Expert Financial Analysis and Reporting

Investment Thesis

Trius announced an important new development today that bolsters my investment case for Trius (TSRX) and I continue with my Buy on the stock. In a recent report, I explained why I thought that Trius could potentially reach $40 per share in 2020. This bolsters the potential for achieving that lofty price target.

I want to make it immediately clear that the patent application that is the subject of this report is based on non-clinical studies that have yet not been confirmed in human studies. However, non-clinical data for antibiotics have considerable predictive importance for human studies. It is a well-established principle that the in-vitro activity of antibiotics is a surrogate for the activity in the human body if in-vitro concentration of the drug matches that in-vivo. There have been comparable examples in the development of hepatitis C virus drugs in which non-clinical data were important harbingers of human activity and I think that this could be the case here.

Trius has discovered that a low dose formulation of tedizolid when combined with Cubist's blockbuster antibiotic Cubicin (daptomycin) can significantly reduce the emergence of bacteria resistant to daptomycin. Daptomycin plays a major role in treating bacteremia (systemic infections including those of the blood and heart) and the emergence of resistance is a serious clinical concern. This discovery led to a recently allowed patent application; tedizolid seems to be much more effective than any other available antibiotic in this regard.

As will be discussed later in this report, this discovery could provide a valuable pathway forward for tedizolid that can shorten the potential time of approval in bacteremia from 2018 to 2016. The recent passage of the GAIN act , which is intended to allow the FDA to move more quickly to advance important new antibiotics, also works in tedizolid's favor.

Bacteremia is a very large commercial opportunity and moving the approval timeline forward substantially increases net present value of the Company.

An interesting angle in this unfolding situation is how this discovery affects Cubicin and how Cubist (CBST) might react from a business development standpoint. The combination could address the concern that growing bacterial resistance to daptomycin, particularly in bacteremia, could negatively impact the usage of Cubicin in bacteremia. Bacteremia accounts for approximately one-third of Cubicin sales in the US and is a strategic growth area for Cubist. Cubist is also faced with even more troubling commercial issue on US sales of Cubicin which account for about 95% of current corporate revenues. Cubist agreed to a patent settlement which allows Teva (TEVA) to introduce a generic daptomycin in 2018, which will cause a very sharp erosion of sales.

The discovery by Trius that a tedizolid-daptomycin combination largely eliminates the key weakness in bacteremia treatment could be the answer to two major problems facing Cubist. It could address the problem with emergent resistant bacteria and it could also blunt the generic risk in 2018. I think that if (and when) Cubist concludes that the combination of tedizolid and daptomycin has such value; it should be highly incented to offer Trius a lucrative partnering deal or perhaps just to acquire Trius outright. Trius currently has a market value of $359 million and Cubicin has a market value of $3.1 billion. Cubicin currently has cash and short term investments of $850 million.

I believe that this is a significant development that adds value to the Trius investment thesis from the standpoint of increasing net present value and increasing the potential for a Cubist (or some other large company) acquisition. I want to close this section with the same warning I used to start it. The effectiveness of this combination will need extensive study and there is no guarantee that it will ultimately be successful.

New Patent is Allowed

Trius just received a notice of allowance on a new patent for its antibiotic tedizolid, its lead product that is on track for approval in mid-2014. This means that the patent is considered a genuinely new invention and that the patent office intends to grant a patent. The patent application pertains to the use of tedizolid in combination with daptomycin-Cubist's (CBST) blockbuster antibiotic Cubicin. The patent covers the use of the combination for the treatment and prevention of gram positive bacterial strains that have developed resistance to daptomycin, notably methicillin resistant Staphylococcus aureus (MRSA).

The patent teaches that tedizolid at concentrations substantially below the current therapeutic dose used in the treatment of skin infections, unexpectedly prevents the formation of daptomycin resistant mutant strains of bacteria, notably Staphylococcus aureus. As will be discussed shortly, of seven other antibiotics tested in combination with daptomycin against gram positive bacteria, tedizolid appears to be by far the most effective in preventing resistance.

Companies developing new molecular entities, like tedizolid, try to develop a broad portfolio of patents with the goal of maintaining marketing exclusivity for the maximum length of time. The most important patent is composition of matter, but companies also seek patents related to manufacturing, formulation and as in this case method of use. Investors consider composition of matter to be the trump card in a patent portfolio and usually don't consider ancillary patents to be meaningful to the investment outlook. I think that the first reaction of investors when looking at this combination patent might be a yawn. However, I think that this patent is different and does add an important, positive new dimension to Trius the investment thesis.

Clinical Background

This patent addresses a major issue for daptomycin. While it is a very effective bactericidal antibiotic, long term dosing in bacteremia can require up to six weeks of dosing and this prolonged exposure can results in the development of resistant bacteria. A recent 2011 article indicated that 15.4% of bacteremic patients were resistant to daptomycin in 2009, an alarming increase from 3.4% in 2007. Another article published in 2011 reported that daptomycin-resistant MRSA has been found in daptomycin-naive patients. These and other reports indicate that the emergence of resistant bacteria when treating bacteremia is a very serious clinical problem for Cubicin and a serious business issue for Cubist.

For most types of drugs, only testing in humans can provide meaningful information on efficacy. However, testing an antibiotic against bacterial strains in a culture dish can provide important data. If an antibiotic can kill bacteria in this setting it is a good indication that it will be effective in humans if the drug is effectively distributed throughout the body. One of the standard studies for predicting the emergence of resistance begins with exposing a bacterial culture to the antibiotic at concentrations below the minimum inhibitory concentration (MIC). This selects for the survival of resistant mutants that are then disproportionately represented in subsequent generations. Doing this sequentially (a process called serial passage), then measuring the increased MIC at each passage is an effective in-vitro model that has predictive value for the development of resistance against a given antibiotic in human bacterial infections.

Trius used serial passage to test daptomycin in combination with vancomycin, Zyvox (linezolid) and five other less widely used gram positive antibiotics and found that the combinations had no mutant prevention activity. Trius then tested low concentrations of tedizolid in combination with daptomycin and this combination was highly effective in preventing the emergence of resistant strains. One would expect that Cubist and others also have used serial passage to determine if the combination of other drugs will reduce resistance that occurs when daptomycin is used alone.

The first question of some investors might be why isn't this obvious and therefore not patentable. The non-obviousness stems from this not being observed with Zyvox (linezolid), the only marketed antibiotic of the oxazolidinone class of antibiotics. Also the concentration was below that used in clinical trials done to date with tedizolid in skin infections.

Development Pathway in Bacteremia Could be Significantly Speeded

Tedizolid is being developed for gram positive infections that occur throughout the body. The FDA requires phase III clinical trials that demonstrate that tedizolid is effective in treating infections according to the organ in which they occur. The following table shows that incidence of infection by location in the body.

The first clinical development effort for tedizolid was based in skin and skin structure infections caused by gram positive bacteria. Two phase III trials in skin and skin structure are the basis of the NDA that will be filed in 2H, 2013. Pneumonia is a more difficult indication to treat and Trius will be starting a phase III trial in pneumonia in 2H, 2013. Bacteremia is even more difficult to treat; the timing of a phase III trial in bacteremia has not yet been announced. The greatest medical need and greatest commercial opportunity is in bacteremia followed pneumonia.

If approved for skin and skin structure, tedizolid will be used off label in other disease sites. However, having the indication approved significantly increases clinical use and commercial returns. The pneumonia indication is on track for potential approval sometime in 2017, assuming success in the clinical trials. Bacteremia is the most important commercial opportunity, but the development pathway is much longer.

This tedizolid-daptomycin combination patent application may open a new and quicker way forward for Trius in developing the bacteremia indication. Conventionally, the pathway involves a Phase II trial in uncomplicated bacteremia, which would treat patients for 14 to 28 days. This would be followed by a phase II trial in complicated bacteremia that would treat patients for 28 to 60 days. Success in these two phase II trials, would allow Trius to proceed to phase III. Trius hasn't given a timeline for how long this might take, but my guess is NDA approval based on this development pathway would be in 2018 or so.

This patent application allows for a more rapid path to development in which tedizolid could be combined with daptomycin and compared to daptomycin alone in complicated and uncomplicated bacteremia. This could take the form of a superiority trial, which the FDA encourages whenever feasible. This trial would be ethical since both arms contain daptomycin that is approved for bacteremia. A possible primary endpoint might be microbiological susceptibility or cure at day 60. Trius has given no guidance but my guess is that this single trial approach could lead to approval possibly as early as 2016.

The Cubist/ Cubicin Angle

Cubist management is guiding that US sales of Cubicin (daptomycin) will reach $900 to $925 million of US sales in 2013, up 11 to 14%, and international sales by partners could reach $80 to $105 million; Cubicin accounts for about 94% of revenues.

Cubicin is approved for skin and skin structure and bacteremia in the US. Because the drug is inactivated by surfactants in the lung, it is not effective in treating pneumonia. The skin and skin structure market is characterized by less severe infections and shorter treatment times and it is becoming more competitive. The Cubist strategy has been to concentrate Cubist marketing in bacteremia where it has important competitive advantages and where length of treatment is 28 days or longer versus perhaps 10 for skin and skin structure. It also has pricing flexibility in bacteremia because of its advantages.

However, this is pricing them out of the more competitive skin and skin structure segment of the market.

The emergence of daptomycin resistant strains is a serious concern for Cubist. I noted earlier that as many as 15% of bacteremia infections treated lead to daptomycin resistant strains and this percentage is increasing at an alarming rate. The combination of tedizolid and daptomycin offers a solution to this clinical problem. Another issue for Cubist in that they have reached a settlement with Teva that allows that company to market a generic version of Cubist in 2018.

Cubist has to consider this discovery with keen interest and it addresses the two most critical issues facing the Company. It could address the resistance problem of daptomycin protecting its position in the treatment of bacteremia. As importantly, this patent protected combination could replace the use of daptomycin alone in bacteremia. This would blunt the impact of Teva's entry with a generic daptomycin in 2018. This could encourage Cubist to offer a lucrative partnering deal or even result in its acquiring Trius.

Other considerations:

1. Both daptomycin and tedizolid are dosed once-daily thereby facilitating a fixed dose combination IV formulation and treatment. The availability of oral tedizolid may also allow for a creative trial design and treatment paradigm. The combination could be used for a period of time and then the regimen might be switched to oral tedizolid.
2. The recent results of a 9 month toxicity study showing that tedizolid does not produce optic or peripheral neuropathies at concentrations of up to 6-fold its therapeutic exposure (maximum dose tested) suggests that tedizolid may be suitable for the treatment of complicated bacteremia and other diseases requiring long term dosing. By contrast, linezolid at 1x its therapeutic exposure shows neuropathies within 3 months.