James Brown - President and CEO Matthew Hogan - CFO WeiQi Lin - SVP, R&D, R&D Business Development and Principal Scientist.

Francois Brisebois - Laidlaw & Company Neil Carnahan - Stifel Nicolaus Len Yaffe - StockDoc Partners.

Greetings, and welcome to the DURECT Corporation First Quarter 2018 Earnings 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, the conference is being recorded.

It is now my pleasure to introduce your host, Matt Hogan, Chief Financial Officer at DURECT Corporation. Thank you. Mr. Hogan, you may begin..

Okay. Good afternoon. Welcome to our first quarter earnings call. The call will begin with a brief review of our financial results and then Jim Brown, our President and CEO, will provide an update on our business. We’ll then open up the call for a Q&A session. Before beginning, I’d like to remind you of our Safe Harbor statement.

During the course of this call, we may make forward-looking statements regarding DURECT's products and development, expected product benefits, our development plans, future clinical trials or projected financial results.

These forward-looking statements involve risks and uncertainties that can cause actual results to differ materially from those in such forward-looking statements. Further information regarding these and other risks are included in our SEC filings, including our 10-K and our upcoming 10-Q under the heading Risk Factors.

So with that, a few financial comments. Total revenue was $3.5 million in the first quarter of 2018 compared to $4.6 million in the first quarter of 2017.

If one excludes all deferred revenue from upfront fees already received by the company, then revenue from our R&D collaborations was up by approximately 0.8 million in the first quarter of 2018 compared with the first quarter of 2017.

Product revenue from the sale of ALZET pumps and LACTEL polymers was 2.4 million in the first quarter of 2018 as compared to 4.1 million in the first quarter of 2017. Q1 2017 had been far and away the strongest quarter for LACTEL polymers shipments in our history, so that set up a tough comparison.

The gross margin for the combined ALZET and LACTEL product lines was 51% in the first quarter of 2018 and these product lines continue to be strongly cash flow positive for us.

R&D expense was 7 million in the first quarter of 2018 as compared with 7.5 million in the first quarter of 2017, primarily due to lower R&D costs associated with POSIMIR partially offset by higher costs for DUR-928. SG&A expenses were 3.2 million in the first quarter of 2018 as compared to 3 million in the first quarter of 2017.

And at March 31, 2018, we had cash and investments of 44.3 million which compares to 36.9 million at the end of the year. We had an underlying cash burn rate of 6.3 million in the first quarter of 2018 which compares to 7.3 million in the fourth quarter of 2017 and 9.1 million in the first quarter of 2017.

And these figures exclude any licensing deals or equity financing activities other than proceeds from option exercises. In the first quarter of 2018, we raised $13.7 million net of expenses by selling around 8.2 million shares using our ATM facility at an average price of $1.73.

I’d also mention that we raised a further 3.1 million net of expenses that settled in early Q2 by selling around 1.5 million shares at an average price of $2.22. We stopped using the ATM facility in early April.

If you add the April settlements to our March 31 cash position, then we have pro forma cash at the end of the quarter of 47.4 million which we feel good about. I also wanted to briefly comment on our proxy that’s been filed in anticipation of our annual meeting on June 19th.

One item in the proxy is a request to increase our authorized common shares from 200 million to 350 million.

It’s not prudent for a company to be in a position where it has inadequate authorized shares available for future use in connection with raising money by selling equity or equity linked securities or to issue options or if a potential acquisition came along that we wanted to use equity partially for.

The timing of the request is driven by the dates for our proxy in our annual meeting and we view it as normal corporate housekeeping. But to give a little bit of history, in 2000 we had 110 million authorized shares. In 2010, we increased that by 90 million shares to 200 million which is to say an 82% increase.

Now eight years later we’re proposing to increase it by another 150 million which is to say a 76% increase. This doesn’t mean we intend to use these authorized shares under any defined timetable. The timing of the request is driven by the annual meeting date.

And in considering the number of shares to request, we engaged a consulting firm which has insight into how ISS regards such requests when they decide whether to recommend shareholders should vote for against a proposal.

And according to that consulting firm, ISS would support a doubling of the authorized shares so we could have asked for another 200 million shares. We talked about it at a recent Board meeting and thought we would just ask for a 75% of that figure. With that, thanks again for joining the call.

And I’ll turn it over to Jim to talk about some other matters in greater detail..

Thank you, Matt, and hello, everyone. We’re about four months into the new year, so let’s briefly review what we’ve accomplished. We’ve started two Phase 2 trials for DUR-928 for two different indications and a third is on track to start in the third quarter.

And we now have PDUFA dates for two product candidates this year, one in July and the other in August. Each of these product candidates could generate milestone payments and set up future royalty and earn-out strength. I’ll now update on the programs in greater detail, beginning with DUR-928.

DUR-928 is lead product candidate in our Epigenetic Regulator Program with a regulatory role in mammalian and lipid metabolism, inflammatory responses in cell survival.

It’s an endogenous, first-in-class small molecule, which may have broad applicability in several hepatic and renal diseases, including nonalcoholic steatohepatitis or NASH and other disorders of the liver such as primary sclerosing cholangitis or PSC, in acute organ injuries such as acute liver and kidney injury, and in inflammatory skin disorders such as psoriasis and atopic dermatitis.

928 has demonstrated positive results in more than 10 different animal models and has achieved reductions in important biomarkers or other signals of potential clinical activity in Phase 1a single dose studies in NASH, psoriasis and chronic kidney disease patients.

We now have two INDs open with two Phase 2a studies underway investigating DUR-928 in PSC and acute alcoholic hepatitis. With the help of life science advisors, we recently held two thought leader calls to inform our investors of the diseases that we’re investigating and our first Phase 2 trials for DUR-928.

The first of these calls was held on February 26th with Dr. Keith Lindor discussing PSC and the second was on April 5th with Dr. Paul Kwo discussing alcoholic hepatitis. The key messages from – the call with Keith Lindor on PSC was the prognosis for patients with PSC is not good.

It leads to severe complications such as psoriasis, hepatocellular carcinoma and liver failure. He noted that liver transplant rates for PBC which is primary biliary cirrhosis have been declining in recent decades but the same rate is flat for PSC due to no improved treatment options.

PSC may be under diagnosed and he discussed one study that suggested that about 7.4% of irritable bowel or IBD patients were found to have PSC-like lesions and 65% of those 7.4% had not been previously diagnosed with PSC. So if there were a shift to using more imaging, it may increase the size of the addressable market for PSC.

Lastly, he noted that there were currently no recommended therapies for PSC and the treatment landscape remains wide open. The key messages from Paul Kwo phone conversation on alcoholic hepatitis were that excessive alcohol use is prevalent and leads to liver disease.

Alcoholic hepatitis is a major cause of morbidity and mortality with enormous associated healthcare costs. In fact, alcoholic-related liver disease has now surpassed hepatitis C as the most common indication for liver transplantation.

Severity of alcoholic liver disease, including alcoholic hepatitis, is typically assessed by tests such as the MELD score and Lille model, both of which we will be monitoring in our Phase 2 trial and both of which include bilirubin and serum creatinine which we’ve impacted in prior Phase 1a studies.

The current treatment options are inadequate basically being able to help patients with alcoholic hepatitis and this has been demonstrated in the STOPAH trial which look at the effective steroid and pentoxifylline treatment in over a 1,000 alcoholic hepatitis patients.

If you’d like a copy of a transcript from these calls, please contact Matt Hogan here direct. The Phase 2 trial for PSC is a randomized, open label study with two cohorts dosing at 10 milligrams and 50 milligrams of orally administered DUR-928.

Each of these cohorts will dose between 15 to 20 patients over a four-week period with a follow-up for an additional four weeks. The objectives of this study include safety, pharmacokinetics, and pharmacodynamic markers, including the percentage change of baseline of serum alkaline phosphatase and other biomarkers.

As this is an open label study, we expect to generate data in 2018. PSC is a chronic liver disease characterized by a progression of cholestasis, that is decrease in bile flow, with inflammation and fibrosis of the bile ducts. And DUR-928 has been granted orphan drug designation to treat patients with PSC.

The Phase 2 trial for alcoholic hepatitis is an open label, dose escalation study that will be conducted in two parts. Part A includes patients with moderate alcoholic hepatitis as determined by the model of end-stage liver disease or MELD score of less than 20. MELD is a common scoring system used to assess the severity and prognosis of AH patients.

Part B will include patients with severe alcoholic hepatitis that have MELD scores of between 20 to 30.

This study is being conducted using three intravenous doses of DUR-928 and those will be 30 milligrams, 90 milligrams 150 milligrams in Part A with sequential dose escalation that will follow the review of safety and pharmacokinetic results from the prior dose level. The dose may be adjusted in Part B based on the findings from Part A.

The trial is expected to enroll at multiple clinical sites in the United States and we are targeting between 24 to 36 AH patients to complete this study. The objectives of this study include safety, pharmacokinetics and pharmacodynamic signals, as is determined by the improvement in liver biochemistry, MELD and Lille scores, and other biomarkers.

As this is an open label study, we expect to generate data in 2018. Alcoholic hepatitis is a syndrome of progressing inflammatory liver injury associated with long-term heavy intake of alcohol and involves a spectrum that ranges from mild injury to severe life threatening liver damage.

The prevalence of AH has not been accurately determined, but is believed to occur at somewhere between 10% to 35% of heavy drinkers. There were over 320,000 hospitalizations related to alcoholic hepatitis in 2010 and the resulting in hospitalization costs of nearly $50,000 per patient.

Pharmacokinetic data from the use of 928 in animal models of acute organ injury support the potential to improve the outcomes of AH patients. The data generated from this trial will also have the potential to be relevant to other liver and acute organ injuries. I’m now going to move to the topical DUR-928 program.

We’ve developed a topical formulation of 928 because of the promising results we achieved in an exploratory Phase 1b study in psoriasis patients utilizing intralesional injections of DUR-928. We are working with advisors to finalize the study protocol for a Phase 2 proof-of-concept study with topically applied DUR-928.

We’ve had pre-IND interactions with the FDA and are completing the last non-clinical study requested by the FDA prior to our planned IND submission later this quarter. We expect to initiate this study in the third quarter of 2018.

There is a sizable market opportunity for new topical drugs in inflammatory skin diseases such as psoriasis and atopic dermatitis. Now onto POSIMIR. We continue to work with our partner Sandoz regarding the next steps for this POSIMIR program. And we will update further when a final decision has been made with regard to the program. Next to RBP-7000.

RBP-7000 is a near-term opportunity for direct shareholders and is the closest to market with the PDUFA date now that is less than three months away. The RBP-7000 product opportunity for DURECT is the result of a patent deal with Indivior.

It is Indivior's investigational once-monthly injectable risperidone product candidate for the treatment of schizophrenia. The PDUFA date for this program is July 28th of this year.

The Phase 3 and long-term safety study data from RBP-7000 demonstrate that the product had good once a month dosing, had a rapid onset of action, no loading dose with the initiation of treatment was required, no supplemental dosing was required during treatment, it demonstrated clinical efficacy and safety in schizophrenia.

Overall, it was well tolerated. There was a measurable quality of life and medication satisfaction benefits seen for the product. And according to Indivior, RBP-7000 is the first once monthly subcutaneous form of risperidone to demonstrate safety and durability of effect and a long-term that is 12-month clinical trial.

Last year, DURECT received an upfront non-refundable payment of $12.5 million from Indivior and we have a potential $5 million milestone payment upon NDA approval. Indivior will also make quarterly earn-out payments based on single digit percentage of U.S. product net sales.

These payments extend until the expiration date of the patents covered by this agreement, and this is until 2026.

Indivior recently stated and I quote, “We believe RBP-7000 if approved will meet key patient needs with risperidone; principally a rapid onset of action with consistent plasma levels of risperidone over the entire monthly dosing interval.” They also went on to say that they have established a new Behavioral Health Business Unit and that has required an investment in new sales and marketing capabilities with expertise in this disease space in order to enable a successful launch of RBP-7000, if approved, with an anticipated launch in the fourth quarter of this year.

They also reiterated their peak sales projection of between $200 million to $300 million. The final product I will update on today is REMOXY ER.

Based on our ORADUR technology, the investigational drug REMOXY ER is a unique long-acting formulation of oxycodone designed to be dosed twice a day and to discourage common methods of tampering associated with opioid misuse and abuse.

In March, Pain Therapeutics announced that the NDA for REMOXY ER had been accepted for review and the PDUFA date was set for August 7th. Later that same month, they announced that the advisory committee meeting for REMOXY ER had been set for June 26th.

The epidemic of opioid abuse continues to be a national crisis, yet the need for these agents to treat patient’s pain remains and the market for extended release oxycodone remains close to $2 billion a year.

REMOXY ER has the potential to provide multiple means of tamper-resistance plus two twice a day dosing and the only 5 milligram dosage strength to this market. As a reminder, DURECT would receive $1.5 million milestone on approval and a royalty on sales that range from 6% to 11.5%.

In summary, with RBP 7000 and REMOXY ER, in roughly the next three months we have the potential to have two NDAs approved. Each of these products could offer differentiating features that may benefit patients and the healthcare system in large and important markets.

Most importantly, we have DUR-928, an endogenous stress hormone that has demonstrated profound effects in various animal models and in single dose studies in human patients with what appears to be a wide safety margin. We're dosing in two Phase 2 trials with the third Phase 2 trial lined up for initiation in the third quarter.

During 2018, we could have two NDAs approved and data from Phase 2 studies with DUR-928. With that, we'd like to take any questions that you might have..

Thank you. We will now be conducting a question-and-answer session. [Operator Instructions]. Our first question comes from the line of Francois Brisebois [Laidlaw & Company]. Please proceed with your question..

Hi. Thanks for taking the questions. A couple here.

I was just wondering what the mentality is, the strategy is behind the revelation of data here, what the interim looks as these are open label trials?.

I guess the timing.

Is that kind of what you’re looking at?.

Yes.

I’m just saying, are you thinking right off the bat or is this something you want to wait and put as much data as you have together or --?.

Well, I think we want to make sure that we have enough data that it’s meaningful. In other words, you can’t look at ones and twos and threes and fours kind of thing. I think we want to have a substantial number of patients. And also a lot of these assays that we’re conducting, a lot of the biochemical assays aren’t the kind of things you do one-off.

Usually you batch those together because they’re more complex assays and are run in groups. So it will be something that we’re looking at I think in the latter part of this year. It’s not going to be on a monthly basis kind of thing..

Okay. And then on the AH Phase 2a Part A and Part B trials, are these trials – are these Part A and Part B staggered and how much time should we expect between each? I know the dose is ranging.

So in order to get the right dose between data and the start of the next one, should we expect Part B to potentially start in 2018?.

Yes, it is our hope to complete both Part A and Part B this year. So that’s the goal..

Okay.

And then the time – in terms of the proof-of-concept for psoriases study, how long should we expect that to take?.

It will obviously – if it starts third quarter – we’re not going to have data this year, I don’t think. But we may finish enrollment this year, that’s possible I think. We’d look at that and then have data sometime in the earlier part of next year..

Okay. And then just lastly here, in terms of the data for oral and IV for PSC and AH, you mentioned that this could be relevant for other liver injuries and conditions.

Can you elaborate more on that and how it can potentially be relevant to NASH, for instance?.

I think AH in particular, because if you look at NASH, NASH is nonalcoholic steatohepatitis versus PSC, PSC is an orphan disease of cholestasis which has certainly some conditioning, some circumstances are the same. You get fibrosis and get those kind of things.

But if you look at NASH and ASH, one is basically a steatosis of the liver caused by simply overeating and too many calories in play and the other is ASH separately is just purely due to the toxin and the toxic effects of alcohol. But in reality, the majority of Americans fits somewhere in between.

If you had a bell shaped curve of America, I’d say 60% to 70% of the people who have chronic liver damage due to taking things into their bodies, it would be a combination of alcohol and – too much alcohol and too much food or in some range. And that’s the patients that we’re actually looking at.

There are very few patients who are just straight up just pure NASH patients just like there are a very few patients in a population that’s straight up pure ASH patients.

And so in this case we’re looking at patients who have acute hepatitis generated by an alcoholic circumstance but the actual acute hepatitis syndrome as it were is – that we’re looking to treat is more relatable to just an acute liver damage over time. And so it can be related back to other inciting causes.

I know it’s a longwinded way but I don’t know if I – we have WeiQi and Myriam here. Either of you guys want to add to that or --? Okay..

Okay. That’s very helpful. Thank you. And then lastly, this is probably more for Matt.

In terms of the collaboration R&D revenue going forward you mentioned, are there one-time things in there or should we expect this rate to kind of keep going or a little less?.

This is a reasonable number for the moment. There’s nothing extraordinary in the first quarter..

Okay, excellent. All right, that’s it for me. Thanks, guys..

Thanks..

Our next question comes from the line of Adam Walsh [Stifel Nicolaus]. Please proceed with your question..

Hi, guys. This is Neil on for Adam. For the PSC Phase 2a study, are there any efficacy endpoints that you guys are going to look at? I assume there’s no control arm in the study.

Are you looking for anything beyond what you’ve listed? And then I just got a follow up on cash flow guidance?.

Sure. We’re going to be looking at various biomarkers and the like. And one of the things we are looking at is alkaline phosphatase which is associated with looking at the severity of the disease. So the drop in that will be something we will be looking at..

Okay. And then obviously RBP-7000 approval would provide you some cash. Can you guys just talk to me about – I don’t know if you want to provide guidance or just how you’re thinking about your current balance sheet situation? I know you’re running or you’re going to be running three Phase 2 studies during this year.

Can you just talk to me about how you’re thinking about your current situation?.

Well, I think we can talk directionally even though we don’t give specific numbers. These Phase 2 studies, as a reminder, are relatively modest in size, the total number of people we’re going to try to enroll. And they’re fairly straight forward, so they’re not that expensive in truth.

So I think our burn rate has moderated and should stay at relatively even keel here..

I think that our balance sheet now, as I mentioned, we kind of have pro forma cash at the end of the quarter of 47.4 million. Now that’s a decent number. So I think we feel pretty well situated to fund the trials. And of course it would all be great if we get some of these other products approved; RBP-7000 and REMOXY, then we get milestone income.

And if both those get approved, it’s a total 6.5 million. And furthermore then you’d be looking at a future stream of income whether that’s royalties or earn-outs as well that we could then do something with..

So hopefully that was helpful..

Yes. Awesome guys. Thank you. Congratulations on the progress..

Thanks..

Our next question comes from the line of Len Yaffe [StockDoc Partners]. Please proceed with your question..

Thank you. Two questions.

First off, Matt, could you kindly review the ATM amounts raised in the number of shares that were issued in both those? And then secondly on the clinical side, was there anything that was presented at the EASL Conference in Paris recently as it relates to NASH that made you feel better about the pathway that you’ve chosen in terms of DUR-928 and how it acts through actually multiple pathways as you look at NASH hopefully further down the road?.

Let me answer your first question to get my colleagues time to think. In the first quarter, we raised 13.7 million net of expenses that entailed selling about 8.2 million shares at an average price of $1.73. And then the early April settlements raised $3.1 million net of expenses and that was 1.5 million shares at an average price of $2.22..

And actually if I could --.

By the way we’re going to file – we expect to file our 10-Q tomorrow, so you’ll see that in writing tomorrow or the day after..

Okay.

And a follow on that, how is that done, those share sales?.

So the way that an ATM facility works is you actually – the company can dictate how much they want to sell and at what different prices they’d be willing to sell, which is kind of an attractive feature. And I think the execution actually was quite good.

If the contrast is you wanted to do a discrete underwritten financing, you’re looking at a fee of 5% to 6% and a discount that’s typically 10% to 15% or maybe slightly more. And in that case, the true cost of the company raising the money is 15% or 20% or maybe more.

With the ATM, we’re literally selling the stock kind of at the market without a discount and there’s a fee at 3%. And I guess as another comment, if you actually look at the period when we were selling from January to early April, we can track what the volume weighted average price is every day and then compare that to the execution on the ATM sales.

And actually what we found was our ATM sales wrote an 8% premium to the VWAP during that period. So we weren’t selling it all at a discount in truth. And I guess the other comment I’d make is the sales had no impact on holding back an increase in our stock price during that period when we were selling.

And while our stock has softened a little bit in the last couple of weeks, that was not when we were selling under the ATM at all. So I guess maybe that was a longwinded answer, but hopefully it answers your question..

Great..

And now to your second part, which I’ll defer to my colleagues..

Len, I’m sorry, can you repeat exactly what you were thinking?.

Yes, sure.

At EASL, there were numerous presentations as it relates to NASH and the various drugs that are being looked at and I wondering if any of the either data flow or ways of trying to treat NASH, pathways and all that, anything presented by any of the KOLs gave you greater comfort in the way that DUR-928 acts potentially in NASH? So when you go into clinical studies even though we don’t know as of now if it’s going to work for NASH that you have greater confidence in the likelihood that it will in addition to the data that you’ve learned from alcoholic hepatitis?.

Yes, maybe I’ll start and if WeiQi wants to jump in, she can. I think – when I look at what’s going on, it is somewhat disappointing I think so far in general I’d have to say.

Over the last couple of years if you look at the data that have been generated and what’s going on, you see things that act as stimulants do and cause changes in metabolic rates reducing fat and there are a few people doing that. And so they’re reducing the lipid load on the liver and then they’re secondarily reducing some inflammation and the like.

You’ve seen some Phase 2 data that the Street has been really excited about. Particularly to me, it’s no different than taking an extra cup of coffee or walking around the block and eating less. So I don’t see that as major medical breakthrough quite frankly.

The important thing is that if we look at the way 928 works, we know that it works by virtue of working on the metabolic component of it all, working on the inflammatory side and then lastly on cell survival. And I think those are the – those three everyone knows – I shouldn’t say everyone.

People believe that one needs to be involved in all three of those areas to have an effect. And to my knowledge we’re the only molecule that has that standard.

And so the more I see out there, the data that’s been generated, it’s supportive and that there is a little bit of some of the metabolic effect, there’s a little bit of some of the anti-inflammatory benefit and there’s some of the cell survival stuff that helps. You see a little bit of all of those from these companies that are testing.

But I don’t see combination products putting all three together and I don’t see products that can bring to the table what we bring. So I think – as far as I’m concerned, the field’s still open for us. I don’t know if WeiQi --.

I think that the consensus right now is that for the NASH you’ll require a combination therapy. And the combination therapy because NASH’s pathogenesis process is so complicated. It’s like a – if you talk to Dr. Jacobson or you talk to whoever the leader like for example if you talk to VCU’s Dr. Arun Sanyal, so everyone agrees.

It’s a combination therapy because NASH involves cell death. That’s why FXR and that’s why the amorexin [ph], that’s why the ACIs inhibitors and then metabolic pathways, then you have ACC1 inhibitors and then you have SREBP-1 inhibitors. But it’s involving multiple pathways. So you need a combination therapy.

If you look at most compounds if you have Gilead's ACC1 inhibitor or you have Gilead's ASK1 inhibitor. What their approach is to put all these together to tackle NASH.

So for our 928 I think we can reasonably say if you look at the mechanism of how 928 works and then based on the most recent published article in hepatology this past February, there’s a chart of mechanism of [indiscernible] agent. And then if you put out 928 on the chart, you can see multiple pathways. 928 is everywhere.

So that’s where I think it comes..

Yes, I think in a way she’s got that pathway up in her office and just checked off all the places where 928 hits and it’s pretty impressive..

Great. Thank you so much..

We have no further questions at this time. I would like to turn the floor back over to management for closing comments..

Okay. Well, we just like to thank you all for listening in. If anyone does have questions after this call, as always, feel free to call us and we’ll be happy to chat with you. Take care..

This concludes today’s teleconference. You may disconnect your lines at this time. Thank you for your participation..