Expert Financial Analysis and Reporting

Meeting With CEO Steve Worland

Anadys' CEO Steve Worland was in town for the Piper Jaffrey conference along with Investor Relations head Amy Conrad. I wanted to get their thoughts on why Anadys had been performing so poorly since the stock offering of October 15, 2010 in which the company raised $23.3 million.

Key Points:

1. Uncertainty about the extent of the role that DAAs will play in treating HCV has led to potential Big Pharma partners for ANA 598 stepping back and reassessing their DAA partnering strategy for the time being.
2. Anadys chose to start a phase IIb on its own rather than running the risk that development could be interrupted as Big Pharma ponders their strategy for DAA partnering.
3. Investors had widely expected that Big Pharma would have stepped in by now and taken over clinical development of ANA 598. The change in outlook has been the catalyst for the decline in stock price.
4. The biggest risk to the stock is slower than expected enrollment in the phase IIb trial of ANA 598 that will start in 1Q, 2011. We will get some inkling of how enrollment is going in 2Q, 2011.
5. Large institutional investors remain steadfast in their holdings.

No Partnering Deal

It was widely expected by investors before the financing was announced that a partnering deal on Anadys’ lead product ANA 598 was probable by the end of 2010. While management was not fixing a time for the signing of a partnering deal, it certainly didn’t discourage speculation. When the company announced the financing, it said that it was doing so to give the company the option of continuing ANA 598 development without being dependent on a partnering deal. Many investors took this as a signal that Big Pharma had cooled its enthusiasm for doing a deal on ANA 598 and reacted negatively.

I asked Steve what he thought might have changed in Big Pharma’s thinking that has led to greater caution on partnering. He attributed it to a change in consensus thinking about the role of direct acting anti-virals (DAAs) in treating hepatitis C (HCV). He felt that a year or so ago the consensus thinking was that interferon and possibly ribavirin would be dropped from what is now the standard of care for HCV, the combination of interferon with ribavirin, and replaced with combinations of DAAs. There are currently three major categories of DAAs under development: protease inhibitors (PI), nucleoside polymerase inhibitors (Nuc) and non-nucleoside polymerase inhibitors (Non-nuc). In addition there are two less clinically advanced classes of DAAs, the NS5as and cyclophillins.

Until recently, Big Pharma was thinking that the likely future standard of care for HCV would be a combination of one or two PIs with a Nuc and/or Non-nuc. Interferon would likely be dropped from the regimen. Big Pharma was scrambling to put together a complete portfolio of DAAs and partnering interest was intense.

The urgency to partner lessened as consensus thinking shifted back to the point of view that interferon might remain as the backbone of the standard of care. This would mean that the role of DAAs would not be dominating standard of care but would just be a component. This uncertainty in thought process led to Big Pharma dragging its heels while it thought through the implications of this change in consensus thinking. Rather than putting its ANA 598 program on hold while waiting for Big Pharma to make up its mind, a process that could have gone on for many months, Anadys made the decision that it would raise the capital necessary to keep the ANA 598 ball rolling by starting the next step in the clinical process, the phase IIb trial of ANA 598.

The company believes that Big Pharma is now looking at two possible scenarios for DAAs. A baseline scenario now might be that DAAs are going to be important to HCV treatment, but not replace interferon. There remains the second and more optimistic scenario that DAA combinations could become the new standard of care. However, no one can really tell which scenario will prevail. Big Pharma now has to make its partnering decisions on the basis of either scenario prevailing. While this thought process matures, partnering enthusiasm has cooled.

Steve believes that in either scenario, Big Pharma will have to build a portfolio of DAAs and that the current cooling in partnering enthusiasm is only temporary. There are many unpredictable variables that will dictate whether Steve’s interpretation is correct. Most importantly, we are still in an early stage of clinical development for the DAAs in which such critical factors as potency in reducing HCV viral load, tolerability and safety of the therapy and resistance have not been determined for the overwhelming majority of the DAAs.

Clearly, the reaction of investors to the Big Pharma hiatus has been very severe and in Steve’s opinion over blown. He views the potential of partnering ANA 598 to be unchanged in probability of success, but just delayed. I am inclined to cast my ballot with Steve on this issue.

Steve noted that one of their major investors was irate over the action of the company stating that he did not feel that Anadys shareholders should have to fund the clinical development of ANA 598. Personally, I find this to be an inane argument. Does this investor want Anadys to twiddle its thumbs waiting for Big Pharma? I think that the decision to fund the phase IIb trial of ANA 598 was the correct one.

Onward and Upward With ANA 598 Clinical Development

Whatever the merits of management’s explanation, the funding development of ANA 598 development is now a fait accompli. The company now plans to begin its phase IIb trial in 1Q, 2011. This trial will enroll 275 patients of whom 200 will be given interferon plus ribavirin plus ANA 598 and 75 will be given interferon and ribavirin. Anadys is finalizing discussions with the FDA and will begin patient dosing in 1Q, 2011.

I am concerned about Anadys’ ability to recruit patients to participate in this trial. The two new protease inhibitors, telepravir and bocephravir, will be introduced in late 2011 or early 2012. My judgment is that doctors and patients will overwhelmingly prefer to go on therapy with either of these two agents in combination with interferon and ribavirin rather than an unknown new agent like ANA 598 combined with interferon and ribavirin. If I am correct, US enrollment will be slow and the trial will be heavily weighted toward foreign patients. This could cause a meaningful delay in the recruitment of patients.

Steve disagrees with this concern. He said that dialogue with clinical trial sites leads him to conclude that there will be no problem with US enrollment. He is extremely optimistic about enrollment in the phase IIb trial. Specifically, he thinks that milestones arising from the phase IIb trial will be as follows:

1. 1Q, 2011 Dosing begins in phase IIb trial.
2. 2Q, 2011 By the end of 2Q, 2011, Anadys will have 8 week results in all 200 patients in the trial who receive ANA 598 plus standard of care, i.e. interferon plus ribavirin.
3. 3Q, 2011 Anadys will have 12 week data on safety and efficacy of ANA 598.
4. 4Q, 2011 The safety profile on ANA 598 will have been established. This is key to the FDA giving the go ahead to begin the phase III trial. Based on the phase IIa trial data, efficacy will not be a gating factor. The phase III trial could actually begin before the completion of the phase IIb trial.

I hope that Anadys is right in these assessments of the enrollment of this trial but my gut tells me that the rate of enrollment will be disappointingly slow relative to Anadys expectations.

Analysts Are Lukewarm on Non-Nucleoside Polymerase Inhibitors Like ANA-598

There has been considerable experience with protease inhibitors, nucs and non-nucs in the treatment of HIV and this has been extrapolated to predict the outcome of DAAs in HCV therapy. The rap on non-nucs has been that they are not that potent and that resistance quickly develops. Hence, most analysts favor the PI and nuc categories of DAAs for HCV over non-nucs like ANA 598.

Steve believes that the analysts are incorrect in their thought process. He thinks that the Wall Street consensus view of categorizing drugs by their mode of action-PI, nuc or non-nuc- is wrong. He believes that the focus should be on individual molecules regardless of the class of DAA that they belong to. He thinks that each molecule should be looked at for its potency, safety, tolerability and no overlap of resistant patterns with other DAAs. He thinks that the phase IIa trial of ANA 598 hints that this is its profile. He believes that the phase IIb trial will be definitive on establishing if this is the case.

Steve says that Big Pharma representatives agree with his point of view.

Reaction of Investors

Anadys has a blue chip lineup of institutional investors that is rare for a biotechnology company. Most of these major investors participated in the recent offering. Wellington and Orbimed both bought stock in the offering to bring them to just undet the10.0% ownership level at which they would have to report each trade. QVT increased their position from 13.0% to 14.9%. Great Point increased ownership from 3% to 5+%. Clearly these sophisticated investors believe in ANA 598.

One of the problems of Anadys is that so much stock is locked up in major institutional hands that aren’t trading it. At the margin, smaller owners can have a significant impact on stick price while the institutions listed above remain steadfast.

Financials

The company netted $23.3 million with its October 15^th stock offering. On a pro forma basis, the cash position at September 30^th was $42.7 million. The company stated in its second quarter conference call that this will last until mid-2012 implying a quarterly burn rate of about $6 million over the next seven quarters. The burn rate is increasing due to the funding of the phase IIb trial of ANA 598.

With this projected burn rate the company would have about $25 million of cash in mid-2011 and $13 million of cash by year end. If a partnering deal is not consummated by 3Q, 2011, the company should raise more money in 2Q, 2011 or 3Q, 2011.. My feeling is that the most likely time for a partnering deal would be 4Q, 2011 or 1Q, 2012.