ZymoGenetics Inc. Q2 2008 Earnings Call Transcript

ZymoGenetics Inc. (ZGEN)

Q2 2008 Earnings Call

August 5, 2008 4:30 pm ET

Executives

Susan Specht - Director of Corporate Communications

Bruce Carter - Chairman and CEO

Doug Williams - President and CSO

Jim Johnson - CFO

Analysts

Marshal Urist - Morgan Stanley

Han Li - Stanford Group

Kevin DeGeeter - Oppenheimer

Tina Huang - Citigroup

Paul Lee - Crown Advisors

Presentation

Operator

Greetings, ladies and gentlemen, and welcome to the ZymoGenetics second quarter 2008 financial results conference call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. (Operator Instructions). As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Susan Specht, Director of Corporate Communications. Thank you. You may begin.

Susan Specht

Good afternoon, everyone. I would like to welcome you to our 2008 second quarter conference call. Before we begin, I need to remind you that we will be making forward-looking statements as part of our prepared remarks and then answering your questions. These statements are subject to many risks and uncertainties that could cause actual outcomes to be much different than we predict. So, please look at our SEC filings, including our Form 10-K for more information.

Now I will turn the call over to our CEO, Bruce Carter.

Bruce Carter

Thank you, Susan. Good afternoon, everyone. Thank you for joining us for the second quarter update. I will begin by giving you an update on RECOTHROM, and then Doug Williams will give you an update on our pipeline. You will hear more from Doug in a few minutes. We are pleased to say, that interferon lambda continues to excite us. I should remind you that interferon lambda is a type-III interferon, and as such, it is structurally very different from all the interferons in the market and in development, which are all type 1 interferons.

Interferon lambda in hepatitis C patients is showing better than expected antiviral activity in the absence of the side effects associated with the use of all the type 1 interferons.

Atacicept as you will hear is now in registration trial for both generalized lupus and lupus nephritis and is also in Phase II trials in rheumatoid arthritis patients and in multiple sclerosis patients.

We will also update you on interleukin-21 which continues to progress in Phase II trial in both renal cell carcinoma and melanoma. After Doug has spoken, Jim Johnson, our CFO will review financial results for the quarter.

Turning to RECOTHROM, we are encouraged by the clinical and commercial progress we have made this year. As we have said before, we did not expect to see meaningful sales until the second half of the year. For the second quarter, net sales were $1.4 million.

As we have said before, the process of selling into the hospital involves many steps and takes time. First, we have to enlist the support of surgeons, nurses, and pharmacists. Then we have to get RECOTHROM on the agenda for upcoming pharmacy and therapeutics committee meetings. Then we need to get the P&T committee to endorse RECOTHROM either as the addiction to the formulary or a commitment to completely convert to RECOTHROM. Then we have to work with hospital pharmacists and surgical departments to process conversions and circle back to surgeons and nurses to encourage the use of RECOTHROM.

At a typical hospital this can take 6 months or longer to work through this process and get RECOTHROM on the pharmacy shelf. For example, a local Seattle hospital has only this month approved RECOTHROM for its formulary. We have learned during our time on the market, and in many cases, the process can become longer through postponement of meetings, getting bump from agendas, or lack of decisions or clear follow-up actions. We have also found that it can take several months after a positive committee decision for regular purchasing to begin.

We believe that our commercial strategy addresses the challenges of selling to the hospital and we have done several things to prepare the way for increasing sales in the second half of the year. In late May, FDA approved the RECOTHROM 20,000 unit vial both alone and through package with a spray kit. In June, we shipped the wholesales, I think of June 10th. Now, we have a full line of product presentations, consistent with that offered for bovine thrombin.

As you know, most hospitals purchase drugs through group purchasing organizations, and we have been negotiating pricing and contracts with six key group purchasing organizations. We have now completed 4 of these 6 GPO contracts to-date and we are continuing to work on the remaining two. Together with our previously disclosed contracts with the governments and hospital networks, we believe that we know have approximately 75% of our target market covered by effective pricing agreements. These contracts should make their mark in the second half of the year.

During our first quarter call, we provided indicators of our progress through late April and I will update those metrics for you know. It is important to note that these new metrics reflect just two months of additional activity, in other words May and June.

169 P&T committee meetings have taken place through late June and 340 additional meetings have been scheduled. As I mentioned before, one reason for the long selling cycle is that P&T reviews are frequently delayed, in some cases multiple times and when they do take place, decisions are not always made. Of the 169 meetings that have taken place as of late June, decisions were made at a 103 meetings, with 66 where decision was still pending. Of the 103 meetings with decisions, 77 approved either complete conversion to RECOTHROM from bovine, or addition of RECOTHROM. 26 P&T committees declined to add RECOTHROM at this time, but many of those of course occurred before the GPO pricing agreements were in place, and before we had a full line of products.

So we need to circle back and get more surgeons at these hospitals. So through late June, the decisions were; 30% to completely convert so RECOTHROM is the only approved product, 45% of the time to add, and 25% to decline at this time.

As of mid-July, a 130 hospitals have now purchased RECOTHROM, and we are pleased to say that approximately 60% have reordered, and a third are already doing so on a routine basis.

So to reiterate; RECOTHROM is being well received by surgeons consistent with our expectations, and I think this is evidenced by a 75% positive response from decisions made to-date. The selling process in this market is long, and in some cases it is taking longer than we anticipated. We have put GPO contracts covering a large portion of the marketing place, and we now have a full line of RECOTHROM product, which will help build sales in the second half of the year, and we are confident that RECOTHROM will become the market leader in the coming years, and that our commercialization strategy is sound.

Now, I will hand the microphone to Doug Williams to talk about our pipeline update.

Doug Williams

Good afternoon, everyone, and thank you very much, Bruce. This afternoon I want to highlight some of the very significant progress being achieved by our research and development teams. It is important to highlight the breadth of our programs and the significant markets they address.

In addition to RECOTHROM, we have atacicept in registrational trials in autoimmune diseases. IL 21 in Phase II renal cell carcinoma and melanoma and interferon lambda in Phase Ib for hepatitis C, as-well-as two partnered and two wholly owned candidates slated to enter the clinic in the next two years in autoimmunity and cancer.

The partnered molecules are the IL- 17RC soluble receptor and the anti IL 31 monoclonal body, which we have collaborations with Merck Serono. In addition we have our anti-IL 21 monoclonal and the first of our dual pathway antagonist antibody molecules directed against PDGF receptor and VEGF.

Our research team continues to consistently deliver innovative IND candidates that will meet our needs over the long term. Our research engine is a time-proven asset to the company. As I stated previously, our emphasis is on creation of a sustainable pipeline of assets that Zymogenetics owns, retains ownership of, in order to retain the flexibility to the partner, when and with whom, we feel we will maximize the value of all of our assets.

Lets start with the review of our progress on interferon lambda. Zymogenetics owns worldwide rights to this unique molecule. This is not just another modified interferon alpha as Bruce has already commented. Interferon lambda is a type III interferon, and as such is an entirely different molecule from the type one interferon alpha. Yet it has comparable antiviral activity against a host of viruses including hepatitis C.

We are currently treating patients with hepatitis C genotype 1, who previously responded to an interferon containing regimen but relapsed. You may recall that this is a two part study, where we are conducting a single agent dose escalation portion, with every other week or weekly dosing with PEGylated Interferon lambda during a 28-day period to be followed by a second part of the study in combination with ribavirin.

We are extremely pleased with the results to-date. In order to proceed to part two of the study, we pre-specified that we must see at least one log of viral load reduction at a given dose with an absence of acute adverse events such as, fever, flu like symptoms or cytopenias, which are commonly associated with interferon alpha. A few conclusions can be reached, already based on our results in the first three cohorts.

First, we have already obtained data, which warrants moving to part two of the study. We have seen significant reductions in viral load at all doses and schedules tested thus far, with an absence of the aforementioned adverse events, one would with associate with interferon alpha.

Second, it is clear that viral load decreases our cumulative with dose. We have seen viral load reductions of multiple logs in individual patients with two or four injections of interferon lambda. Further dose escalations with weekly dosing are planned, and we expect even greater activity against HCV in the final plan dosing cohort, a part one of this study.

Third, we have received agreements from the FDA to accelerate our evaluation of PEG-Interferon lambda in combination with ribavirin and we will now go ahead to part two, while in parallel completing the monotherapy cohorts. This is good news for the program timetable.

Finally, our abstract which describes our results in part one of this study has been accepted for oral presentation, at the AASLD meeting in November.

We believe that interferon lambda could be a game changer in terms of the interferon component of HCV combination regimens. If the data continues to support our target product profile of a molecule with at least comparable anti-viral activity to interferon alpha, but with superior tolerability, we believe this could become the interferon of choice.

The improved tolerability will be an important advantage, allowing more flexibility to combine with the direct anti-virals many of which have their own tolerability issues. Its safe to say that there is substantial partnering interest in this asset.

Let's turn now to Interleukin-21, where we have made significant progress this year. Our team has just completed patient enrollment in the Phase II study combining IL-21with Nexavar in patients with renal cell cancer. In late October we plan to present interim results for this phase II study at the EORTC NCI symposium.

We are also testing IL-21 in another tough to treat indication that represents a clear unmet medical need that is metastatic melanoma. In collaboration with the National Cancer Institute of Canada, we are continuing to enroll and treat patients with metastatic melanoma in a Phase II study with IL-21 as a single agent and we are on track to complete enrollment around the end of the year or early next year. We expect to discus interim results from the Phase II melanoma study late this year.

We will have final data on these IL-21 studies in renal cell cancer and melanoma in the first half of next year, after which we will decide whether to take this molecule forward into Phase III. If we do reach a go-decision then we plan to partner or license the molecule to facilitate late stage development and commercialization of this asset.

Now let's move on to atacicept. We believe this molecule has the broadest mechanism of action of the B-cell directed therapies. In addition to its action on mature B cells, atacicept is unique in its action on plasma cells which produce autoantibodies associated with autoimmune diseases. This is a broad clinical program which addresses a number of autoimmune indications, including lupus, rheumatoid arthritis, and multiple sclerosis and is partnered with Merck Serono.

We are continuing to enroll and treat patients in Phase II-III registrational trials for lupus in both lupus nephritis and general SLE. Both of these studies are being conducted under a special protocol assessment with FDA. Atacicept is also being tested in large, well-controlled Phase II clinical trials in rheumatoid arthritis and relapsing multiple sclerosis. We expect that this program will produce top line data in Phase II RA and MS programs in the second half of the year. Atacicept is a broad development program pursuing a number of parallel indications. We believe it is an important late-stage asset and offers tremendous promise as a potential treatment for multiple autoimmune diseases.

Here are the key clinical development events that we expect this year. An oral presentation of the PEG-interferon lambda hepatitis C data at the AASLD meeting on November 3rd of this year. Presentation of IL-21 Phase II interim data with Nexavar in renal cell carcinoma at the NCI-EORTC meeting in late October. Presentation of IL-21 Phase II interim data in metastatic melanoma at our Investor Day meeting in New York on December 11^th, and in November, we plan to start GLP toxicology studies for our antibody directed against IL-21 as preparation for moving it into the clinic in 2009.

To conclude, our R&D team is making great strides in the lab and clinic, and we are fortunate to have a very productive team. We continue to evaluate all of our R&D assets to ensure responsible spending and maximization of value. We look forward to reporting continuing progress in the coming quarters.

That completes my remarks. I will turn it over to Jim Johnson, our Chief Financial Officer.

Jim Johnson

Thanks, Doug. Overall results for the second quarter were in line with our expectations. Net loss was comparable in amount to the second quarter of 2007. However, both revenues and expenses were higher this year. Revenues were $12.6 million for the quarter, compared to $4.2 million a year ago. Revenues for the quarter consisted of $1.4 million of RECOTHROM net sales, $1.7 million of royalties, and $9.5 million of collaboration and license revenues.

There were two factors responsible for the increase in collaboration and license revenue; $5.2 million of revenue under our recombinant thrombin collaboration with Bayer, and a $2.5 million milestone payment from Novo Nordisk related to recombinant factor 13. The $1.4 million of RECOTHROM net sales included ongoing sales plus wholesaler inventory build related to the launch of the 20,000-unit vial and spray kit.

Our cost of product sales reflected only the packaging and distribution costs incurred after FDA approval. Most of the cost of manufacturing this product were previously expensed to R&D in 2007. R&D expense totaled $33.1 million for the quarter which was about 3% higher than in 2007. Compared to the previous quarter, it was 16% lower. Generally, our R&D expense related to RECOTHROM has decreased, but this effect has been largely offset by increased atacicept expenses consistent with the expanded clinical development program that Doug referred to.

Selling, general and administrative expense for the quarter increased $16 million, compared to $10.1 million in the second quarter of 2007. Most of the increase was related to launch of RECOTHROM, including cost of the sales force, marketing and related administrative infrastructure. We recorded $5.1 million of stock-based compensation expense in total for the quarter, $3.2 million was included in R&D expense and $1.9 million was classified as SG&A.

We ended the quarter with $117 million of cash investments. In addition of these funds on-hand, we now have access to $100 million under the funding arrangement completed with their field management in late June. We have not yet drawn into the facility and we have no imminent plans to do so. The funds are available to be drawn in $25 million installments between now and January 2010.

As we pursue partnering opportunities for interferon lambda in other potential transactions, this facility should provide strategic flexibility. Together with our cash and investment on-hand, we believe it provides adequate funding to take the company well into the future.

So with that, I will turn things over to the operator and we will be happy to take your questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions). Our first question is from Marshal Urist from Morgan Stanley. Please go ahead with your question.

Marshal Urist - Morgan Stanley

Yeah, hi, guys, good afternoon.

Bruce Carter

Good afternoon.

Marshal Urist - Morgan Stanley

First of all, could you give us a sense of what you guys are planning on doing differently from the formulary placement process, going forward in the back half of the year, as we expect to start to see follow through on sales?

And then second, what are you seeing early on in terms of share or order patterns from the formulary space that you’re sharing with bovine thrombin?

Bruce Carter

I can't give an answer to the second half of the question. With respect to the first half of the question, you have to remember that it was early in the middle of June that we had the 20,000 units in the spray kit available, and really it was only post that period in which are reporting that we have all the GPL contracts filed. Three of those are effective in July and the fourth was effective on the 1st of August.

And I think what we have to do as we continue to go forward is to bring forward the advantages of plasma free RECOTHROM, and we have to bring forward the advantages that coagulative -- I wish I could say, clotting c problems are not just a theoretical issue, that there are many instances and is probably on the report and we have to bring that and make that alive to hospitals.

Marshal Urist - Morgan Stanley

All right. And then just one other follow-up, when you say you have 75% your target market covered, can you give us a sense of, obviously that the GPO government purchasing agreement? Then you can give us a sense of that 75%; how much, how far are you on the formulary placement part of it to drill down to the hospital level?

Bruce Carter

I am not sure I could answer that; when I say 75%, our target hospital is 1200 hospitals.

Marshal Urist - Morgan Stanley

Okay.

Operator

The next question is from Han Li with Stanford Group please go ahead with your question.

Han Li - Stanford Group

Yes, good afternoon everyone.

Doug Williams

Hi.

Han Li - Stanford Group

Hi. Question on RECOTHROM. Now you have a full quarter of sales of RECOTHROM, can you give us some color on the price dynamic on the market for a stand-alone thrombin. Is this a price sensitive product or market? Do you have to give a significant discount to gain market share?

Bruce Carter

The question there is varied. Its not price sensitive, any hospital that has seen a clotting problem, there is not price sensitivity at all. Once they've seen it, they say to themselves, never again. So there's no pricing sensitivity there. And then you go to the other extreme where people say, you know that this is just a theoretical risk, we have never had a problem in our hospital, and then it does become price sensitive.

We believe that it's been important to have those GPO contracts in place, so that we have a competitive pricing. It will still be at a small premium, but we think a premium that's worthwhile.

Han Li - Stanford Group

Okay, and then the second questions on the interleukin-21 cancer program. I remember you mentioned that that Novo Nordisk is at certain points looking to their lifetime program and looking for a new partner. Can you give us update on the potential partnership transition on that interleukin-21 cancer program?

Doug Williams

Hi this is Doug. We are obviously coordinating our activities with Novo Nordisk as far as thinking about the prospects for partnering the molecule, so we are in close contact with them. As you recall, we had a data-sharing agreement in place, but the programs that are being conducted here in the US by us are actually being led by us in built generate the data that I think will really dictate whether the molecule goes forward. Of course, if there is a partnering deal to be had that point, we will coordinate our activities with Novo Nordisk to do that on a world wide basis.

Han Li - Stanford Group

Thank you very much.

Operator

(Operator Instructions) the next question is from Kevin DeGeeter with Oppenheimer. Please go ahead with your question

Kevin DeGeeter - Oppenheimer

Hey, few questions this afternoon. First, a couple for Jim here. Can you kind of give us a sense, a little more quantitative sense, what the inventory build in the quarter was?

Jim Johnson

Yeah, hi Kevin this is Jim, it’s difficult to say precisely. We estimate that about half of the sales represented additional wholesaler stocking.

Kevin DeGeeter - Oppenheimer

Okay, perfect, thanks so much. And at what point will we be prepared to write some sales guidance on RECOTHROM, I guess for six, seven month on the launch now. Is it reasonable to begin to think about that?

Doug Williams

Well, I think that, as Bruce said, we are finding that the process of going through this P&T review can take longer at some hospitals. I think we're still in a position whereby the end of this year we may have enough data, sort of a big enough data set, where we feel that will be able to create some reliable input for 2009 but at this point it remains to be seen. I think there is still a lot of data to be generated over the next six months, but clearly it's our plan, once we feel we have enough information, to support a quality estimate that we will share that with the street.

Kevin DeGeeter - Oppenheimer

Okay. And maybe two more quick questions if I may. It looks like we continue to see about 45% of these P&T committees leaving bovine on formulary base, quite putting both products on formulary, which I think is very different than what everyone was expecting previous to launch. I think we expected hospital either be bovine, human, or recombinant. First, I guess, just answer that the way which you think about the overall market, or is there something different in these early adopters that may suggest they have a different attitude towards single product on formulary versus multiple? And if it's going to be half the market, give or take, it's going to have multiple products on formulary. How does that change the sales message here?

Bruce Carter

I think that what we believe, as you're seeing, is that some people fully convert. Others, and I don't think it's at all surprising, say, look, you guys are new. We'd like to put you on the formulary. We're going to try you out on the formulary. We want to make sure that you can consistently supply us, so we don't want to remove the other product. So we feel comfortable that you can consistently supply us. And we believe that over a matter of time, people will convert to just one, and we believe that will be RECOTHROM.

As we've said before, we see this as a ratchet mechanism. In addition, of course, remember that a number of these people are putting us on the formulation time when we didn't have the full complement, we didn't have the 20000-unit, we didn't have the spray. So they would feel that converting completely to RECOTHROM was not appropriate at that particular point in time. So we're not surprised. We would also, as I've said once before, expect full conversion eventually.

Kevin DeGeeter - Oppenheimer

Okay, thanks. That's very helpful, Bruce. And then may be one if I could get Doug in here. I have a feeling Doug might… On PEG-interferon lambda, I mean, I guess, this is really taking a lot of share from sharing and being able to offer a sort of fixed dose as opposed to a weight-titrated dosing regimen. Any opportunity here to go for more of a fixed dose, dosing schedule with PEG-interferon, or should we think about it with the current Phase I dosing is way best?

Doug Williams

Hi, Kevin. This is Doug. No, I think there is still the opportunity to program as early enough to be able to consider something like that. But I do think that our aims are a little more lofty than just trying to provide the market with another sort of slightly more convenient incremental benefit. I think the product profile that we are looking for in that at least so far seems to be holding up is one that will provide the market with something that is very, very differentiated from the existing interferon offerings and we hope it will be a much better tolerated, and much more flexible agent to use in these combination regimens in the future.

Kevin DeGeeter - Oppenheimer

Fair enough. Good luck guys.

Operator

Next question is from Lucy Lu with Citigroup. Please go ahead with your question.

Tina Huang - Citigroup

Hi, guys. This is [Tina Huang] on behalf of Lucy Lu. Just wanted to ask couple of questions. Out of the 25% of the meetings where the decisions were not quite taken or outcomes are still pending, can you share with us what percent may be of dose [would off set], w're not interested versus ones that are waiting? And if you could also share with us some of the feedback you are getting and whether what are the some of the reasons that are taking little longer to decide? Thanks.

Bruce Carter

What was exactly the last sentence, I didn't catch the last sentence?

Tina Huang - Citigroup

Yeah. I was just wondering if you can kind of share with us some of the feedback you are getting from the P&T meetings, and why they are holding up in making decisions?

Bruce Carter

Okay. When we are getting declines, remember we are getting declines at the time, as I said couple of times before we didn't have a GPO contracts in place until July. We didn't have the full 20,000-unit range. But there are some hospitals that have declined and said to us, look, we have never seen a problem, this is the theoretical issue, we have never seen a problem, and we don't want to pay any premium.

So that decline we see as a temporary setback. We mustn't go back through on the next P&T committee meeting and irritate them. But when we find that we have to sort of get more surgeon advocates and educate those and get them to advocate for us. Sometimes the declines went off, our surgeon advocate is actually in the surgery at the time the P&T committee takes place, so we don't have him in there at that particular time.

Tina Huang - Citigroup

Okay. And I believe you last quarter about 18% were not decided. I was wondering if any of those 18% come around and either added RECOTHROM?

Bruce Carter

I don't have that piece of information in front me, but most assuredly some will have done and some will have declined, but I quite honestly can't tell you the answer to that.

Tina Huang - Citigroup

Okay, great. Thank you.

Operator

(Operator Instructions). The next question is from [Paul Lee] with Crown Advisors. Please go ahead with your question.

Paul Lee - Crown Advisors

Hi. I have a question regarding the cost of manufacturing RECOTHROM. If it comes down to the price, you have to match the price in order to get the traction in the marketplace. Do you have the cost -- do you think that you are in the cost disadvantage in terms of manufacturing or you think your cost is very competitive with the bovine thrombin.

Bruce Carter

Now I would guess – I don’t know the precise cost associated with the production of bovine thrombin -- but I would guess that it would be difficult for us to match the cost of goods of bovine thrombin. However, the other, when it comes to human thrombin in collecting plasma from humans, then I think that's a different issue. That's going to much, much more expensive. At the moment our cost of goods is less than it would be because of our prior production of [above] material and people have asked in the past, what do we consider to be our cost of goods and we have repeated it is the sort of standard cost of goods that you would expect for a biopharmaceutical product.

Paul Lee - Crown Advisors

Sure, that depends on the price, correct?

Bruce Carter

Yes.

Paul Lee - Crown Advisors

Anyway the other question I have is for interferon lambda, at what stage you will seriously consider partnering the product for clinical patients?

Bruce Carter

So, we are currently in Phase Ib testing right now. As I indicated, we will present the data at the AASLD meeting. We have presented data previously at a couple of other liver meetings and have already started to get expressions of interest from potential partners. I think there are a number of companies with experience in this space who have seen our data and who are intrigued by the prospects of really having a very different interferon offering. We are having some conversations, but always it comes down to whether or not any sort of transaction would be appropriate for us.

So, at the present time we are running our own studies. We have world wide rights to the molecule and we will only partner if we feel that its in the best interest of both the company and the product on a going-forward basis.

Operator

I am showing no further questions in queue. I would like to turn the call back over to the management for closing remarks.

Susan Specht

Thank you, and that ends our call. Please contact corporate communications if you have questions. Thank you.

Operator

This concludes this teleconference. You may disconnect your line at this time. Thank you for your participation.

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