Expert Financial Analysis and Reporting

Summary and Investment Thesis
InSite Vision (INSV.OB) just reported that topline results for AzaSite Plus and DexaSite in the DOUBle trial were disappointing and failed to meet the primary endpoint of that trial. Clinical trials can fail because the drug(s) is ineffective, but they can also fail because of trial design and there are good reasons to believe that this was the case in this failure. Following an FDA meeting on August 19th we will know if there is a way forward for AzaSite and DexaSite. If so, this might require another phase III trial that would cost about $8 million to conduct and could report results in late 2015 or early 2016.

The Company’s other main product asset is BromSite. It reported results of a highly successful phase III trial earlier this year and results from a second confirmatory phase III trial are expected later this year for which the chances for success are excellent as it largely replicates the just reported trial. I see this drug as coming to the market in 2015 and as having up to $100 million of sales potential five years after launch.

The Company ended 1Q, 2013 with $4.5 million of cash. However, in April management completed a royalty deal for Besivance that brought in $15 million bringing the cash balance at that time to just under $20 million. Management has provided no guidance, but I estimate that the intrinsic quarterly burn rate of the Company is about $2 million per quarter without clinical trial expense. If this is correct and if the cost of a new phase III trial for AzaSite Plus and DexaSite is $8 million, I estimate that the Company will need about $35 to $40 million to continue operations and complete a new phase III trial for AzaSite Plus and DexaSite that could show topline results in late 2015 or early 2016.

This analysis suggests that the Company will need to bring in an additional $15 to $20 million or more of cash over the next two and one half years. Through the potential partnering of BromSite and equity offerings this seems achievable. If the Company does not do another phase III trial for AzaSite Plus and DexaSite, the cash needs are substantially less, but the product appeal is also diminished.

So how will the market treat the stock? My expectation is that the stock will weaken as the market digests the news on the DOUBle trial. However, I do not see a sharp decline due to the current cash position which will last the Company into mid, 2014 and the promise of BromSite. I then see the stock stabilizing as investors await further data analysis of DOUBle and the outcome of an FDA meeting on August 19 that will determine if there is a path forward for AzaSite Plus and DexaSite. Until that point, I can’t come up with a compelling investment reason to either buy or sell the. For investors who own the stock, I would advise them to sit tight, at least until late August.

DOUBle Trial Topline Results Were Disappointing
InSite Vision reported topline results from the key DOUBle trial on July 3, 2013. The trial did not meet the primary endpoint of complete clinical resolution of all clinical signs and symptoms of moderate to severe blepharitis. Blepharitis is a common, chronic eye disease characterized by inflammation of the eyelid with periodic acute flare-ups. Symptoms of blepharitis may include redness, swelling, flaking skin, cysts, “gritty” or burning sensations, itching and vision impairment. The acute flare-ups of this disease can be painful and extremely irritating. It is estimated that greater than 34 million people in the U.S. suffer from blepharitis. There is currently no FDA-approved drug treatment for blepharitis.

There were 1,112 patients enrolled in four arms of the study which included AzaSite Plus, AzaSite, DexaSite and DuraSite; the latter is the drug delivery vehicle for those three products and takes on the role of placebo. In addition, each arm was added to standard of care which is rinsing of eyelid margins twice a day. The primary endpoint was to show complete resolution of symptoms at day 15.

The results of the trial showed strikingly low resolution in each of the arms. Altogether only 57 patients out of over 1000 saw their symptoms completely resolve at day 15 as shown below:

Patients who achieved Disease Severity Score of Zero (Day 15)

AzaSite Plus: n = 25 (8.4% of patients treated with AzaSite Plus)
DexaSite: n = 17 (5.8%)
AzaSite: n = 8 (5.3%)
Vehicle: n = 7 (4.9%)

Interesting the study showed that the vehicle arm, which is effectively the standard of care or eyelid margin rinsing, is ineffective as judged by the primary endpoint. AzaSite Plus, DexaSite and AzaSite were all numerically superior to lid margin cleansing, but the numbers involved were too small to approach statistical significance.

Is There A Way Forward with AzaSite Plus and DexaSite?
The most immediate observation of management and one that I agree with is that this data shows that blepharitis is a chronic disease and it is unrealistic to expect any treatment to work in the short time span of 15 days. Sometimes clinical trials fail because the drug(s) is ineffective and sometimes they fail because of inappropriate trial design. Management feels that the latter may be the case for the DOUBle trial if the results show that standard of care is ineffective.

It has been the hypothesis of InSite management that blepharitis is a chronic disease. However, FDA insisted on the 15 day acute endpoint. This was not because FDA was stupid or obstinate. Rather it reflects conventional wisdom among treating physicians about the nature of blepharitis. DOUBle is a landmark study in the treatment of blepharitis and one of FDA’s goals was to see if eyelid margin rinsing is an effective acute treatment. Remember that the goal of FDA is to advance treatment paradigms, not just to approve or disapprove new drugs.

If the conclusion that is drawn from the trial is that this primary endpoint is not the correct one then the next question to ask is what the right primary endpoint might be? At this point, we don’t know. However, there is an absolute wealth of data in the DOUBle trial far beyond just the disappointing topline results. There will be close analysis of results by various patient groupings and there are also quality of life and long term treatment (much beyond 15 days) results that will be analyzed. Out of all this data, it may be possible to come up with new understanding on the nature of the disease, i.e. is it acute or chronic, and potentially to work with FDA to determine a more appropriate primary endpoint.

InSite will be doing further analysis on the data and will release new information as they go. The Company will then meet with the FDA on August 19 to discuss the data and see if there is a path forward. This could involve a new phase III trial design with different endpoints. For example, AzaSite Plus and DexaSite did demonstrate statistically significant improvements over vehicle in the clinical signs and symptoms of blepharitis at day 15.

There are two distinct outcomes that will become apparent to investors sometime after August 19. One would be that it is futile to go on developing AzaSite Plus and DexaSite. The exact opposite case would be that the FDA and company agree on a new phase III design. In the latter case, it would probably take two to two and one half years to complete the study (sometime in late 2015 or early 2016) and present topline results. Management estimates the cost of such a study at $8 million. The next question to ask is what the prospects are for InSite if AzaSite Plus and DexaSite development is abandoned and what is the strength of the balance sheet.

BromSite
Earlier this year, the results of the first phase III trial of BromSite trial were announced and were encouraging. It indicated that 65% of patients reached the primary endpoint of clearance of inflammatory cells 14 days after cataract surgery. The clinical significance of this endpoint is that inflammatory cells are linked to the rare occurrence of cystoid macular edema, which carries the risk of blindness. The current market leader is Bausch & Lomb’s BromDay and Bausch is just launching Prolenza, the presumed successor to Bromday. On the same endpoint used by BromSite, only 45% of patients in their trials reached the same endpoint. Each of these products uses the same active ingredient, the anti-inflammatory agent bromfenac. The difference in efficacy is attributable to the drug delivery vehicle used.

The second phase III trial of BromSite is scheduled to complete late this year. If successful, the NDA could be filed and US approval received in early 2015. There is a high probability of success in the second phase III trial given that it uses the same trial design as used in the first phase III. The Company will shortly start a pharmacokinetic study comparing BromSite and Prolenza, the current standard of care, with the objective of showing that BromSite delivers more bromfenac to the back of the eye. This would be further evidence that BromSite is more effective than Prolenza. Assuming that the second phase III trial shows comparable results to the first and the PK study shows marked superiority for BromSite, I think that doctors would move rapidly to replace most of the BromDay/ Prolenza usage with BromSite. I estimate that sales of BromDay/Prolenza are over $100 million in the US.