thinkequity report on drrx

Durect Corp. DRRX: $0.78Buy Price Target: $3.00

DRRX: Initiate Coverage With A Buy Rating And $3Price Target

THINK ACTION:While DRRX has had a bumpy road over the past few years in our view, wecontinue to see a compelling combination of large-pharma collaborations with anundervalued pipeline that could provide potential upside surprise. DRRX’s leadproduct is Remoxy, a less-abusable Oxycontin partnered with Pfizer (PFE), whichwe believe could be potentially re-filed with the FDA by late 2013E. In 2H12,DRRX could file an NDA for the post-surgical pain injection Posidur, partneredwith Hospira (HSP) and targeting 10M-20M US surgeries. Additionally, in ourview, DRRX has a deep pipeline of earlier pain compounds.

KEY POINTS:Remoxy: the primary value driver at DRRX, in our opinion. DRRX hasdisclosed that they receive a 6%-11.5% sales royalty on sales of Remoxy, whichwe estimate could reach 7%-12% on sales of Remoxy when COGS & markups are included. While the path to NDA approval has been rocky in our view(2 complete response letters so far), partner PFE has publicly stated that theyremain committed to getting this product FDA approved, which to us seems likelygiven PFE’s demonstrated ability to get drugs approved by the FDA. Even a smallpenetration into the ~$3B US Oxycontin market could drive substantial royaltiesto DRRX over the next few years, and we believe with PFE behind the drug, amore substantial market penetration than our estimates could be possible.

Posidur: post-surgical pain injection could be NDA filed in 2H12. While themost recent phase 3 trial didn’t achieve statistical significance, DRRX plans tomeet with the FDA, and we believe could potentially submit an NDA for Posiduras early as 2H12 using positive data from earlier hernia & shoulder trials that diddemonstrate statistically significant reductions in pain & narcotic usage over days1-3. Given that Pacira’s (PCRX) competing product Exparel was approved onsimilarly small-surgery models (bunionectomy & hemorrhoidectomy), we believethat this strategy has merit and could lead to a potential FDA approval bylate 2013 or early 2014. DRRX estimates that 10M-20M of 70M US surgeriesare candidates for Posidur post-surgical pain treatment, which represents asignificant market opportunity at ~$250/injection for Posidur.

Pipeline assets offer potential upside. DRRX’s pipeline includes Relday,partnered with Zogenix for a long-acting Risperidone for schizophrenia whichwe expect to start phase 1 trials in 2013, and a pipeline of additional painproducts that could potentially offer upside, should the company be able to re-partner and re-start the development process. These include: Transdur, a morepowerful Duragesic for chronic severe pain; Eladur, a longer acting Lidodermfor moderate to severe pain, and 2 additional undisclosed abuse resistant painproducts included in the PFE Remoxy partnership. We currently have a modestvalue attributed to these pipeline compounds.

Initiate with a Buy rating and $3 price target. We value DRRX at $3/sharebased on a sum-of-the-parts analysis. We value Remoxy at $1.50/share basedon a 5x multiple of 2017E royalties discounted back 5 years at 25% (to accountfor the development risk to this program), Posidur at $1/share based on a 5xmultiple of 2017E royalties discounted back 5 years at 40% (to account for thedevelopment risk to this program), and value the base business and cash (end2012E) & technology value at $0.50/share.

Specialty Pharmaceuticals

James Molloy

617-778-9308, [email protected]

Changes Current PreviousRating BuyPrice Target $3.00FY12E REV (M) $29.5E --FY13E REV (M) $25.4E --FY12E EPS ($0.12)E --FY13E EPS ($0.14)E --

52-Week High: $3.7752-Week Low: $0.71Shares O/S-Diluted (M): 87.4Market Cap (M): $68.2Average Daily Volume: 459,147Short Interest: 2.8%Debt/Total Cap: NANet Cash Per Share: $0.28P/E (12-month forward): NAEst. Long-Term EPS Growth: NAP/E/G: NMFiscal Year-End: Dec

REV (M) $ 2011A 2012E 2013E

Mar 8.6A 7.7E NAJun 7.8A 7.2E NASep 8.1A 7.4E NADec 8.9A 7.2E NAFY 33.5A 29.5E 25.4E

FY P/S 2.0x 2.3x 2.7x

EPS $ 2011A 2012E 2013E

Mar (0.07)A (0.04)E NAJun (0.06)A (0.04)E NASep (0.06)A (0.03)E NADec (0.02)A (0.02)E NAFY (0.21)A (0.12)E (0.14)E

FY P/E NM NM NM

Please see analyst certification (Reg. AC) and other important disclosures on pages 16-18 of this report.

March 22, 2012Company Report

Initiation of Coverage

March 22, 2012

Company Report

SUMMARY & INVESTMENT THESIS We are initiating coverage on Durect Corp. (DRRX) with a Buy rating and a $3 price target. DRRX is a specialty pharmaceutical company focused on improving the delivery of opioids and reducing the use and abuse of strong opioids. DRRX is partnered with PFE on the development & sale of Remoxy, an abuse-resistant Oxycontin that PFE has stated could be re-filed with the FDA in late 2012/early 2013. DRRX is partnered with Hospira (HSP) in the US for the development & sale of Posidur, a long acting post-surgical delivery of bupivacaine for pain control. DRRX is also developing Transdur, a strong-opioid patch similar to Duragesic for severe pain; Eladur, a transdermal bupivacaine patch similar to Lidoderm for mild-to-moderate pain; and Relday, a needle free long-acting dose of risperidone for schizophrenia. DRRX also has a legacy manufacturing business that is based on the Alzet osmotic pump for animal trials drug delivery, and Lactel biodegradable polymer raw materials for drug & medical device development. OUR TOP 4 REASONS TO OWN DRRX 1. Remoxy: the primary value driver at DRRX, in our opinion. DRRX has disclosed that they receive a 6%-11.5% sales royalty on sales of Remoxy, which we estimate could reach 7%-12% on sales of Remoxy when COGS & mark ups are included. While the path to NDA approval has been rocky in our view (2 complete response letters so far), partner PFE has publicly stated that they remain committed to getting this product FDA approved, which to us seems likely given PFE’s demonstrated ability to get drugs approved by the FDA. Even a small penetration into the ~$3B US Oxycontin market could drive substantial royalties to DRRX over the next few years, and we believe with PFE behind the drug, a more substantial market penetration than our estimates could be realistic. 2. Posidur: post-surgical pain injection could be NDA filed in 2H12. While the most recent phase 3 trial didn’t achieve statistical significance, DRRX plans to meet with the FDA and we believe could submit the NDA for Posidur as early as 2H12 using positive data from earlier hernia & shoulder trials that did demonstrate statistically significant reductions in pain & narcotic usage over days 1-3. Given that Pacira’s (PCRX) competing product Exparel was approved on similarly small-surgery models (bunionectomy & hemorrhoidectomy), we believe that this strategy has merit and could lead to a potential FDA approval by late 2013E/early 2014E. DRRX estimates that 10M-20M of 70M US surgeries are candidates for Posidur post-surgical pain treatment, which represents a significant market opportunity at ~$250/injection for Posidur. 3. Pipeline assets offer potential upside. DRRX’s pipeline includes Relday, partnered with Zogenix for a long-acting Risperidone for schizophrenia, which we expect to start phase 1 trials in 2013, and a pipeline of additional pain products that could potentially offer upside, should the company be able to re-partner and re-start the development process. These include: Transdur, a more powerful Duragesic for chronic severe pain; Eladur, a longer acting Lidoderm for moderate to severe pain, and 2 additional undisclosed abuse resistant pain products included in the PFE Remoxy partnership. We currently have a modest value attributed to these pipeline compounds. 4. DRRX has been a long, strange trip but we see value at current levels. DRRX’s has had a storied history of drug development in our view, with key management members having split off from Alza long ago to form DRRX. Since then, DRRX’s key asset and primary value driver - Remoxy - has been out-licensed to 1) Pain Therapeutics (PTIE) by DRRX; 2) King Pharmaceuticals by PTIE; and 3) Pfizer (PFE) when PFE bought King in 2011. Over the past 2 years, we believe the main driver of DRRX’s stock underperformance has been driven by the inability of these partners to get Remoxy through the NDA process at the FDA, with the drug receiving back-to-back Complete Response Letters (CRL) from the FDA. Most recently, DRRX’s second value driver, Posidur, failed in the large phase 3 BESST trial (Bupivacaine Effectiveness and Safety in Saber Trial) which negatively impacted the stock price. While in our view these issues are a real impediment to driving value to the stock unless they can be resolved, we believe that at current levels the risks to both programs are more than adequately priced in. Should DRRX succeed in addressing either issue, or demonstrate a realistic path to FDA approval, we believe the stock could react positively.

March 22, 2012

Company Report

UPCOMING POTENTIAL CATALYSTS EXHIBIT 1:

VALUATION We value DRRX at $3/share based on a sum-of-the-parts analysis. We value Remoxy at $1.50/share based on a 5x multiple of 2017E royalties discounted back 5 years at 25% (to account for the development risk to this program), Posidur at $1/share based on a 5x multiple of 2017E royalties discounted back 5 years at 40% (to account for the development risk to this program), the base business and cash (end 2012E) & technology value of $0.50/share. EXHIBIT 2:

COMPANY DESCRIPTION Durect is an emerging specialty pharmaceutical company located in Cupertino, California. The company focuses on the development of pharmaceutical systems based on its proprietary drug delivery platform technologies that treat chronic debilitating diseases and enable biotechnology products. These platform technologies include the Saber Delivery System (a patented depot injectable that can be used for proteins, peptides and small molecule delivery), and the Oradur sustained release oral gel-cap technology (an oral sustained release technology with several potential abuse deterrent properties). DRRX also partners with pharmaceutical and biotechnology companies to develop and commercialize proprietary and enhanced pharmaceutical products based on its technologies. KEY PRODUCTS To value a drug delivery company, we evaluate the potential of near-term, disclosed proprietary compounds and then add in a subjective valuation for smaller products and a technology value. We combine these inputs for a sum-of-the-parts analysis to value the company’s stock. Remoxy – Abuse-resistant Oxycontin- $1.50/share Key issues: We see this as the main value driver for DRRX. Partnered with PFE, the drug has faced hurdles at the FDA but since we believe that PFE acquired KG primarily to get this drug we expect they should potentially get it over the finish line at the FDA in the 2013-2014 time-frame.

Product In collaboration with King Pharmaceuticals (acquired by PFE) & Pain Therapeutics (PTIE), DRRX developed Remoxy, a controlled release formulation of the opioid oxycodone (Oxycontin – a ~$3 billion US branded

Event Expected Timing

FDA meeting on Posidur NDA filing 2Q12E

PFE meets FDA on Remoxy re-filing 3Q12E

Remoxy NDA re-filing by PFE 4Q12E/1Q13E

Posidur NDA filing 1H13E

Source: Company reports and ThinkEquity LLC estimates

Sum-of-the-parts valuation: DRRXSegment Valuation Per share

(000's) value

Remoxy $150,344 $1.50

Posidur $116,027 $1.00

Base polymer business $24,430 $0.25

Cash (end-'12E) & tech $31,761 $0.25

SUM $322,562 $3.00

Shares out '12E (000) 109,205

Source: ThinkEquity LLC estimates

Exhibit 3: Remoxy gel-cap

Source: www.durect.com

March 22, 2012

Company Report

market according to IMS) using the proprietary Oradur gel-cap technology. Remoxy is a twice-daily controlled release formulation that is intended to match the pharmacokinetics (PK) of Oxycontin, but with enhanced abuse deterrence properties due to the nature of DRRX’s Oradur technology. The main concept hinges on putting oxycodone into a gel formulation such that it cannot be crushed and abused. The technology involves entrapping the majority of its oxycodone inside DRRX’s Oradur sustained release oral gel-cap technology. Oradur uses a sucrose acetate isobutyrate, a high viscosity, biodegradable liquid matrix that is formed into an oral gel-cap to provide 12-24 hours of controlled release of oxycodone. Clinical Data PTIE conducted two anti-abuse studies in England. In the first study, five healthy volunteers received a 10mg oral dose of Remoxy and five healthy volunteers consumed 10mg of Oxycontin. Each preparation was stirred for 10 minutes in vodka and chased by a glass of water. Oxycontin released over 200% more drug than Remoxy (p=0.03). In the second study, five healthy volunteers were instructed to chew a 10mg oral dose of Remoxy for five minutes and to swallow the resultant slurry with a glass of water and five other volunteers chewed a 10mg oral dose of Oxycontin for five minutes and then swallowed the resultant slurry with a glass of water. In the second study, Oxycontin released over 170% more drug than Remoxy (p=0.03). These early studies demonstrate that similar manipulation of Remoxy leads to much lower substance blood levels. The Remoxy formulation’s high viscosity capsule is also designed to make it difficult to inject intravenously or to snort the drug, if crushed, which should also help with abuse deterrence. See details below. EXHIBIT 4:

FDA Complete Response Letter and re-filing…and Complete Response Letter and re-filing… King/PTIE initially filed Remoxy with the FDA on June 10, 2008 and it was accepted for priority (6 month) review on August 12, 2008. On November 13

th 2008, an FDA panel unofficially voted 11 to 8 in favor of approving Remoxy. The

primary concern of the panel was apparently the distinction between “abuse-resistance”, a strong claim of non-abusability, and “tamper-resistance”, a weaker claim. This concern was echoed by the FDA on December 11

th 2008 when it issued a

Complete Response Letter (CRL) to KG’s NDA filing saying that Remoxy’s NDA could not be approved in its present form. The FDA has asked for additional non-clinical data to support the approval of Remoxy. King/PTIE re-filed Remoxy on 12/27/10 with a 6-month review cycle, and subsequently King was acquired by PFE on 2/28/11. We believe one of the key assets that induced PFE to purchase King was the Remoxy abuse-resistant Oxycontin. On June 24

th

2011, the FDA issued yet another CRL for Remoxy and PFE expects to conduct a bioavailability study in 2Q12 and then meet with the FDA in 3Q12 to discuss the regulatory path forward for Remoxy. We expect that the clinical trial and regulatory

Phase 3 tria l: Rem oxy for osteoarthritis

Aim efficacy & safety of 2x/day oxycodone for O A pain

Design phase 3, 12 week, random , 2x blind, p lacebo contro lled, m ulti-center study. W ashout fo llowed by 2 week

titration, then random ized to study. 1st 4 weeks titration to analgesic effect, then fixed dose for 8 weeks

to tria l end

Dosing 5m g-20m g BID (10m g-40m g TDD) for 12 weeks

Endpoints 1': decrease in L ikert pain scores, 2 ': Q uality of Anelgesia, g lobal assessm ent, W O MAC O A index

decrease & SF-12 Health Survey

Patients 412 m ale & fem ale patients w ith O A; Active: 132 com pleted, 75 early term ination; P lacebo: 131

com pleted, 70 early term inated

Safety No safety issues, com m on opioid side effects observed

Results 1 ': decreased pain intensity on Likert scale (p=0.007); Q ofA (p=0.004), G lobal assm nt (p=0.007),

W O MAC (p=0.023), SF-12 (p=0.003)

Source: Caris & Com pany estim ates, Com pany reports

Exhibit 5: Projected DRRX Remoxy royalty

Source: ThinkEquity LLC estimates

March 22, 2012

Company Report

expertise of PFE behind the Remoxy re-submission will get this product across the finish line this time. We project a 1H13 re-submission, 6-month review, and a 2H13 potential NDA approval, with a potential 1Q14 launch. See our table “Branded Drugs Trial Timelines” at the end of this report for more detail. Competitive positioning Purdue Pharmaceuticals (private) won approval for and launched an abuse-resistant version of Oxycontin in August 2010 called Oxycontin-CII. Other products include PFE’s Embeda (abuse-resistant once-daily morphine) that utilizes a pharmacological approach to abuse deterrence by embedding spheres of naltrexone in the pill to block the release of opioid if the pill is crushed for abuse. Economics Remoxy was originally licensed by DRRX to PTIE, who subsequently out-licensed the technology to King, who was acquired by PFE 1Q11. PFE has exclusive US rights to develop and to commercialize Remoxy and certain other opioid drugs formulated with DRRX's Saber technology. PFE controls any pre-clinical, clinical, commercial manufacturing and sales/marketing activities for additional abuse-resistant opioids developed under this agreement. DRRX is reimbursed for its expenses for formulation and other work performed under the contract and will receive payments based on the achievement of certain technical, clinical or regulatory milestones, in addition to receiving royalties on product sales that start at 6% and scale up to ~11.5%. We model in the following royalty rates: 8.7% in 2014, 9.5% in 2015, and 10% in 2016. We assume a COGS mark-up for delivering raw materials to KG for production. EXHIBIT 6:

Valuation Our DCF analysis indicates a Remoxy value of $1.50/share. Our key assumptions include estimates of the company’s share of the Oxycontin market and price, and a 55% chance of ultimate approval, which we believe is in line with the late-stage nature of the filing and the 2 prior CRLs. We model in pricing of $325, which we believe will be in-line with branded Oxycontin prices by the time Remoxy potentially makes it to market. We view this as a niche product among practicing physicians at the outset, but believe that it could gain wider acceptance if it ends up showing clinically relevant decreases in abuse.

Patent We expect that the patent should last post-2015, but drug delivery patents can come under multiple legal challenges, and there can be no guarantee that generics do not appear prior to this date. In particular, it is unclear to us how the drug release profile of this product compares vs. Purdue Pharma’s regular Oxycontin. At the end of the day, in our view it is effectively just a 2x/day Oxycontin product, abuse resistant or not. If the drug pharmacokinetic profile (PK curve ) is within a 20% correlation of Oxycontin’s then it could be a violation of Purdue’s patents. Both King and PTIE have insisted in the past that Remoxy’s PK profile is not similar to Oxycontin and does not violate Purdue’s patents, but this data has not been made publicly available.

Remoxy timelineEvent Timing

PTIE licenses Remoxy from DRRX December 2002

KG licenses Remoxy from PTIE Novemer 2005

KG submits 1st Remoxy NDA June 2008

Complete Response Letter #1 received December 2008

PFE announces KG acquisition October 2010

KG re-submits Remoxy NDA December 2010

PFE closes KG acquisition March 2011

Complete Response Letter #2 received June 2011

PFE to conduct 2 bioavailability studies 2Q12E

PFE to meet FDA on next steps 3Q12E

PFE expected to re-submit Remoxy 2H12E

Source: Company Reports and ThinkEquity LLC estimates

March 22, 2012

Company Report

Posidur - saber bupivacaine for post-surgical pain - $1/share Key issues: DRRX plans to meet with the FDA to discuss filing Posidur based on earlier phase 2b hernia & shoulder that showed statistically significant reductions in pain & opioid use, in spite of the recent failed phase 3 BESST trial. If the FDA agrees with DRRX’s strategy this product could have a potential 2013 PDUFA date. Posidur is a long-acting local anesthetic being developed for the treatment of post-surgical pain. It is injected following surgery adjacent to the incision, where it continuously releases bupivacaine in a controlled fashion, which can be adjusted to provide up to 72 hours of local analgesia. We believe the advantage to Posidur is its longer duration, which can provide full dosing over the post-surgical period without the need for re-dosing every 4-6 hours (the current indication for bupivacaine). The market for this product is substantial, as there are over 70 million combined inpatient and outpatient surgical procedures performed each year in the U.S. We believe that Posidur could be utilized in 33% of these procedures (surgeries include: abdominal, orthopedic, hernia, among others). Phase 3 BESST clinical trial data DRRX announced on 1/5/12 that the phase 3 BESST (Bupivacaine Effectiveness and Safety in Saber Trial) trials that Posidur had failed to reach statistical significance on either co-primary endpoint: pain intensity on movement 0-3 days post-surgery or supplemental opioid use 0-3 days post-surgery. Cohorts 1 and 2 Posidur vs commercially available Bupivacaine HCl solution after laparotomy and after laparoscopic cholecystectomy, respectively. Cohorts 1 and 2 were prespecified to be pooled due to their small sample size. With respect to Cohorts 1 and 2 (pooled), the mean reduction in pain on movement was approximately 20% (p=0.0111) for the POSIDUR group compared to the patient group treated with bupivacaine HCl. In relation to median total morphine-equivalent opioid dose for supplemental analgesia during the period 0-72 hours post-dose for Cohorts 1 and 2 (pooled), the patient group treated with POSIDUR reported approximately 18% less opioids consumed compared to the bupivacaine HCl group (p=0.5455). Cohort 3 Posidur versus Saber-Placebo, laparoscopically-assisted colectomy. With respect to the co-primary efficacy endpoint of pain reduction as measured by mean pain intensity on movement (normalized) Area Under the Curve (AUC) during the period 0-72 hours post-dose, the patient group treated with Posidur 5.0 mL (660 mg) reported a mean pain reduction in pain scores of approximately 7% (p=0.1466). The statistical analysis plan included pain on movement as recorded at scheduled times through an electronic diary plus pain scores reported whenever supplemental opioids were administered with such scores attributed as if they were pain on movement. In the prespecified sensitivity analysis (which includes only scheduled pain assessment on movement scores as collected on the electronic diary), the patient group treated with Posidur 5.0 mL reported approximately 10% less pain versus placebo (p=0.0410). In relation to the co-primary efficacy endpoint of median total morphine-equivalent opioid dose for supplemental analgesia during the period 0-72 hours post-dose, the patient group treated with Posidur reported approximately 16% less opioids consumed versus the placebo group (p=0.5897). Overall, the Posidur groups showed a similar systemic safety profile as the patient groups treated with Saber-Placebo and active comparator. There were no signs of systemic safety issues. Local site reactions were observed more frequently in the Posidur and Saber-Placebo groups than in the active comparator groups; most of these observations were discolorations, the majority of which resolved without treatment during the trial. No negative safety signal was seen in the initial cardiac and neurologic safety assessment in BESST; however further analysis is underway. See table below for a summary of the BESST trial data details.

Exhibit 7: Posidur gel

Source: www.durect.com.

March 22, 2012

Company Report

EXHIBIT 8:

Phase 2b clinical trial data DRRX presented Posidur phase 2b data in 3Q07 from an Australia & New Zealand trial that was designed to evaluate the tolerability, activity, dose response and pharmacokinetics of Posidur in patients undergoing open inguinal hernia repair. The study was a multi-center, randomized, double blind, placebo-controlled study in 122 patients. Study patients were randomized into three treatment groups: patients that were treated with Posidur 2.5 mL (n=43), Posidur 5 mL (n=47) and placebo (n=32). The co-primary efficacy endpoints for the study were Mean Pain Intensity on Movement area under the curve (AUC), a measure of pain over a period of time, 1-72 hours post-surgery, and the proportion of patients requiring supplemental opioid analgesic medication during the study. Secondary efficacy endpoints included Mean Pain Intensity on Movement AUC over the period 1-48 hours post-surgery, mean total consumption of supplemental opioid analgesic medication, and time to first use of supplemental opioid analgesic medication. The study hit on some Mean Pain Intensity on Movement primary endpoints in the 5mL dose, but missed on the % of patients taking supplemental opioids. See details below. EXHIBIT 9:

Next steps for Posidur DRRX anticipates meeting with the FDA in mid-2012 to discuss the potential path forward for Posidur. While the recent phase 3 BESST trial was a failure, DRRX believes that there may be a legitimate path forward for Posidur utilizing the 2007 phase 2b Hernia study (data in exhibit above) and the phase 2 shoulder surgery study (data in exhibit below) that apparently shows a reduction in pain scores and opioid use over 3 days. While DRRX has yet to publicly disclose the details of the shoulder study due to prior requirements of former partner Nycomed, we expect that DRRX could disclose

Phase 3 BESST trial: Posidur abdominal surgery - results 1/5/12Aim Safety & efficacy of Posidur in reducing pain and opioid-related side effects following various

abdominal surgeries

Design multicenter, random, 2x-blind, parallel assignment. 3 cohorts: (1): 48 pts Posidur 5mL vs. placebo

after laparotomy, (2): 50 pts Posidur 5mL vs placebo after laproscopic cholecystectomy, (3): 207

pts Posidur 5mL vs placebo after laproscopically-assisted colectomy

Dosing 5mL Posidur directly onto wound post surgically

Endpoints co-1': pain intensity on movement AUC 0-3 days post, supplemental opioid use 0-3 days post;

2': mean pain on movement, time to 1st rescue meds, opioid side effects, pain at rest

Patients cohort 1 n=48; cohort 2 n=50; cohort 3=207

Safety no signs of systemic safety issues, local site reactions were observed more frequently

Results - 1/5/12 results trended positive for pain reduction & reduction of supplemental opioids days 0-3 post

surgery, but they did not reach statistical significance.

Source: Company reports

Phase 2b trial: Posidur for Inguinal Hernia - results 7/17/07Aim tolerability, activity, dose response & PK profile in patients undergoing inguinal hernia repair

Design Australia & NZ multi-center, random, 2x blind, placebo controlled; randomized to

Dosing 2.5ml or 5ml Posidur post-surgical

Endpoints 1': mean pain intensity on movement 1-72hrs, % of pts requiring supplemental opioids

2': mpiom 1-48hrs, total supplemental opioids, time to 1st supplemental opioid use

Patients 122 patients: 3 groups: Posidur 2.5ml (n=43), Posidur 5ml (n=47), placebo (n=32)

Safety comparable safety in 2.5ml/5ml groups to placebo

Results - 7/17/07 1': 5ml -31% mpiom 1-72hrs (p=0.0033), 2': 5ml -35% mpiom 1-48hr (p=0.0007)

1': 53% 5ml group took supp. opioids (vs. 72% placebo) (p=0.09, not sig.)

2.5ml dose showed trends but not stat sig. 5ml dose will be used in phase 3


March 22, 2012

Company Report

the full shoulder study data set by the end of 1Q12. This data set would closely resemble the small-surgery model path to approval that Pacira Pharmaceuticals (PCRX) followed in their 2011 approval for Exparel (DepoBupivacaine) where they submitted data in hemorrhoid & bunion removal models (see Exparel data in below exhibits). Assuming the FDA agrees with DRRX’s Posidur submission plan, we believe that Posidur could have an NDA filed by 1H13 with a potential 1H14 FDA approval & potential mid-2014 launch (see Branded drugs trial timelines chart at end of report for more details). EXHIBIT 10:

EXHIBIT 11:

Phase 2b trial: Posidur for shoulder surgery - results 2/9/11Aim Safety & efficacy of Posidur in reducing pain and opioid-related side effects vs placebo & active

comparator in arthroscopic shoulder surgery

Design 3 treatment groups: 1) 5mL Posidur; 2) bupivacaine HCI solution; 3) Saber-placebo

Dosing 5mL Posidur/comparator/placebo directly onto wound post surgically

Endpoints co-1': non-inferiority of Posidur to Saber-Placebo for pain intensity measured as an Area Under the

Curve (AUC) 1-72 hrs post-surgery; 2) Superiority of Posidur to placebo in use of rescue meds 0-

72 hrs post surgery

Patients N = 107

Safety comparable safety profile between the three groups and Posidur appeared well tolerated

Results - 2/9/11

Topline only

1': stat sig pain intensity reduction and in opioid sparing vs Saber-placebo; No stat sig difference

compared to active comparator


Phase 3 trial: Exparel (DepoBupivacaine) for bunionectomy - results 10/20/09Aim Safety & efficacy of Exparel for prolonged postoperative analgesia in patients undergoing metatarsal

osteotomy (bunionectomy)

Design multicenter, random, 2x-blind, parallel-group, placebo controlled study; Pain intensity rated by patients

on 0-10 numeric rating scale (NRS) out to 72 hours. Rescue meds (5mg oxycodone/325mg

acetaminophen orally every 4-6 hrs as needed or ketorolac 15-30mg IV).

Dosing 106mg Exparel directly into wound at conclusion of surgery

Endpoints 1': cumulative area under the curve (AUC) of NRS pain intensity over 1st 24 hrs post surgical;

2': % pts pain free 8-48 hrs; % pts requesting & total amount rescue meds through 24hrs;

Patients N = 193

Safety Well tolerated, AE's similar to placebo; No SAEs

Results - 10/20/09 1': reduced NRS scores (p=0.0005) 24 hrs post-surgery;

2': % pts requesting rescue meds (1% vs 7% placebo; p<0.05), fewer opiods over 24 hrs post

(p=0.0077); pain free at 2,4,8,48 hrs post-surgery than placebo (p<0.05)


March 22, 2012

Company Report

EXHIBIT 12:

Competitive positioning The primary competing therapy for Posidur (besides traditional Lidoderm post-surgical infusion) is PCRX’s Exparel, a long acting bupivacaine that was approved in October 2011 for postsurgical analgesia and is expected to be launched in April 2012. PCRX has stated they expect to command a little over $250 per injection for Exparel. Economics In 2Q10, HSP paid DRRX $27.5M up-front with $185M in development & sales milestones with an undisclosed sales royalty (we assume a tiered 14%-20% sales royalty). In 4Q06, Nycomed paid DRRX a $14M upfront for the European rights to Posidur with a potential for up to $180M in development and sales milestones. Following the 1H11 acquisition of Nycomed by Japanese pharmaceutical company Takeda and the recent announcement of the failed phase 3 BESST trials, Nycomed returned the EU rights to DRRX. US partner Hospira remains committed to the continued US development of Posidur (at this point anyway) and while we believe the Nycomed return likely slows EU development it also opens the door to re-out licensing Posidur for the EU in the future. Valuation Our DCF analysis indicates a Posidur value of $1.00 per DRRX share. Our key assumptions include estimates about the share of the U.S. post-operative surgical market and price. We assume pricing of ~$300 per usage starting in 1H14E, which we believe will be in-line with current treatment costs for acute post-operative pain. We expect the competing product Exparel by PCRX to be priced around $250 per treatment starting in 1H12E, which could reasonably be in the ~$300/dose range by 2014E. We have applied a 35% discount rate to our valuation to account for the risks to approval for Posidur. Alzet & Lactel – valuing the base business at DRRX - $0.25/share Key issues: In our view this is the “backstop” program for DRRX and represents the basic valuation parameter for the company. While not a high growth, high margin business, it does generate a consistent $12M-$13M annually for DRRX. The Alzet implantable pump line consists of miniature, implantable osmotic pumps and accessories used for experimental research in mice, rats and other lab animals. The pumps are not approved for, nor intended for human use. ALZET pumps continuously deliver drugs, hormones and other test agents at controlled rates from one day to four weeks without the need for external connections, frequent handling or repeated dosing. In laboratory research, these infusion pumps can be used for systemic administration when implanted under the skin or in the body. They can be attached to a catheter for

Phase 3 trial: Exparel (DepoBupivacaine) for hemorrhoidectomy - results 12/1/09Aim Safety & efficacy of Exparel for prolonged postoperative analgesia in patients undergoing

hemorrhoidectomy

Design multicenter, random, 2x-blind, parallel-group, placebo controlled study; Pain intensity rated by patients

on 0-10 numeric rating scale (NRS) out to 72 hours. Rescue meds (morphine sulfate 10mg IM every

4hrs as needed).

Dosing 266mg Exparel directly into wound at conclusion of surgery

Endpoints 1': cumulative area under the curve (AUC) of NRS pain intensity over 1st 72 hrs post surgical;

2': % pts opioid free; time to 1st opioid rescue; total opioid consumption through 72 hrs;

Patients N = 189

Safety Well tolerated, AE's similar to placebo; No SAEs

Results - 12/1/09 1': reduced NRS scores (p<0.0001);

2': % opioid free (p<0.0008); median time to rescue med (p<0.0001); total opioid consumption through

72 hrs (p=0.0006)


Exhibit 13: Alzet & Lactel

Source: www.durect.com.

March 22, 2012

Company Report

intravenous, intracerebral, or intra-arterial infusion or for targeted delivery, where the effects of a drug or test agent are localized in a particular tissue or organ. The Alzet product line is referenced in more than 12,000 scientific texts currently. Lactel Absorbable Polymers are a range of standard or custom designed biodegradable polymers based on lactide, glycolide and caprolactone for pharmaceutical and medical device manufacturers for use as raw materials in their products. The polymers are manufactured and sold from DRRX’s Alabama facility and are used for a variety of controlled-release and medical-device applications, including several (undisclosed) FDA-approved commercial products. Both the Alzet and the Lactel products are sold through a direct sales force in the US and through a network of distributors OUS. Other assets – Eladur, Relday, Transdur Key issues: Few of the following products are close to the market, or have experienced clinical trial failure or are otherwise inexplicably halted. While there is little near-term benefit from this group it highlights the diverse applicability of DRRX’s Saber drug delivery technology. Eladur DRRX is developing the transdermal bupivacaine patch Eladur utilizing the DRRX transdermal technology from Transdur that is designed to provide continuous delivery of bupivacaine for up to three days from a single application. This compares with a 12 hr. wear with ENDP’s Lidoderm. We expect Eladur to have many differentiating attributes from Lidoderm including an extended duration of action and better wearability. In April 2011, DRRX reported top-line results from a 263 patient phase 2 clinical trial in chronic low back pain for Eladur where Eladur failed to differentiate from placebo for the endpoint of mean change in pain intensity scores from baseline to the mean of week 11 and week 12. PFE recently returned Eladur back to DRRX, and the company is continuing to evaluate the recent study failure to determine the next steps with this program and potential new partners for this program. Relday DRRX is partnered with Zogenix (ZGNX) for the clinical development and commercialization of Relday, a proprietary, long-acting injectable formulation of risperidone using DRRX’s Saber controlled-release formulation technology in combination with ZGNX’s DosePro needle-free, subcutaneous drug delivery system. The companies will also share non-clinical development responsibilities. ZGNX expects to initiate clinical studies for Relday in patients with schizophrenia in 1H13 following filing of an Investigational New Drug (IND) application. ZGNX has made a $2.25M upfront payment to DRRX, with an additional $103M in potential future clinical, regulatory and commercial milestone payments based upon successful achievement of certain events. ZGNX will have exclusive global rights to commercialize Relday and will pay DRRX an undisclosed royalty on Relday sales. Transdur One of the major class of drugs utilized to treat chronic pain is comprised of oral opioids, such as Oxycontin, a branded extended-release oral oxycodone-based painkiller which accounted for over $3B in worldwide sales in 2010 according to IMS. Another major class of drugs utilized to treat chronic pain is transdermally delivered opioids such as Duragesic, a leading transdermal fentanyl product which accounted for approximately $750M in worldwide sales in 2010 according to IMS. DRRX is developing a transdermal sufentanil patch (Transdur-sufentanil) for continuous delivery of sufentanil for up to seven days from a single application, as compared to the two to three days of relief provided by currently available Duragesic & generic Duragesic. DRRX has developed a smaller sufentanil patch (~1/5th the size of currently marketed transdermal fentanyl patches for a therapeutically equivalent dose) with a longer duration of delivery that could offer improved convenience and compliance for patients. In 2008, ENDP successfully completed a phase 2 clinical trial for Transdur in which ENDP evaluated the conversion of patients on oral and transdermal opioids to Transdur. The phase 2 trial met its primary and secondary objectives of establishing a successful dose-titration regimen and dose potency relationships, demonstrating safety and tolerability at the therapeutic dose, and achieving effective analgesic pain control. The phase 2 data, extensive non-clinical data that had been generated by ENDP and a potential regulatory pathway for the phase 3 program were reviewed with the FDA at an end-of-phase 2 meeting on February 19, 2009 and the program was returned by ENDP to DRRX. The current path forward for Transdur remains muddled in our view given the lack of movement since the drug was returned in 2008.

March 22, 2012

Company Report

EXHIBIT 14:

MANAGEMENT James E. Brown, D.V.M. co-founder, President, CEO and Director. Prior to 1998, Dr. Brown worked at ALZA Corporation as Vice President of Biopharmaceutical and Implant Research and Development from June 1995 to June 1998. Prior to that, Dr. Brown held various positions at Syntex Corporation, a pharmaceutical company, including Director of Business Development from May 1994 to May 1995, Director of Joint Ventures for Discovery Research from April 1992 to May 1995, and held a number of positions including Program Director for Syntex Research and Development from October 1985 to March 1992. Matthew J. Hogan, CFO. Mr. Hogan joined Durect from Ciphergen Biosystems, Inc., where he was the Chief Financial Officer from 2000 to 2006 and a consultant from March 2006. Prior to joining Ciphergen, Mr. Hogan was the Chief Financial Officer at Avocet Medical, Inc. from 1999 to 2000. From 1996 to 1999, Mr. Hogan was the Chief Financial Officer at Microcide Pharmaceuticals, Inc. From 1986 to 1996, he held various positions in the investment banking group at Merrill Lynch & Co., most recently as a Director focusing on the biotechnology and pharmaceutical sectors. Mr. Hogan holds a B.A. in economics from Dartmouth College and an M.B.A. from the Amos Tuck School of Business Administration. Felix Theeuwes, D.Sc., Chairman, co-founder, and Chief Scientific Officer. Dr. Theeuwes was with ALZA Corporation from 1970 until June 1999 holding positions directing research, technology development, and product development for a variety of controlled drug delivery systems. His work led to the product introduction of the ALZET® mini osmotic pump series for animal research, and the OROS® systems series of products. He directed research in transdermal research and development, initiated the electrotransport/iontophoresis program, and initiated the DUROS® osmotic implant program. He holds more than 210 U.S. patents covering these systems and published more than 80 articles and book chapters. RISKS TO PRICE TARGET Exogenous events could impact our outlook. We believe that pharmaceutical companies have the least control over competitive, political, and regulatory risks. Although we have incorporated competitive assumptions into our forecasts, there may be other risks beyond the scope of our analysis. Changes in the drug reimbursement system, as well as any political or regulatory amendments, may significantly influence the earnings power of these companies. Actual clinical results and the FDA’s conclusions may deviate from our expectations. Many of our assumptions are based on a review of incomplete clinical trial data available in the public domain. Often our conclusions are drawn from early-stage data, which may not be reflected by pivotal studies. Furthermore, the FDA’s conclusions may not coincide with our own, materially changing our revenue and earnings assumptions. Compliance issues, product recalls, and other mandates by regulatory authorities could materially change our expectations. Regulatory compliance issues, ranging from accounting irregularities to defective manufacturing practices, could materially change our assumptions and earnings outlook. Unanticipated product recalls and labeling changes could also have adverse consequences on our earnings assumptions. Legal risks could lead to additional liabilities and revenue loss. In addition to the expenses incurred by patent challenges, product liability and other legal suits could occur and lead to additional liabilities and revenue loss, which could substantially change our financial assumptions.

Drug PatentRemoxy 2025

Posidur 2015; 1 pending patent to 2025


March 22, 2012

Company Report

EXHIBIT 15:

Durect Corporation

Branded drugs trial timelines

2011A 2012E 2013E 2014E 2015E

1QA 2QA 3QA 4QA 1QE 2QE 3QE 4QE 1QE 2QE 3QE 4QE 1QE 2QE 3QE 4QE 1QE 2QE 3QE 4QE

Remoxy - less abusable OxyContin

KG re-files with the FDA 4Q10 - NDA accepted 1/27/11

FDA PDUFA #2 - June 23rd PDUFA - CR Letter #2 FDA 2

PFE to run 2 bioavailability studies BA's

Meet FDA meet

Refile NDA (3rd time) NDA 3

FDA PDUFA #3 - assume 6-mo review again FDA 3

PFE launch LAUNCH

Posidur (SABER-Bupivacaine injection for post-op. pain, partnered with Nycomed in EUR)

Phase 3 - FAILED PRIMARY ENDPOINT 1/5/12 phase 3 - US data

BESST Trial, 1H11 complete enroll

6/7/10 Partner with Hospira for US

Meet FDA to discuss filing plans meet

NDA filing & FDA approval (file shoulder & hernia trials) NDA FDA

Launch - US by Hospira LAUNCH

Nycomed 2 phase 2b's "Optesia" trade name in EU

hysterectomy - FAILED 6/16/10

Phase 2 shoulder - mixed data 2/9/11 data

Takeda (Nycomed) returns Posidur back to DRRX prtnr

Relday LA risperidone (for schizophrenia) with Zogenix

CMC pre-clinical development CMC activities

Phase 1 phase 1

Phase 2 & 3 timing uncertain additional trials


Specialty PharmaceuticalsJim Molloy (617) 778-9308 | [email protected]

March 22, 2012

Company Report

Durect Corporation

Quarterly income statement

2011A 2011A 2012E 2012E 2013E

($000 except per share) 1QA 2QA 3QA 4QA Year 1QE 2QE 3QE 4QE Year

Revenues

Product revenue, net $3,092 $2,645 $2,909 $2,481 $11,127 $3,371 $2,880 $3,039 $2,925 $12,215

Collab. R&D & other 5,512 5,188 5,206 6,454 22,360 4,322 4,322 4,322 4,322 17,287

Total revenues $8,604 $7,833 $8,115 $8,935 $33,487 $7,693 $7,201 $7,361 $7,247 $29,502

Expenses

COGS 1,401 1,085 1,300 927 4,713 1,154 1,080 1,104 1,087 4,425

Gross profits 7,203 6,748 6,815 8,008 28,774 6,539 6,121 6,257 6,160 25,077

Research & development 9,880 8,708 8,452 7,013 34,053 7,000 6,500 6,500 6,250 26,250

Selling, general & admin 3,716 3,327 3,377 3,154 13,574 3,000 2,750 2,750 2,750 11,250

Total operating expenses 14,997 13,120 13,129 11,094 52,340 11,154 10,330 10,354 10,087 41,925

Income (loss) from ops (6,393) (5,287) (5,014) (2,159) (18,853) (3,461) (3,129) (2,993) (2,840) (12,423)

Interest & other, net 36 42 (11) 21 88 20 20 20 20 80

Debt conversion expense

Earnings before taxes (6,357) (5,245) (5,025) (2,138) (18,765) (3,441) (3,109) (2,973) (2,820) (12,343)

Income tax provision 0 0 0 0 0 0 0 0 0 0

Net income (loss) (6,357) (5,245) (5,025) (2,138) (18,765) (3,441) (3,109) (2,973) (2,820) (12,343)

1x items, after tax

Net income ex-1x items

EPS ($0.07) ($0.06) ($0.06) ($0.02) ($0.21) ($0.04) ($0.04) ($0.03) ($0.02) ($0.12)

EPS ex-1x milestonesWeighted avg. shares (000) 87,270 87,404 87,450 87,514 87,410 87,614 87,714 117,814 117,914 102,764

Fully diluted shares (000) 96,270 108,557 108,855 108,919 108,710 109,019 109,119 139,219 139,319 124,169

Margin & expense analysis

Gross Profit 84% 86% 84% 90% 86% 85% 85% 85% 85% 85%

Operating margin -74% -67% -62% -24% -56% -45% -43% -41% -39% -42%

Net margin cont. ops. -74% -67% -62% -24% -56% -45% -43% -40% -39% -42%

Tax rate 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%

Year-over-year change

Total revenue 12% 7% 0% 5% 6% -11% -8% -9% -19% -12%

COGS 2% 26% 51% -21% 10% -18% 0% -15% 17% -6%

R&D 5% -5% 4% -26% -6% -29% -25% -23% -11% -23%

SG&A 6% -7% -11% -22% -9% -19% -17% -19% -13% -17%


Specialty PharmaceuticalsJim Molloy (617) 778-9308 [email protected]

March 22, 2012

Company Report

Durect Corporation

Annual income statement

($000 except per share) 2011A 2012E 2013E 2014E 2015E Comments

Revenues

Remoxy royalties $19,691 $44,750 Assume 2H13 approval

Posidur royalties 18,588 44,865 Hospira US partner, post op pain

Product revenue, net $11,127 $12,215 $12,766 13,344 13,951 Alzet & Lactel polymers

Collab. R&D & other revenue 22,360 17,287 12,603 5,600 5,600 amortized milestones here

Total revenues $33,487 $29,502 $25,369 $57,224 $109,166

Expenses

COGS 4,713 4,425 3,552 8,011 15,283

Gross profits 28,774 25,077 21,818 49,213 93,883

Research & development 34,053 26,250 27,000 29,750 33,500

Selling, general & admin 13,574 11,250 11,000 12,000 13,500 Headcount reduced in 1Q12

Total operating expenses 52,340 41,925 41,552 49,761 62,283

Inc (loss) from ops (18,853) (12,423) (16,182) 7,463 46,883 Guide: ~$12M burn in 2012

Interest & other net 88 80 50 46 180

Earnings before taxes (18,765) (12,343) (16,132) 7,509 47,063

Income tax provision 0 0 0 0 12,448 $400M NOL's & R&D credits

Net income (loss) (18,765) (12,343) (16,132) 7,509 34,615

EPS, fully diluted ($0.21) ($0.12) ($0.14) $0.05 $0.25

Weighted avg. shares (000) 87,410 102,764 118,164 118,564 118,964

Fully diluted shares (000) 108,710 124,169 139,664 140,064 140,464

Cash & equivalents $28,431 $24,730 $17,161 $32,549 $77,382 FY12 Guide: $12M burn rate

Margin & expense analysis Gross Profit 86% 85% 86% 86% 86%

Operating margin -56% -42% -64% 13% 43%

Net margin cont. ops. -56% -42% -64% 13% 32%

Tax rate 0% 0% 0% 0% 26%

Year-over-year change

Total revenue 6% -12% -14% 126% 91%

COGS 10% -6% -20% 126% 91%

R&D -6% -23% 3% 10% 13%

SG&A -9% -17% -2% 9% 13%

Source: Company reports and ThinkEquity LLC estimatesSpecialty Pharmaceuticals

Jim Molloy (617) 778-9308 [email protected]

March 22, 2012

Company Report

Durect Corporation

Balance sheet model

(values in 000's) 2010A 1Q11A 2Q11A 3Q11A 2011A 2012E 2013E 2014E 2015E

Assets

Cash & equiv. $10,437 $4,830 $5,486 $7,031 $8,896 $24,730 $14,731 $30,119 $74,952

ST investments 35,005 33,541 29,247 25,428 19,535

Total current assets 54,845 47,793 42,539 40,409 37,301 37,624 32,209 40,544 86,278

Net PP&E 1,776 1,752 2,204 3,412 3,124 22,750 30,000 30,000 32,500

Goodwill 6,399 6,399 6,399 6,399 6,399 6,399 6,399 6,399 6,399

Total assets 67,560 59,945 54,344 53,249 49,196 71,635 69,911 84,071 141,581

Liabilities

Total current liabilities 17,909 16,132 15,769 16,402 14,891 14,751 15,222 14,306 22,925

Total liabilities 53,073 49,285 46,935 48,334 45,719 44,751 47,722 48,306 59,675

Additional paid-in capital 351,679 353,766 355,757 357,504 359,006 394,736 406,173 412,240 458,379

Accumulated deficit (337,205) (343,135) (348,380) (353,405) (355,543) (367,886) (384,019) (376,510) (376,510)

Shareholders' equity 14,487 10,660 7,409 4,119 3,477 26,884 22,190 35,765 81,906

Total liab & net worth 67,560 59,945 54,344 52,453 49,196 71,635 69,911 84,071 141,581


Durect Corporation

Statement of cash flows model

(values in 000's) 2010A 1Q11A 2Q11A 3Q11A 2011A 2012E 2013E 2014E 2015E

Operating cash flow

Net loss ($22,898) ($6,357) ($11,602) ($16,627) ($18,765) ($12,343) ($16,132) $7,509 $34,615

Depreciation & amort. 2,214 284 519 735 1,176 1,033 888 1,717 3,275

Change in assets &

liabilities 1,302 (1,840) (533) 1,145 (1,222) (255) (554) 313 (1,558)

Cash from operations 7,763 (8,143) (12,139) (13,104) (17,386) (4,566) (8,799) 16,538 46,333

Investing cash flow

Purchase of PP&E (256) (256) (937) (2,328) (2,467) (2,000) (2,500) (2,500) (3,000)

Cash from investing (6,130) 1,811 6,177 8,718 14,734 (2,000) (2,500) (2,500) (3,000)

Financing cash flow

Common stock issuance 565 737 994 994 1,126 22,350 1,250 1,300 1,450

Cash from financing 517 725 1,011 980 1,111 22,400 1,300 1,350 1,500

Net change in cash 2,150 (5,607) (4,951) (3,406) (1,541) 15,834 (9,999) 15,388 44,833

Cash at beginning of period 8,287 10,437 10,437 10,437 10,437 8,896 24,730 14,731 30,119

Cash at end of period 10,437 4,830 5,486 7,031 8,896 24,730 14,731 30,119 74,952


COMPANIES MENTIONED IN THIS REPORT:Company Exchange Symbol Price Rating

Endo Pharmaceuticals Holdings Inc. NASDAQ ENDP $35.98 Buy

Important DisclosuresAnalyst CertificationI, James Molloy, hereby certify that all of the views expressed in this research report accurately reflect my personal views about thesubject securities and issuers. I also certify that no part of my compensation was, is, or will be directly or indirectly related to the specificrecommendations or views expressed in this research report.

The analyst(s) responsible for preparing this report has/have received compensation based on various factors, including the firm's totalrevenues, a portion of which is generated by investment banking activities. The analyst(s) also receive compensation in the form of apercentage of commissions from trades made through the firm in the securities of the subject company of this report, although not for anyinvestment banking transactions with or involving the subject company.

ThinkEquity LLC makes a market in Durect Corp. and Endo Pharmaceuticals Holdings Inc. securities; and/or associated persons may sellto or buy from customers on a principal basis.



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