURECT Corp 2011 A 2012 A Q1A Q2A Q3E Q4E 2013 E 2014 E 2015 E 2016 E

Posidur (Royalty) $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 YOY Growth - - - - - - - - - -

Remoxy (Royalty) $0 $0 $0 $0 $0 $0 $0 $0 $0 $0.0 YOY Growth - - - - - - - - - -

Sufentanil-Patch (Royalty) $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 YOY Growth - - - - - - - - - -

Eladur (Royalty) $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 YOY Growth - - - - - - - - - -

Relday (Royalty) $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 YOY Growth - - - - - - - - - -

ORADUR-Opioids (Royalty) $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 YOY Growth - - - - - - - - - -

ORADUR-Methylphenidate (Royalty) $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 YOY Growth - - - - - - - - - -

Alzet Pumps & Lactle Polymers $11.1 $10.6 $3.2 $3.0 $2.9 $3.0 $12.2 $11.5 $12.0 $12.0 YOY Growth - -5.0% 13.4% 17.3% 7.3% 22.5% 14.9% -5.4% 4.3% 0.0%

Collaborative Revenue $22.4 $42.5 $0.9 $0.9 $0.7 $0.7 $3.2 $10.0 $15.0 $15.0 YOY Growth 11.3% 90% -98% -59% -38% -14% -92% 210.8% 50.0% 0.0%

Total Revenues $33.5 $53.1 $4.2 $3.9 $3.6 $3.7 $15.4 $21.5 $27.0 $27.0 YOY Growth 6.0% 58% -90% -18% -6% 13% -71% 39.9% 25.6% 0.0%

Cost of Goods Sold $4.7 $4.7 $1.7 $1.0 $1.1 $1.2 $5.0 $4.7 $4.80 $4.80 Product Gross Margin 57.6% 56.0% 48.8% 65.7% 62.1% 60.0% 58.9% 59.0% 60.0% 60.0%

SG&A $13.6 $12.1 $2.9 $3.2 $3.0 $3.2 $12.3 $12.5 $13.0 $13.5 % SG&A 40.5% 22.8% 69.9% 81.9% 83.3% 86.5% 80.1% 58.1% 48.1% 50.0%

R&D $34.1 $20.3 $4.8 $4.8 $4.6 $5.0 $19.2 $20.0 $22.0 $24.0 % R&D 101.7% 38.2% 115.3% 123.4% 127.8% 135.1% 125.1% 93.0% 81.5% 88.9%

Operating Income ($18.9) $16.1 ($5.2) ($5.2) ($5.1) ($5.7) ($21.2) ($15.7) ($12.8) ($15.3) Operating Margin - 30.3% - - - - - -73.1% -47.4% -56.7%

Interest & Other Net $0.1 $0.1 $0.0 $0.0 $0.0 $0.0 $0.1 $0.1 $0.1 $0.2

Pre-Tax Income ($18.8) $16.2 ($5.2) ($5.1) ($5.1) ($5.7) ($21.1) ($15.6) ($12.7) ($15.1)

Taxes $0 $0.0 $0.0 $0.0 $0.0 $0.0 $0.0 $0.0 $0.0 $0.0 Tax Rate 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%

Net Income ($18.8) $16.2 ($5.2) ($5.1) ($5.1) ($5.7) ($21.1) ($15.6) ($12.7) ($15.1) YOY Growth - - - - - - - - - -

Net Margin - 30.5% - - - - - -72.6% -47.0% -55.9%

Reported EPS ($0.21) $0.18 ($0.05) ($0.05) ($0.05) ($0.06) ($0.21) ($0.15) ($0.12) ($0.13) YOY Growth - - - - - - - - - -

Shares Outstanding 87.4 88.6 101.9 102.0 102.2 102.5 102.1 105.0 110.0 115.0 Source: Zacks Investment Research, Inc. Jason Napodano, CFA


HISTORICAL ZACKS RECOMMENDATIONS

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small-cap research - jason... · current recommendation buy prior recommendation neutral date of...

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