Expert Financial Analysis and Reporting

Purpose of This Report

I have written frequently about omecamtiv mecarbil, Cytokinetics’ extremely promising new drug for congestive heart failure (CHF). I believe that it has the potential to be a therapeutic breakthrough for CHF which can significantly reduce mortality and morbidity. I see it as an add-on therapy to current standard of care drugs like ACE inhibitors, ARBs and beta blockers so that should be broadly used in most CHF patients. All major drugs in these three classes are now generic, but when they were patent protected there were several drugs with sales of one to five billion in each of these three categories. I think omecamtiv has worldwide peak sales potential well in excess of $5 billion if the clinical profile suggested by phase 2 trials is replicated in phase 3 and then the real world.

As important as the medical benefit, I think that payors may also embrace this drug. With current standards of care, the average CHF patient is hospitalized on average 2 1/2 times per year. Each hospitalization can cause several thousands of dollars and if omecamtiv mecarbil can reduce re-hospitalization, it could greatly reduce payor costs for treating CHF.

Cytokinetics has been partnered with Amgen on this drug since 2005. Many investors have been concerned about the glacial pace of development and that Amgen was not discussing omecamtiv mecarbil in its presentations to investors; this led many investors to be cautious on the drug or even to write it off. I personally have been waiting for some (any) sign from Amgen about their view on the drug for the last five years. Until very recently, Amgen has been radio silent and I began to second guess my conviction on the drug. The silence now has been shattered like the first thunderbolt of a thunder storm and that is the reason for this note.

At a recent brokerage conference, Dr. Sean Harper, Executive Vice President of Research and Development for Amgen spoke for about 30 minutes and devoted about 5 minutes to omecamtiv mecarbil. This note summarizes his comments and I think that when you read them, it is obvious that he is extremely positive on the drug. I think that the successful completion of the COSMIC-HF trial late last year was the direct reason for his enthusiasm.

Investment Thesis in Brief

While Amgen and Cytokinetics have both hinted that they will soon announce plans to begin a long, extensive and expensive phase 3 trial, they have not yet officially announced that they are doing so. Hence, there remains some uncertainty on the part of investors about Amgen’s intentions. Amgen essentially has to make two decisions. The first is whether the drug has a meaningful therapeutic role. As you read through Dr. Harper’s comments, he leaves no doubt that Amgen believes that omecamtiv mecarbil is an important therapeutic advance in CHF.

The next decision for Amgen is whether the substantial investment (I estimate somewhere between $300 and $500 million) required to perform the phase 3 clinical trials is justified by the potential economic return. The long period that the drug has been in clinical development may limit its period of exclusivity to ten years. I discussed the patent situation at length in my report  Comments on the Patent Situation of Omecamtiv Mecarbil and I don’t think this is a stumbling block that will deter Amgen.

The other issue that could affect the economic return decision is that Amgen sublicensed rights to omecamtiv in Europe to Servier in July 2013 which means that they will only get a royalty on European sales. I am not sure what lay behind this decision because in June 2013, they licensed Japanese rights from Cytokinetics. They indicated that Servier had a better cardiovascular marketing infrastructure in Europe. I find this a bit strange, but it does limit potential sales and profit returns in Europe for Amgen, which may be partly offset by Servier sharing in costs of development. None of this meaningfully affects Cytokinetics’ profit potential. Net, net I would be extremely surprised if Amgen does not start a phase 3 in 2H, 2016.

I believe that omecamtiv alone is suffice reason for buying the stock at the current fully diluted market capitalization of $308 million. However, like a television commercial not only do you get omecamtiv when you buy Cytokinetics, you also get tirasemtiv which is in a phase 3 trial in ALS for which topline data will be available in mid-2017 and CK 107 that will report topline results from a phase 2 trial in the orphan disease spinal muscular atrophy in late 2016 or early 2017. And don’t forget an extensive number of pre-clinical candidates that are arising from the company’s clear leadership position in the biology of cardiac and skeletal muscle contraction. I am not going to go into a detailed analysis of the investment thesis for Cytokinetics in this note. I did this in December 7 2015 report called An Update on Potential (Highly Probable) Phase 3 Trial of Omecamtiv Mecarbil in Heart Failure  and I would urge you to read that note in conjunction with this one.

There is another aspect of omecamtiv that I wanted to elaborate on. Cytokinetics is slated to receive more than $600 million of milestone payments from Amgen on omecamtiv mecarbil of which half or $300 million is attributable to pre-commercialization events. It is logical to think that the final pre-commercialization event would be approval which could occur in 2021 or 2022 so that most of this $300 million is likely to be received at the backend of the 2016 to 2021 period. Then there is another $300 million to be received which is related to commercialization and sales milestones. Cytokinetics has the option of applying the pre-commercial milestones against clinical trial expense for omecamtiv which in return would give it roughly 50-50 economics with Amgen in the US and a royalty of up to 20+% on foreign sales. If they don’t elect this option, they will get a similar 20+% royalty in the US.

I think that Cytokinetics will exercise the option to apply some amount of this roughly $300 million of pre-commercialization milestones to clinical development. Beyond this, it has no other obligations so essentially it will not have to spend any of its own cash on the clinical trial of omecamtiv. So here in this scenario, we are looking at the Company receiving a very significant amount of the worldwide economics and yet not having to put up any more of its own cash to complete the phase 3.

Think also if the option is not exercised and omecamtiv is successfully developed and commercialized. Cytokinetics would receive about $300 million of cash in the next five years and perhaps another $300 million in the subsequent five years. It would also get a royalty that tops out at over 20%. If I am correct in thinking that peak sales in the late 2020s reach $5 billion, which would create $1 billion of annual royalties in the late 2020s. Not bad huh, and then there are tirasemtiv and CK-107 and the pre-clinical pipeline.

Summary of Dr. Harper’s Remarks on Omecamtiv Mecarbil

I listened to Dr. Harper’s remarks at the brokerage conference and took extensive notes which are reproduced in the following sections.

Mechanism of Action of Omecamtiv Mecarbil Is Exciting

Dr. Harper said that he is very excited about the data generated on omecamtiv mecarbil in the ATOMIC-AHF and COSMIC-HF phase 2 trials. He emphasized that the drug is based on novel and elegant biology research that was done at Stanford University and then spun out to Cytokinetics to develop and commercialize. Omecamtiv mecarbil is an activator of cardiac myosin which is a protein found only in heart muscle that plays an essential role in the contraction of the heart. He stated that this is a new and very unique approach to improving the functioning of the heart in patients with congestive heart failure.

He emphasized that the drug increases stroke volume. This is the amount of blood ejected in one contraction by the left ventricle. This is the chamber of the heart that pumps oxygenated blood through the aortic artery and into systemic circulation. There are several drugs called positive inotropes which have the same effect with the most well known being digitalis which was first used in heart failure by a Scottish physician in 1775.

Digitalis and other inotropes have a dramatic effect on patients causing them to quickly feel better as a result of an increase in oxygenated blood rushing through their arteries. However, these drugs have a major drawback because they make a damaged heart work harder and demand more oxygen; this can trigger cardiac arrhythmias that can then result in fatal heart attacks. Physicians have told me about situations in which they have used positive inotropes on a temporary basis in CHF patients to make them feel better. They then tell patients that they should not continue on the drug because it can cause a heart attack. The response of many patients is that they feel so much better that they will take this risk and elect to stay on the positive inotrope. Dr. Harper emphasized that the data shows that omecamtiv mecarbil has the therapeutic benefit afforded by inotropes, but (and this is critical) the heart does not have to work harder and increase the risk of a heart attack.

How Omecamtiv Mecarbil Differs from Positive Inotropes

Omecamtiv prolongs the period of systole which is the period of the heart beat when the heart muscle contracts and pumps blood from the heart chambers into the arteries. Positive inotropes like digitalis help the heart pump with more force and pump more blood with fewer heartbeats. Their mode of action is to increase the amount of calcium in the heart which is critical in causing the heart to contract. Omecamtiv mecarbil and the positive inotropes both cause the heart to pump more blood, but the critical difference is that omecamtiv does not make the heart work harder.

Dosage is Key for Omecamtiv Mecarbil

Omecamtiv has a therapeutic window. If you give too much of the drug, it prolongs the period of systole; remember this is the phase of the heartbeat in which the heart is contracting and pumping blood. If this occurs there is not enough time during diastole; this is the phase of the heartbeat when the heart muscle relaxes and allows the chambers to fill with blood. If this occurs, the chambers may not fill with enough blood and this can lead to a heart attack. This means that the amount of drug has to be kept in a therapeutic range. The purpose of the COSMIC-HF trial was to find a dose that would keep omecamtiv mecarbil in this therapeutic range. Dr. Harper says that an optimized formulation that was used in that trial achieved this goal very nicely.

Omecamtiv Mecarbil Remodels the Heart; What Does That Mean?

Patients with congestive heart failure have damaged hearts due to a heart attack or some other cause. Heart attacks destroy some amount of tissue and cause scar tissue in parts of the heart which are surrounded by normal tissue. This erratic cardiac architecture can affect the pumping action of the heart and its ability to pump enough blood. The central nervous system senses this and sends a message to the heart to pump harder. Asking a damaged heart to work harder (it is a muscle which enlarges as it works harder) causes the heart muscle to get larger and this leads to a floppy inefficient muscle under significant stress.

This change in the physiology of the heart of a CHF patient is referred to as remodeling and involves the overall heart size increasing with chamber volume getting bigger which leads to an increase in stress in the chamber walls. The data from COSMIC-HF suggests that this remodeling of the heart which occurs during heart failure is actually reversed during omecamtiv therapy; i.e. the heart returns to a more normal size. This is exciting because it means that the drug is not just addressing the symptoms of CHF, but is improving the condition of the heart; it partially reverses congestive heart failure.

Effect of NT-proBNP is also positive; this is Good

N-terminal pro b-type natriuretic peptide (NT-proBNP) is a protein produced in the heart that is released when the heart is working hard to pump blood and of course increases when the heart is stressed. It is an important biomarker for diagnosing and evaluating the severity of heart failure. Dr. Harper emphasized that as omecamtiv dose is increased, NT-proBNP decreases. This is another important indication that the heart is working less hard.

Dr. Harper’s Bottom-line

Dr. Harper feels that all of the data hangs together and points to a positive drug effect in pumping more blood without increasing the workload of the heart as positive inotropes do, The heart rate actually comes down and the central nervous system is not feeling obligated to flog the heart to pump more blood. All of these biological effects are moving the heart back toward a normal state (remodeling).

What Key Opinion Leaders Think?

Amgen has shown the phase 2 data to heart failure experts from all around the world. Dr. Harper has said that it has been quite unique in his experience to see such a uniformly enthusiastic response to the phase 2 data. In one way or another each expert has essentially said that they see this as the most compelling heart failure data set of all the drugs they have ever seen.

Medical and Economic Role of Omecamtiv Mecarbil in CHF

He believe that omecamtiv is an add-on therapy that can have a significant effect on morbidity and mortality which meets a great unmet medical need. He also emphasized that CHF is the number one cause of rehospitilization in the US. Patients are extremely expensive to care for as they are being hospitalized on average 2 1/2 times per year. The economic burden for health care systems is as high as any disease that exists. He believes that this drug can produce both great medical benefits while reducing costs for payors by reducing rehospitilization.