Expert Financial Analysis and Reporting

Introduction

This report is an update on my thinking on Cytokinetics. It should be read in conjunction with earlier reports, especially my initiation report of March 15, Cytokinetics: Critical Phase IIB Data is Upcoming in 2013 for Omecamtiv Mecarbil and Tirasemtiv (CYTK, $6.30).

In that report, I first recommended purchase and I continue to do so with this report.

Investment Overview

Cytokinetics is pioneering a novel drug development technology based on a deep understanding of the biology of muscle contractility. It is relatively unique in this space and has a strong leadership position and novel products. Its research has led to the discovery of two unique molecules that are in late stage development and have great commercial potential. Omecamtiv mecarbil improves cardiac contractility and is in two phase IIb trials in congestive heart failure; it is partnered with Amgen. Tirasemtiv increases skeletal muscle contractility and is in a phase IIb trial in ALS; it is unpartnered.

An extremely careful and thorough clinical development program that was begun in 2005 has provided strong evidence that suggests that omecamtiv mecarbil will be an effective drug. Amgen and Cytokinetics are now conducting two phase IIb programs that are the final studies before making the decision on whether to proceed to phase III. The ATOMIC-AHF trial is studying the acute use of the intravenous dosage form of omecamtiv mecarbil in hospitalized patients and COSMIC-HF is meant to determine the oral dosage form that will be used in phase III trials. The promise of omecamtiv mecarbil is in chronic use outside the hospital using the oral dose. Acute use in the hospital with the IV dosage has limited commercial potential as current therapy is effective and there is no significant unmet medical need. However, the IV dose is important in that some patients will be started in the hospital on the IV and switched to and discharged on the oral.

Many small companies developing drugs rush through clinical trials and then find that they have not properly anticipated and dealt with key issues. They often end up with complete response letters form the FDA requiring additional trials that result in several years of delay. Amgen and Cytokinetics have been extraordinarily careful in their clinical development program and this gives hope that they will avoid this pitfall.

If there are no problems arising from ATOMIC-AHF and COSMIC-HF, omecamtiv could begin phase III trials in 2H, 2014. These will be large trials involving several thousand patients and their durations will depend on the primary endpoint. If the FDA demands overall survival as the primary endpoint, the trial could take three or more years so that topline results would come in 2017 and approval potentially in 2018. If the FDA accepts reduced hospital admissions and some measures relating to quality of life as mixed primary endpoints, approval could come in 2017.

I know that at this point some readers are thinking why should I be interested in a drug that is still three to four years from commercialization. I would offer several reasons. Congestive heart failure has a very profound health effect on individuals and a concomitant effect on national healthcare spending. It occurs in 2.4% of the US population (primarily older patients) and because of the aging baby boomer population this percentage will increase. It is a chronic disease that patients may live with for some years but short term exacerbations often lead to acute hospital stays. It is the most frequent cause of hospitalization for people over 65 and there are about 1 million hospitalizations and discharges from the hospital in which CHF is determined to be the primary cause. There are an additional 1 million hospitalization in which CHF is listed as a secondary cause. There is an enormous unmet medical need for an orally effective agent for congestive heart failure. This is a multi-billion dollar opportunity in which Amgen and Cytokinetics have a commanding development lead. In my opinion, omecamtiv mecarbil is one of the most promising drugs in development in the biopharma industry in terms of both sales and medical significance.

The second drug in development is tirasemtiv; whereas omecamtiv mecarbil increases cardiac contractility, it increases skeletal muscle contractility. It has applications in several disease states but the lead indication is in ALS. Tirasemtiv does not address the neurological pathology that causes nerve degeneration and loss of muscle function, but by increasing the response of muscles to diminished nerve impulses it can improve quality of life and perhaps in doing so could prolong life. Cytokinetics has full rights to this drug on a global basis. The drug is currently in a phase IIb trial called BENEFIT-ALS that could report topline results in 1Q, 2014.

BENEFIT-ALS is a phase IIb trial and in its base case, Cytokinetics is assuming that a second confirmatory phase III trial will be needed if this trial is successful. However, if the results in BENEFIT-ALS are strong on the primary endpoint of ALSFRS-r and the secondary endpoints that relate to quality of life are supportive, there is some chance for accelerated approval based only on the results of BENEFIT-ALS. This could lead to approval in 2015. There is enormous pressure from the ALS community to get drugs on the market as patients generally have a life expectancy of 3 to 5 years from diagnosis and suffer a terrible deterioration in quality of life as the disease progresses. There is also a great unmet need for a drug to treat ALS as only one drug has been approved in the last 20 years. If a second confirmatory trial is required, approval would likely be in 2017. In past reports, I have estimated that the potential sales for tirasemtiv in ALS are $700 million in the US and about the same in foreign markets.

The performance of the stock in the next year will obviously be dependent on the results of the ATOMIC-AHF, COSMIC-HF and BENEFIT-ALS trials. I think that the results from ATOMIC-AHF and COSMIC-HF will be positive and that omecamtiv mecarbil will be advanced to a phase III trial in 2H, 2014. Announcement of the decision to move to phase III could be an important boost for the stock. This could occur in 1H, 2014.

The results of the ATOMIC-AHF trial will be presented at the European Society of Cardiology or ESC on September 3 in Amsterdam. The same results will also be presented at the Heart Failure Society of America or HFSA Conference on September 23 in Orlando, Florida. It is very important to understand that this trial may not reach the primary endpoint of dyspnea for reasons that are explained in detail in this report. However, this is not likely to affect the decision to go forward into phase III. Management has repeatedly stated that reaching this endpoint is not essential for beginning phase III. This potential outcome is well known, but nevertheless there is the potential for a short term negative reaction if some news agency puts up the headline that ATOMIC-AHF failed to reach its primary endpoint. I want readers to be prepared for this possibility.

ATOMIC-AHF results have been unblinded and the results are known to Amgen and Cytokinetics. However, they have not been released as it is customary for companies to release results from major trials at key medical conferences where the lead investigators present the results to their peers. This is the reason why topline results won't be released until September 3 at the ESC conference. I think that if the results were discouraging, there would have been an announcement as this would be a material event. I also think that the acceptance of this trial as a late breaker presentation in ESC and HFSA suggests that the trial was successful. Finally, Amgen on June 12 extended its collaboration with Cytokinetics on omecamtiv mecarbil to include Japan. I don't think they would have done this if they thought that the results of ATOMIC-AHF would result in a decision to not go to phase III.

I think that the gating factor for beginning a phase III trial of omecamtiv mecarbil is the data from COSMIC-HF. I think that results will be positive and that topline data will be reported in 1H, 2014. This should result in a decision to move forward into phase III shortly thereafter and this could be a major boost to the stock.

I have somewhat less confidence in my ability to project the outcome of BENEFIT-ALS. The development has been well thought out and conducted, but has not been as methodical as the omecamtiv mecarbil development. Also ALS has been a graveyard for drug development as no new drugs have been approved in over 20 years. I think that there is high risk with this trial. I think that if BENFIT-ALS is successful, there is the potential for an asymmetric upside move even if Cytokinetics has to perform a confirmatory study. Again, the topline data should be released in 1Q, 2014.

Cytokinetics has a strong cash position as I estimate that it will end the year with $45 to $50 million of cash. The agreement with Amgen on omecamtiv mecarbil has the potential to bring in up to $650 million in milestones, which the Company has indicated are primarily pre-commercial. As a guess, this could result in $400 million of cash infusions between now and the commercial introduction of omecamtiv mecarbil in 2017 or 2018. If the results of BENEFIT-ALS are strikingly good and lead to the potential for accelerated approval, Cytokinetics has the financial potential to develop the product entirely for its own account. If the data is encouraging, but a second confirmatory trial is required, I think that it is more likely that Cytokinetics would seek a partner which would lead to a substantial upfront payment in 2014. Again as a guess because it would depend on the data, this could be a payment on the order of $50 to $75 million.

Putting the ATOMIC-AHF Trials in Perspective with the Entire Clinical Program

The first human was dosed with omecamtiv mecarbil in 2005. Since then, Cytokinetics and its partner Amgen have completed seven phase I trials involving 203 patients. They have further conducted two phase IIa trials, a 45 patient trial in stabile heart failure and a 94 patient trial in ischemic cardiomyopathy (heart failure caused by heart attacks). These phase II patients had experienced a significant deterioration in the function of their heart muscle due to damage from heart attacks, prolonged hypertension and other causes. These patients are at risk of dangerous forms of irregular heartbeats due to the damaged heart muscle that can cause sudden cardiac death. The most common symptoms are dyspnea (breathlessness) and peripheral edema (swelling of the legs).

The phase I and phase IIa studies of omecamtiv mecarbil have resulted in the selection of an intravenous dosage form and also three closely related oral dosage forms. Amgen and Cytokinetics believe they have demonstrated safety and tolerability as well as characterizing the pharmacokinetics and pharmacodynamics of the drug. Pharmacokinetics determines how the body absorbs a drug, how it is distributed throughout the body and chemical changes (metabolism) that occur to the drug in the body. Pharmacodynamics is how the drug affects the body, its mechanism of action and the relationship between drug concentration and effect. Pharmacokinetics is essentially the study of what the body does to the drug and pharmacodynamics is the study of what the drug does to the body.

The phase IIa trials were randomized, placebo controlled trials that have shown in healthy volunteers and in heart failure patients that there is a ruthlessly consistent (CEO Robert Blum's words) dose dependent effect of omecamtiv in improving cardiac performance with increasing plasma levels. This is a very strong indication that it will be an effective drug. The ATOMIC-AHF trial is a continuation of the long, extremely careful and thorough phase I and II programs. Proof of concept of drugs often relies on a phase IIb trial, but in the case of ATOMIC-AHF, it is more of a continuation of a long series of trials that have largely determined proof of concept.

Design of ATOMIC-AHF Trial

ATOMIC-AHF is a randomized trial that compares an intravenous dosage form of omecamtiv mecarbil to placebo in patients who have been hospitalized for heart failure. The study was done over a 48 hour period. The primary endpoint was dyspnea (shortness of breath) which was measured at 6, 24 and 48 hours. Previous patient populations studied had earlier stages of heart failure; the patients in ATOMIC AHF are the most severely ill patients yet studied in the clinical trials and are likely to be characteristic on the most severe group of heart failure patients for which omecamtiv mecarbil may be used if it is approved.

The phase I and phase IIa trials provided information on clinical efficacy and safety that encouraged the companies to begin the ATOMIC-AHF phase IIb trial in acute heart failure patients with the intravenous formulation of omecamtiv. This trial is a dose escalation trial designed to assess both efficacy and safety as the dose is increased. Previous trials have suggested that the dose effect in humans plateaus at 400 ng/ ml. Obviously, it makes no sense to go above this dose but the companies have to answer the question of what blood levels are effective and what are the side effects associated with these doses.

In order to answer this question, the company designed a phase IIb trial that enrolled three cohorts of patients starting with a low dose in the first cohort. The first cohort of patients began the trial in April of 2011 at a dose of 115 ng/ml. The second cohort began enrolling in May of 2012 at a dose of 230 ng/ml. The third and final cohort began enrolling at 330 ng/ml in November of 2012 and completed enrollment in early 2013. The progression from the first to the second and then the third cohort indicates that there have been no worrisome safety issues at the two lower doses.

ATOMIC-AHF which is short for Acute Treatment with Omecamtiv Mecarbil to Increase Contractility in Acute Heart Failure Patients. The primary endpoint of ATOMIC-AHF is dyspnea (shortness of breath) in patients with left ventricular systolic dysfunction hospitalized for acute heart failure. (Note: The left ventricle pumps oxygenated blood into the aorta from which it is distributed throughout the body. Systole is the contraction of the left ventricle that drives blood out of the heart). The secondary endpoints are: (1) additional measures of dyspnea, (2) patients' global assessments of how they feel, (3) change in N-terminal pro brain-type natriuretic peptide (a biomarker associated with the severity of heart failure) and (4) short-term clinical outcomes in these patients. The trial will also evaluate the relationship between plasma concentrations and echocardiographic parameters.

The ATOMIC-AHF trial will give an insight into the clinical benefit of omecamtiv for short term usage of the intravenous dose in hospitalized patients. However, this is not a significant unmet medical need and has meaningful, but much less potential than an oral formulation for outpatient usage. One therapeutic goal of omecamtiv is to treat a patient in the hospital setting and then switch them to the oral form when they are discharged. The therapeutic aim is to sharply reduce readmissions. A second goal is to give the patients an oral dosage form that will keep them out of the hospital. The oral is by far the most important dosage form.

Amgen and Cytokinetics are most focused on the secondary endpoints in assessing whether omecamtiv mecarbil will progress to a phase III trial. The dyspnea primary endpoint was included to see if there might be a possible reading for an endpoint that regulatory authorities consider a sign of clinical benefit. While dyspnea is a possible registration endpoint for trials in congestive heart failure, it is probable that the endpoint that will be used in the omecamtiv mecarbil phase III will be a composite of overall mortality and hospital readmissions.

What Will the ATOMIC-ALS Results Be?

The Company has locked the database and unblinded the data so that they know what the results. However, it is customary to let the lead investigators present results on significant trials at major medical meetings that are widely attended by their peers, hence, the decision to present topline results at ESC.

I think that we can assume that the companies feel the results are positive and supportive of continuing into phase III. If the results were disappointing, they would be required to disclose this as it would be a material event. I also think that the inclusion of these studies by conference administrators as late breaking presentations in the two upcoming conferences signals that the results are positive.

However, it is quite possible that the primary endpoint of dyspnea will not be achieved and there may be no demonstration of long term benefit. It is extremely difficult to reverse damage to the heart that has occurred over many years in just a two day trial. The Companies have consistently said that with ATOMIC-AHF they are looking for a confirmation of pharmacokinetics, pharmacodynamics, safety and tolerability that has been demonstrated in the previous phase I and II trials in a very sick and vulnerable part of the congestive heart failure patient population. The trial does not have to reach the dyspnea primary endpoint for the companies to deem the trial as supportive of beginning a phase III program.

Data is being collected out to 30 days and to six months to make sure there are no adverse outcomes associated with the treatment versus placebo. It may be reasonable to assume that administration of omecamtiv mecarbil for two days is not going to have a treatment benefit out to 30 days or six months and this was not the expectation or objective of the trial. As was previously pointed out, the companies were looking for dose-dependent and plasma concentration related effects.

Thoughts on COSMIC-HF

The use of omecamtiv mecarbil in many cases will begin with an intravenous administration in the hospital and the patient will then be switched to an oral dosage form that will be continued after discharge. COSMIC-HF is a Phase II double-blind, randomized, placebo-controlled dose escalation study designed to evaluate three modified release oral formulations of omecamtiv mecarbil in congestive heart failure. The three oral forms are ones that were studied in a prior Phase I study and are not that different one to another. This is a fine tuning of the final oral formulation.

COSMIC-HF will be conducted in two phases. The first will be a dose escalation phase which will compare the pharmacokinetic profile of the three oral dosage forms. This will first be done at 25 mg twice daily in cohort one and then at 50 mg twice daily in cohort two; each cohort is dosed for seven days. The first cohort has been completed and the second is enrolling. This will result in the selection of the oral dosage form for a second expanded phase of the trial that will also be used in phase III. This expansion phase will be a randomized trial of 25 mg twice per day, 50 mg twice per day and placebo. The Company has not given guidance other than to say that it expects to initiate the expansion phase in late 2013 and that they are not expecting to release data until 2014.

BENEFIT-ALS Trial in ALS

Cytokinetics is conducting a phase IIb trial in ALS called BENEFIT-ALS. It was intended to be a randomized trial in ALS patients over a period of 12 weeks and began enrollment in November of 2012. It was scheduled to enroll up to 500 patients and complete enrollment in mid-2013. Topline data originally was expected to be presented at the at the ALS M&D meeting in December 2013.

In April 2013 the Company announced that it had enrolled 200 patients and the target enrollment of 500 was reached by mid-year as planned. However, there was a surprise announcement on July 8, 2013 that a drug assignment error was detected by Cytokinetics that resulted from a programming error by a third party involved in the trial. The study drug assignment caused 58 patients initially randomized to and treated with tirasemtiv to receive placebo at the subsequent visit and for the remainder of the study.

Once the error was detected, Cytokinetics took immediate steps to ensure that no further incorrect study drug assignments occurred and to correct the programming error. In addition, they convened the Data Safety Monitoring Board or DSMB to assess whether this error had impacted the safety of the 58 affected patients. After a review, the DSMB reported no safety concerns regarding the 58 patients. At that point, over 450 patients had been enrolled into BENEFIT-ALS and over 100 had completed 12 weeks of treatment. Cytokinetics and all clinical trial site personnel remained blinded to the specific patients affected by the error although it was known that they were enrolled in several different countries.

Following consultation with experts, clinicians and regulatory consultants, Cytokinetics proposed to the FDA and other regulatory authorities a protocol amendment that would preserve the scientific value and integrity of BENEFIT-ALS. The protocol was amended to exclude not only the 58 patients from the primary efficacy analysis but all patients randomized in any block that included these 58 patients regardless of the treatment they received. This was a conservative decision that was made to ensure that all patients included in the primary analysis would have been randomized concurrently between the drug and placebo group.

In order to retain the intended statistical power, the target enrollment has now been expanded to approximately 680 patients in order to replace all patients in randomization blocks in which the programming error occurred and who were excluded from the primary efficacy analysis. This will result in the enrollment of approximately 180 more patients than the 500 who have been enrolled.

The Company expects to now complete enrollment in 2H, 2013 and announce topline results in early 2014. This is a delay from the previous goal that would have resulted in the release of topline data by yearend 2013 with data presented at the ALS M&D meeting at the end of the year. They might now present the data at the AAN Meeting that takes place in 2Q, 2014, but topline data could be presented earlier. This protocol amendment will add $5 million to the cost of BENEFIT-ALS.

There is a solid basis for the decision to study an additional 180 patients and not just 58. It is to assure that the placebo patients and tirasemtiv patients are enrolled concurrently. There is the potential that there might be different characteristics between patients enrolled at centers at different points in time. For example, the first patients selected for enrollment might be sicker than subsequent patients enrolled at the same center. This could result in bias for or against tirasemtiv that could not be determined or controlled but would affect the integrity of the data. The excluded patients will not be included in the primary analysis but will be analyzed separately.

What Comes After BENEFIT-ALS

BENEFIT-ALS is a phase IIb study and the Company believes that the most likely outcome is that they will need to do another confirmatory phase III trial. The treatment period would likely be longer than three months in BENEFIT-ALS, perhaps six months. In order to have 90% statistical power, the trial would likely be less than 680 patients but more than 500. It could start in 2H, 2014 and complete in early 2016. This would allow for an NDA filing in 2016 and approval in 2017.

In ALS, the unmet medical need is so high that there might be a quicker route to regulatory approval. There have been no new drugs introduced in the last 20 years and there is enormous pressure on the FDA from the ALS patient community to get new therapy to patients. It is possible that tirasemtiv could be designated as breakthrough therapy that provides for a condensed development program. This might be the case if the data on the primary endpoint of ALSFRS-r are not just borderline but are convincing and are supported by secondary endpoints. Cytokinetics has to prepare for the possibility that BENEFIT-ALS will support an accelerated registration while at the same time also planning to conduct a confirmatory phase III trial.

Financial Considerations

In June 2013, Cytokinetics signed an agreement to give Amgen rights to omecamtiv mecarbil in Japan and announced a new collaboration with Astellas. These two financial agreements brought in $15 million of upfront payments from Amgen, $16 million from Astellas and an additional $10 million from the sale of stock to Amgen. The deal with Astellas will also provide $24 million to support cash burn on research over the next two years. The Company ended the second quarter with $75 million of cash.

During the second quarter conference call, Cytokinetics issued guidance for the second half of 2013. Management estimates that cash arising from revenues will be $40 to $42 million in 2013. It anticipates the amount of cash to be spent on R&D at $52 to $55 million for the year and S, G&A expenditures at $15 to $16 million. Going through the math, this implies that the Company will end the year with about $45 to $50 million of cash.

The agreement with Amgen on omecamtiv mecarbil gives Cytokinetics double digit royalties. It also has the potential to bring in up to $650 million in milestones, which the Company has indicated are primarily pre-commercial. Arbitrarily assuming this implies about 60%, this means that Cytokinetics could receive around $400 million of cash infusions from Amgen between now and possible launch of omecamtiv mecarbil in 2017 or 2018. These milestones probably are based on beginning phase III (2014), successful completion of phase III (2016 or 2017), filing of an NDA (2016 or 2017) and FDA approval (2017 or 2018). However, management has not given any guidance on whether these are the milestones that will generate cash payments. Cytokinetics also has the right to invest the milestone payments in clinical and regulatory development, which would improve the Company's economics on omecamtiv mecarbil.

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