Viralytics — Update 25 November 2015

Viralytics has entered into a clinical trial collaboration agreement with Merck, that means that the second stage of the ongoing STORM trial will test IV administration of its Cavatak oncolytic virotherapy in combination with Merck’s anti-PD1 ICI antibody Keytruda (pembrolizumab) in advanced bladder cancer and non-small cell lung cancer (NSCLC).

The proposed trial design illustrated in Exhibit 1 shows that three escalating dose cohorts of three patients each will receive, respectively, 1x108, 3x108 and 1x109 TCID50 doses of Cavatak in combination with fixed doses of Keytruda. These are the same three doses of Cavatak that have been tested in the ongoing monotherapy study that comprises stage 1 of the trial. The highest dose cohort will be expanded to include ~80 subjects across both cancer types. The aim of the study is to establish a recommended dose for the Cavatak/Keytruda combination and to assess anti-cancer activity and patient tolerability.

Under the collaboration agreement, Viralytics will provide Cavatak and sponsor the study, Merck will provide Keytruda and conduct biomarker analysis. The agreement allows for the collaboration to be extended to include a potential Phase III trial. No other details of the collaboration have been disclosed.

The combination study will build on the encouraging evidence of efficacy for IV Cavatak seen in the monotherapy arm of the STORM trial to date. Initial results from the first 12 out of a target of 18 patients, including six patients who have received the highest dose of Cavatak, showed that the treatment is well tolerated. Several patients achieved a best overall response of stable disease, including one patient from the highest dose cohort with a confirmed partial response (Exhibit 2).

The two melanoma patients in cohort 3 showed evidence of successful tumour targeting following IV administration, with Cavatak RNA detected in tumour biopsies taken eight days after the first dose of Cavatak was administered. These biopsies also showed the presence of immune cell infiltration and high levels of PD-L1 staining, suggesting a potential benefit from combining Cavatak with an ICI such as Keytruda (Exhibit 3).

In addition, measurement of serum viral load suggests that viral replication, possibly within tumours, is occurring within at least some of the patients following IV administration.

Preclinical studies in melanoma indicate that Cavatak combination therapy has the potential to significantly improve the percentage of patients who respond to checkpoint inhibitor therapy. For example, studies in a mouse model of melanoma showed that combining Cavatak with an anti-PD-1 ICI (similar to Keytruda) produced significantly greater antitumour activity and prolonged survival compared to use of either agent alone, as shown in Exhibit 4.

On 27 October, the US FDA approved Amgen’s T-vec (talimogene laherparepvec) for the treatment of melanoma lesions in the skin and lymph nodes that cannot be completely removed by surgery. The drug will be marketed under the brand name Imlygic.

Imlygic is the first oncolytic virotherapy drug that has been approved by the FDA. We view the approval as a positive development for Viralytics, as it confirms that regulators are comfortable with this new class of anti-cancer therapy. This is particularly relevant given that the efficacy of intra-lesional Cavatak in melanoma in Viralytics’ Phase II CALM trial was similar to that reported for T-vec where comparable data are available.

Amgen is also investigating the potential of combining T-vec with ICIs. Amgen and Merck are collaborating on Phase I trials of T-vec and Keytruda in both melanoma and squamous cell carcinoma of the head and neck (SCCHN). In May 2015, they announced that would extend the ongoing Phase I trial of the combination in melanoma to a Phase III trial (MASTERKEY-265, clinical trials registry NCT02263508). However, in September 2015 the enrolment recorded on clinicaltrials.gov record was changed from a target of 680 to actual enrolment of 21 and the trial is no longer actively recruiting subjects. This could indicate that there is a delay in initiating the
Phase III component of the trial, or alternatively, it may indicate that Amgen is reconsidering its plans to initiate a Phase III trial in melanoma.

Viralytics is not far behind Amgen in the development of oncolytic virus/ICI combination therapy in Melanoma, having already initiated separate Phase I trials of Cavatak in combination with either Keytruda or Yervoy. If Amgen and Merck have indeed scaled down the T-vec/Keytruda combination trial as we suspect, Viralytics may be even closer behind Amgen than we had previously believed. We note that Cavatak has the advantage over T-vec in many other cancer types in that it can be safely administered IV, whereas T-vec cannot.

Researchers presented an update on the CANON Phase I study of Cavatak in patients with early-stage bladder cancer at the Society for the Immunotherapy of Cancer (SITC) conference in November. Recruitment of patients in the monotherapy cohorts is complete. Recruitment of ~19 patients in the mitomycin-C combination cohorts is underway.

The SITC presentation showed that one of the three patients in monotherapy cohort 3 had a complete clinical tumour response, confirmed by histopathology as shown in Exhibit 5. While the data are still preliminary they support the thesis that neoadjuvant therapy with Cavatak has the potential to reduce the reoccurrence rate in patients with non-muscle invasive bladder cancer.

We update our valuation of Viralytics, which now stands at A$192m or A$1.04/share (undiluted, previously A$189m or A$1.03/share). This reflects the fact that we have increased forecast uptake of Cavatak in NSCLC and metastatic bladder cancer, partly offset by increased R&D expenditure and pushing back our assumption of likely Cavatak deal timing from FY16 to FY17.

We have increased forecast peak market penetration in NSCLC and metastatic bladder cancer from 2% to 5% due to potential combination therapy with Keytruda or other ICI.

Our valuation assumes a partnering deal or out-licensing of Cavatak driven by data from the Phase Ib ICI combination trials. As we view the Keytruda combination trial to be the most likely deal catalyst, we have delayed our forecast deal timing by 12 months to 2017 (from 2016), when we expect to see initial data from the trial. The decline in the valuation is due to the slightly later receipt of milestone payments and Viralytics being responsible for funding R&D expenses in FY17, which we previously assumed would be borne by the partner.

Our valuation uses a risk-adjusted net present value (rNPV) method to discount future cash flows through to 2033 of the cancer indications shown in Exhibit 6, using a 12.5% discount rate. It assumes a partnering deal or out-licensing of Cavatak in 2017, with the costs of all subsequent clinical development borne by the partner/licensee. Our model includes risk-adjusted upfront payments and clinical/regulatory milestones (but not sales milestones) from a potential licensing deal, based on average Phase II deal metrics from BioCentury (US$25m upfront payment, US$240m total milestones – we assume half of those payments [US$120m] are for clinical and regulatory milestones).

Viralytics is subject to typical biotech company development risks, including the unpredictable outcome of trials, regulatory decisions, success of competitors, financing and commercial risks. In particular, it has a very high single-product risk, with its entire value residing in Cavatak. The investment case hinges on the outcome of clinical trials and the company’s ability to secure a partnership (or further capital) to advance Cavatak into late-stage trials. Ideally, a partner would have the resources to evaluate Cavatak in multiple cancer indications. The greatest commercial opportunity for Cavatak is likely to be in combination with checkpoint inhibitors or other targeted agents – outcomes of ongoing and planned Phase Ib combination trials could be critical to future clinical and commercial success.

Viralytics' Q116 4C quarterly cash flow report showed cash at 30 September of A$19.5m. Payments for R&D expenses of A$2.0m in Q116 were 150% higher than the previous corresponding period (pcp, A$0.8m), while operating cash burn of A$2.7m was 120% higher than pcp (A$1.2m). Cash burn for FY15 (ended 30 June) was A$4.5m, including the benefit of a rebate of A$2.5m under the Australian R&D tax incentive scheme. R&D expenditure for the year was A$5.0m. With the clinical trial programme continuing to expand, we double our forecast R&D spend in FY16 and FY17 to A$10.0m (previously A$5.0m). After deducting the R&D rebate we forecast net R&D expenditure to be A$5.7m for each of those two years. The company has sufficient cash to fund operations for the next two years, but it is likely to require additional funding in FY18 if a partner or licensee is not secured for Cavatak before by that time (we include A$2m of debt in our FY18 forecasts).