Napodano: Expecting Steady News Flow From Zalicus

Ion Channel Pipeline Rolling Forward Beyond Synavive, Zalicus is developing an attractive suite of ion channel candidates for both acute and chronic pain. These include T-type and N-type calcium channel blockers and Nav1.7 sodium channel blockers. In early February 2012, Zalicus and Hydra Biosciences, Inc., a leader in the discovery and development of novel ion channels, announced that they have entered into a collaboration to advance development of Zalicus’ preclinical ion channel modulator product candidates for the treatment of pain. We like the deal from a cost-savings and development standpoint. This collaboration brings together the Zalicus portfolio of novel, preclinical ion channel product candidates, representing multiple calcium and sodium channel modulators, with Hydra’s expertise in ion channel discovery and preclinical drug development. The goal of the collaboration is to advance ion channel drug candidates into clinical development for the treatment of pain.

Under the terms of the agreement, Zalicus will pay Hydra an upfront payment (undisclosed) and fund research and development activities at Hydra for a two-year period. Hydra will perform the preclinical development activities necessary and Zalicus will retain all intellectual property and commercial rights to its product candidates. In connection with the collaboration agreement, Zalicus also announced it will discontinue its Vancouver, British Columbia-based ion channel discovery research operations, resulting in a workforce reduction of 16 employees (approximately 28% of the workforce).

We expect Zalicus to record a one-time restructuring charge of $1.1 million in the first quarter 2012. However, the costs savings from closing down Vancouver, the old Neuromed headquarters, should be in the area of $3 to $4 million for 2012 alone. The upfront payment to Hydra was undisclosed, but we are modeling the deal to be cash neutral in 2012. In 2013, Zalicus will continue to fund preclinical activities at Hydra, but the costs will be more variable as opposed to fixed costs associated with owning the Vancouver facility. We note that Zalicus has provided written notice of termination of the sublease agreement to the facility in Vancouver. Additionally, Dr. Christopher Gallen, Zalicus’ Executive Vice President, Research and Development, resigned effective March 1, 2012, as part of the announcement.

…Z160 Successfully Completes Phase 1…

On March 5, 2012, Zalicus announced it had successfully completed a phase 1 (n=16) pharmacokinetic and safety study with new formulations of Z160 (formerly NMED-160), a novel oral N-type calcium channel blocker. Management noted that Z160 has been reformulated to overcome bioavailability and food effect challenges from previous studies. One formulation demonstrated substantially improved bioavailability based on the PK/PD analysis.

Additional formulation studies continue, but we expect that Zalicus should be in position to commence a phase 2 trial in neuropathic pain during the second half of 2012. We remind investors that preclinical data suggests Z160 is effective across multiple models of inflammation and neuropathic pain. We believe the new formulations being developed by Zalicus may also improve patent protection. With position phase 2 data in neuropathic pain, we believe Z160 will be an attractive in-licensing candidate for a larger specialty pharmaceutical company. The profile of Z160 should provide for utility in patient suffering from chronic pain such as with PHN, DPN, or fibromyalgia.

…Z944 To Complete Phase 1 Soon…

In December 2011, Zalicus announced the initiation of a phase 1 clinical trial evaluating the pharmacokinetics and safety of Z944, a novel oral T-type calcium channel blocker with demonstrated preclinical potential for the treatment of acute and inflammatory pain in animal pain models. We are expecting results from the trial to be announced in the second quarter 2012. Keep in mind, this is a maximum tolerated dose (MTD) trial, so conceivably, the longer it runs the better. Based on what we have seen with previous phase 2a programs in pain / inflammation, this study can move rather quickly (at low cost), which would put Zalicus in position to seek out-licensing partners for Z944 in 2013.

…Out-Licensing To Come…

Between the above two candidates and the preclinical pipeline now being developed at Hydra, we believe Zalicus has the potential to sign ion channel development partnership in 2013 and 2014. We find it interesting that in January 2012, Roche announced a collaboration agreement with privately-held Xenon Pharmaceuticals to discover and develop compounds for the treatment of pain. Under terms of the agreement, Xenon could earn up to $646 million in research, development, and commercialization related milestones plus royalties from Roche. Xenon’s most advanced candidate, XEN402, is an oral Nav1.7 inhibitor currently in phase 2 clinical trials. This could provide a good valuation road-map for Zalicus in 2013 when it seeks to partner or out-licenses its phase 2 candidates.

Prednisporin Still Alive At Sanofi

Sanofi continues its formulation scale-up work on Prednisporin. We remind investors that Sanofi initiated a phase 2b clinical program testing Prednisporin in subjects with persistent allergic conjunctivitis in June 2010. This trial has completed in December 2010, but Sanofi has not shared the results. However, the fact that Sanofi has moved into scale-up for a commercial formulation is a clear sign that the data was positive. We are expecting Sanofi to conduct a bridging study with this new formulation later this year, and then move into a phase 3 program sometime during the second half of 2012.

Zalicus is eligible for $3 million milestone payment from Sanofi when the phase 3 trial initiates. If commercialized, Zalicus is eligible to receive milestone payments of up to approximately $65 million and tiered royalty payments of up to 12% on the development and commercialization of certain products generated from the Zalicus platform. The milestone $65 million schedule includes: $25 million in development and regulatory milestones, $25 million in sales-related milestones, and $15 million in additional indication approval milestones. We note prednisporin may have potential for the treatment of dry eyes as well.

32mg Exalgo Filing Soon

We have learned that Covidien plans to file for approval of a 32mg dose tablet with Exalgo during the first half of 2012. Exalgo has been tight-lipped on the status of the filing. It is possible that the application is currently under review. As noted in our previous reports, the 32mg dose of Exalgo will make the product more competitive with Endo’s Opana-ER. We note that gaining approval of a 32mg dose for Exalgo will also extend the intellectual property protection for Covidien, as Watson has not challenged the 32mg dose (as of yet).

In December 2011, Covidien announced it would spin-out its pharmaceutical division to shareholders. We think this is good news for Zalicus, as the new stand-alone pharmaceutical company will be seeking to expand its top-line and provide growth through new products. We think driving Exalgo growth with a 32mg tablet will be key to this goal for the new pharma division once independent.

Cash Position & New ATM & Recommendation

In December 2011, Zalicus borrowed $8.5 million under Term-C of its existing loan agreement with Oxford Finance Corporation. Cash on hand at the end of 2011 was just shy of $50 million.

On January 10, 2012, Zalicus entered into an equity distribution agreement with Wedbush Securities whereby Wedbush may make available up to $15 million in value of common stock. We have no update on the status of the At-The-Market (ATM) financing. However, we expect that management has been using the ATM over the next several weeks, and will continue to use it, to maintain a healthy cash position ahead of the phase 2b SYNERGY results and plan for the phase 2a programs on Z160 and Z944.

We are maintaining our Outperform rating, and $3 price target on shares of Zalicus. The biggest driver of the stock in 2012 will be the results of the SYNERGY trial in the third quarter 2012.