Expert Financial Analysis and Reporting

Investment Thesis

Windtree is facing the ultimate of binary events when it releases topline results in July for its critical phase 2b proof of concept trial of Aerosurf in premature babies with RDS syndrome. It is on track to run out of cash in July if it does not receive some type of cash infusion. If the results of the phase 2b trial are disappointing, it is highly likely that the company will go bankrupt. The current market valuation of about $26 million (based on fully diluted shares of 28.6 million) strongly suggests that the stock market is expecting the trial to fail.

In looking at all of the clinical data on Aerosurf and its parent product Surfaxin, I think that there is a reasonable chance that the results will be positive. Here are my key thoughts in brief:

• The active ingredient in Aerosurf and its parent product Surfaxin is the synthetic surfactant KL-4. The FDA has approved this drug in a liquid distillate formulation (the same used by the animal surfactants) to treat RDS.
• We know that KL-4 is an effective drug. The issue is whether an aerosolized form of KL-4 (as delivered in Aerosurf) can disperse as effectively throughout the lungs as the liquid distillate formulations used with Surfaxin and current animal surfactants that now dominate the market. Studies in primates indicate that Aerosurf does achieve such desired dispersion in primate lungs.
• The most important issue for neonatologists, parents and others involved in the care of babies with RDS syndrome is safety. We are dealing with fragile premature infants and safety is paramount. The Data Monitoring Committee for the phase 2 b trial has twice conducted an interim review to look at safety issues and each time recommended that it continue. This is reassuring that there is no safety issue with Aerosurf.

However, the goddess of clinical trials is cruel and while the points just listed raise hopes for success, it is very hard to predict outcomes of clinical trials with great confidence as there are just so many unconstrained variables. Sometimes trials can fail even though the drug may ultimately be shown to be effective because of incorrect dosing, selecting the wrong endpoints, improper conduct of the trial at some centers and on and on. Also, in the case of Aerosurf, we are dealing with a drug/ device combination and the medical device used is novel and not yet validated. This compounds the risk. I am not being evasive and weasily in raising these caveats, it is just acknowledging reality.

If the phase 2b results are encouraging, I am not concerned with the Company raising cash to keep the doors open past July. A February financing raised $10.5 million from sophisticated investors (Bakers Brothers was one) that has allowed Windtree to conclude the phase 2b trial. It is unimaginable to me that they would not then invest additional cash to give management time to develop a business relationship with a biopharma partner that would provide a path for completion of a phase 3 trial, which along with the phase 2b trial could be the basis for filing an NDA. I am estimating that the monthly burn rate post July could be about $1.5 million per month. I have no way of projecting how long it might take to conclude a business development deal, but I would not be surprised if it took six months. If so, the investors I just referred to would have to invest at least another $9 million.

There are several types of potential business development deals that range from an outright acquisition of Windtree to numerous versions of licensing and partnering. I can’t predict with any degree of confidence what the ultimate deal structure might be. Obviously, it is highly dependent on the quality of the phase 2b data.

Let me list some key issues that may determine where the stock might sell in six months or so.

• The July reporting of phase 2b data is critical. If it is clearly negative, the stock price probably goes to zero. If it is very positive, we should expect a significant bounce in the stock.
• The financing concern could dampen this bounce as the need for an immediate financing is obvious. As biotechnology investors well understand, cash strapped companies often have to finance on disastrous terms if they go the public market. Hopefully, Windtree can quickly execute a private deal with the previously cited investors and quickly get this behind the company.
• I am assuming that the Company will then have six months or so to consummate a business development deal. The ideal deal would provide a clear path forward for Windtree (with its partner) to complete a phase 3 trial. This could take over two years and cost over $50 million. In addition, it would be highly desirable if this deal also would allow Windtree to fund its operations over this period, potentially retire $25 million of debt owed to Deerfield Management and have some reasonable cash balance at the time of the completion of the phase 3 trial in 2019 or 2020. Somehow though a relationship with a business partner or through equity issuance in the equity markets, Windtree may have to gain access to $100 million over the next two years.

We know with great accuracy that the downside on the stock is zero. Let me now try to estimate what the stock price might be if everything goes smoothly and the Company consummates a very positive business deal. I think that the validation of the technology by a successful phase 2b trial and a business deal with a credible partner that further validates the technology and steers a clear path to completion of the phase 3 could lead to dramatic increase in market value. As I said, the current market valuation of $26 million suggests that there is scant hope that Aerosurf will be successfully developed. The market valuation could increase dramatically if investors conclude that the chances for successful completion of the phase 3 trial are reasonable. Based on looking at valuations of other late stage companies, I think that a market valuation of $200 million would be conservative and $500 million would not be so outlandish.

The next question to ask is how many additional shares will have to be issued in this highly positive scenario. There is no reasonable way of making a projection. The current share count is made up of 10.3 million basic shares and another 18.3 million shares that should be issued if the stock rises to say $3 or more so that there are effectively 28.6 million shares outstanding. As a result of the February 2017 deal that brought in about $10 million, there are 7.0 million shares reserved for conversion of preferred stock and 7.0 million warrants exercisable at $1.37. Essentially, existing shareholders were diluted by 140% by this deal as measured by shares outstanding. Of course, without the deal, the Company would have gone out of business.

If I am correct that the Company will raise another $9 million or so from these same investors, so how many more potentially dilutive shares could be issued? If the stock doesn’t budge from $0.92 with positive topline results because of concern about the life or death financing, then we could see another 14 million potentially dilutive shares bringing the share count to 43 million and the market capitalization would be $39 million. If the stock went to $2.00 or beyond, the dilution from a financing might be substantially less.

One of the most positive scenarios I can come up with is a partnering deal that would assure the funding of the phase 3 trial and provide some type of upfront payment that would obviate the need for more capital to be raised from the public market. In this event, it is not unrealistic to imagine a $500 million market valuation as such a deal from a credible partner would add a powerful validation to the “presumed” positive topline phase 2 b results. There would be 43 million shares outstanding so that the resultant stock price might be $12 or more. I am skeptical about the possibility of an outright acquisition but I would guess that it might be in the $5+ range if it occurred.

There are an almost infinite number of partnering and licensing possibilities and one of the more negative would be perhaps a reverse merger into a shell company that could bring in say $25 to $50 million of cash and would enable Windtree to begin the phase 3 trial, but would require a public financing in say 2018 or 2019. Without the validation of a strong partnering deal and with the financing overhang, I wouldn’t be surprised to see a lot of discouragement with a market valuation of $100 million and with a 43 million share count, the stock price might be $2.30. These two examples are only illustrative in nature and they are based on a lot of incredibly arbitrary assumptions, but at least this is a way of thinking about the possibilities.

So what am I recommending? This is such a high risk and indeterminate situation that I am leaving each investor to assess the facts as I present them and as they see them and then make up their own mind. I am going to buy about one-third of the normal position I take in a stock and will do this before the July topline results and then decide where to go from there. Anyone who buys the stock must be aware that they could lose their entire investment if the topline phase 2b results are negative. If they are positive, the shape of the partnering deal, if any, will shape the stock price.

Phase 2b Results are a Critical Catalyst

Windtree has announced that it has nearly completed enrollment of its phase 2b trial of Aerosurf in babies of 28 to 32 weeks gestational age suffering from respiratory distress syndrome (RDS). This was a randomized, global trial that enrolled 240 babies. If results are positive, Windtree could use this as one of two clinical trials needed to seek regulatory approval. The next step would be a phase 3 trial which as a guess could report topline results in mid-2019 and assuming a positive outcome, could lead to approval in 2020.The primary outcome measure of the phase 2b is time to respiratory failure or death due to RDS.A number of secondary endpoints address safety and measures of lung function

Medical Need Addressed

Aerosurf could lead to a paradigm shift in the treatment of premature babies by improving on the safety and efficacy of animal surfactants in many (not all) premature babies. The use of natural surfactants extracted from the lungs of swine and cattle to augment surfactant deficiencies in premature babies has been one of the great advances in medical history. The lives of countless babies have been saved and enabled them to go on to lead a normal life. Think of it this way, the survival benefit for many babies treated with animal surfactants is a lifetime. In cancer therapy, a drug that increases median overall survival by 4.5 months is considered a meaningful advance.

While the benefits of animal surfactants are tremendous, there is a major drawback in that the baby must be intubated and placed on a mechanical ventilator which carries the risk of serious lung damage. Aerosurf is based on WINT’s synthetic surfactant KL-4 (it is not derived from animal lungs like current products) that is lyophilized and delivered by a proprietary medical aersolizer developed by Windtree. It delivers aerosolized KL-4 through nCPAP. If Aerosurf is as effective as the animal surfactants, its non-intubation delivery could revolutionize the treatment of premature babies with RDS.I believe that if it is found to be safe and effective that it could rank among the most medically important drugs developed by the biopharma industry. Yes, you read that correctly.

Will The Phase 2b Trial Be Successful?

I am not going to go into depth on the Aerosol’s drug attributes and clinical data in this note. For those who would like a more extensive review, I refer you to this link that directs you to articles I have published. In brief, here are my key thoughts about Aerosurf.

• The active ingredient in Aerosurf is KL-4. The FDA has approved this drug in a liquid distillate formulation (the same used by the animal surfactants) to treat RDS
• We know that KL-4 is an effective drug. The issue is whether aerosolized form of KL-4 (contained in Aerosurf) can disperse as effectively throughout the lungs as the liquid distillate formulations used with animal surfactants. Studies in primates indicate that Aerosurf does achieve such desired dispersion in primate lungs.
• The most important issue for neonatologists, parents and others involved in the care of babies with RDS syndrome is safety. We are dealing with fragile premature infants and safety is paramount. The Data Monitoring Committee for the phase 2 b trial has twice taken an interim look at the phase 2b trial and recommended that it continue. This is very reassuring that there is no safety issue.

These observations give me reasonable confidence that the phase 2b trial will produce a positive outcome. However, after 30+ years of monitoring clinical trials, I am constantly reminded of how unpredictable biology can be and a positive outcome is not a sure thing. Even if the primary endpoint is met, I would be surprised if there were not some questions or concerns raised about the results. I have no idea what they might be. It is just that rarely does one trial produce pristine safety and efficacy data. However, let us hope that this will be the case with Aerosurf.

Is Now the Time to Buy?

The timing for completion of the phase 2b trial was extended several times and still another extension and change in the enrollment plan was announced last fall. Because of this delay, I recommended taking a tax loss on WINT in a report published on October 25, 2016. My intent was to go back to a buy at some later point. I have not recommended going back into the stock since last October. Needless to say, some people are asking if now is now the time to go back in given that I think there is a good possibility for success. The answer would seem to be of course, but this decision is made complex because of the weak financial position.

Financial Position Is Perilous

Because of a long list of setbacks over the past decade, some self-imposed and others resulting from regulatory agency dysfunction, Windtree has lost credibility with investors which has made it very difficult to access capital. Windtree finds itself in perilous financial position.  It ended the March 31 quarter with a cash position of $8 million. In the first quarter, the cash burn was $7.3 million due largely to spending $1.9 million on G&A and $6.4 million on R&D; much of the R&D spend was on the phase 2b trial. The monthly burn rate was about $2.4 million.

The monthly burn rate in April and May should also come in around $2.4 million. There will still be some reduction of R&D expenses related to the trial in June because it is winding down so that I am guessing that the burn rate comes in around $1.5 million. If these calculations are in the ballpark (and I think they are), Windtree will end the June quarter with $1.7 million of cash, roughly enough to keep the doors open in July.

Quickly Bringing in Capital is Critical

If the phase 2b results are disappointing, Windtree will almost certainly be forced into bankruptcy so the downside is clear, but what happens if the results are positive and support conducting a phase 3 trial. The Company will have to move quickly to bring in cash. I think that they would turn to the same investors who invested $10.5 million in the February private placement. It doesn’t take a genius to surmise that these sophisticated investors completely understood that the Company would run out of cash in July and this was factored into their thinking.

I can only surmise that there must be a contingent plan for them to invest more money if the phase 2b trial is successful. In the event of success, I would expect them to participate in another private placement to bring in cash to keep the doors open and to give management time to execute a business development plan for executing a phase 3 trial of Aerosurf. I think that the monthly burn rate beyond July without the expenses of the phase 2 trial could decline from $2.4 million to $1.5 million. If so, an investment of $4.5 million would allow the Company to keep operating for three months and an investment of $9 million would do so for six months. I cannot imagine that the investors who participated in the February offering would not quickly step up to put another $5 to $9 million into the Company if phase 2b results are positive.

Based on the reasoning just presented, I think that if the phase 2b results are positive that the Company will have time to execute a business development plan to maximize the value to shareholders of what would then be a very valuable asset in Aerosurf. I will address various business development options at length later in this report. However, the next point to address is what happens to the stock market valuation of Windtree with successful phase 2b results?

More Thoughts on What Happens to the Stock Price If Phase 2b Results are Positive?

In its 1Q, 2017 report, the Company reported 10.3 million shares outstanding. In addition to this, there are roughly 18.3 million additional shares that could be issued so that reasonably there are now 28.6 million fully diluted shares outstanding. At the current price of $0.92 the market capitalization is $26 million. There are several critical questions that current shareholders and investors who are considering buying the stock before the release of phase 2b topline results need to answer. The first is what will the stock market reaction be?

I can only conclude that the $26 million market capitalization means that the stock market participants believe that the trial will fail or results will be too equivocal to allow management to bring in capital and give them time to come up with a business development plan to take Aerosurf into phase 3. A clearly positive result would be a major upside surprise and this should produce a corresponding major upside move in the stock, but how much? I hypothesize that if Windtree were a private company and elected to come public following a successful phase 2b trial, it could command a much larger market capitalization. Its credentials would be as follows:

• The Company could enroll and complete a phase 3 trial for Aerosurf in a very short time frame. Reaching the endpoint of time to respiratory failure or death due to RDS takes only a few weeks for each patient. This is unlike many phase 3 trials that can take many months or years for a patient to reach the clinical endpoint; e.g. median overall survival in cancer trials.
• I believe that there is a great unmet medical need for a product with the clinical attributes that Windtree is trying to demonstrate with Aerosurf. There are an estimated 120,000 pre-term babies with RDS in the US who are initially treated with nCPAP because doctors want to avoid intubation and mechanical ventilation. From a cost standpoint, the cost of treating a baby on nCPAP is about $5,000 whereas a baby on intubation costs about $50,000 or more. Assuming a price of $8,000 per treatment the addressable market in the US would be about $1 billion 120,000 x $8,000). For the rest of the world it might be 1.5 times as much or $1.5 billion.
• The product is very novel; I do not see a potential competitor on the horizon and the expected life cycle could be decades. Numerous attempts to aerosolize the animal surfactants have failed because they are complex, sticky mixtures of proteins and lipids that clog up aerosolizers.
• Developing an AB rated generic to Aerosurf would be extremely difficult. Any attempt to do so would require the demonstration that the generic delivers the aerosolized KL-4 surfactant precisely in the same distribution as Aerosurf. I don’t know how this could be shown without large and expensive clinical trials that did a head to head comparison. And what institution would participate in a trial that would test a drug that is attempting to show that it is only as good as a proven drug and that has the potential to cause unforeseen side effects. I can’t imagine parents signing off on allowing their premature babies to be enrolled in such a study. If this reasoning is correct, I can’t see how a Company could develop either an AB rated generic or a 505 (b2) pathway product.
• Aerosurf is based on a novel drug delivery system that can deliver KL-4, small molecules and peptides to the lungs that can address a number of diseases of the lung and also trauma to the lung. It is essentially a pipeline in a drug.

Company after company with cancer targeted therapies have come public at $300 million or much higher valuations even though they face intense competition and only have drugs in phase  or 2 development. We seem to be running out of cancers without effective treatment but the supply of biotechnology companies developing cancer treatments seems limitless. I can easily hypothesize that if Windtree were a private company and investors were presented with the business credentials that I just outlined that the market capitalization in an IPO would be $300 million, $500 million or higher.

Alas, Windtree has accumulated a lot of baggage over the years and short of bankruptcy it has produced about as much disappointment as one can imagine. Investors have lost enormous amounts of money over the year. The Company filed for approval of Surfaxin in February 2005 and received approval in October 2013. In between, the Company received seven Complete Response Letters. The long awaited launch of Surfaxin was slow and disappointing and with limited financial resources, Windtree decided to withdraw Surfaxin from the market and focus all of its resources on Aerosurf. The stock price has declined from about $102 in February 2005 to a current price of $0.92. No one who has ever bought and held the stock has ever made a profit.

Thinking About Business Development Deals

The next question is what value potential business partners might put on Aerosurf as they consider buying the Company or partnering or licensing the drug. For a business partner, this is also untrodden ground. The aerosolizer device, in particular, is something with which they not familiar. It is potentially a high risk decision given the unknowns about the market. Also doing business with a bulletin board company with a market capitalization of $9 million could raise eyebrows in the board room

Business Development Scenarios If Phase 2b Results are Positive

I previously postulated that the same investors who invested $10.5 million in February will invest an additional $4.5 to $9 million if the phase 2b results are positive and that could give the Company 3 to 6 months to come up with a business development plan. Windtree has retained worldwide rights to Aerosurf to this point but I see no chance to retain worldwide control. Completing the phase 3 trial and gaining regulatory approval would likely take two years or more. As a guess, Windtree might need $100 million to achieve this. I give this scenario virtually no chance. They will have to find a corporate partner. Here are the things that a potential partner would have to consider or worry about.

• The cosmetics of doing a deal with a Company with a small market capitalization that has almost no cash might be a difficult for a business development person to present to management and then for management to present to the board. Windtree’s long record of disappointing performance would also weigh on this.
• In preparing an NDA, a company has to present compelling clinical data, but it also has to submit a data section called Chemistry, Manufacturing and Control (CMC). Investors pay most of the attention to clinical data but companies looking to partner must be very concerned about CMC which has to do with being able to assure that a product can be manufactured with consistent quality when commercialized. CMC surprises have produced some disastrous outcomes. For example, Astra Zeneca acquired ZS Pharma for $2.7 billion in December 2015 anticipating that approval would be gained by yearend 2016. CMC issues resulted in a first CRL in May 2016 and then a second CRL in March 2017 so that the product has not yet been approved. Aerosurf may be of particular concern to business development people because it uses a lyophilized peptide that is more complex to manufacture than small organic molecules. Also, the medical device used in phase 3 must be identical to that of the commercial product. Business development teams will be very concerned that the cash strapped Windtree has achieved this degree of precision with the aerosolizer. If there is a problem that needs to be corrected, it could add years to the NDA filing timeline.
• Like investors, business development people at major companies aren’t familiar with neonatology as there has not been much drug development in the area. Unlike in cancer for example, they don’t have a sense of how neonatologists might react to Aerosurf and the difficulty in gaining formulary acceptance and reimbursement’

The point I am making is that this is a fairly high risk project for a business development person at a major corporation. It is easier to champion a product that is evolutionary in nature with a high chance for success than one that is paradigm changing and high risk. This can only reduce the number of partners willing to consider Aerosurf and extend the due diligence time needed to assess and act on a deal. That said, let’s consider a number of scenarios.

• One possibility would be to partner Aerosurf in foreign markets and retain US rights. This would have to entail enough money to complete the phase 3 trial and more. This would require great conviction on the part of the business partner and would be a big financial commitment.
• There could be an outright acquisition of Windtree. I think this might be the best outcome, but again it requires a lot of commitment.
• Perhaps a potential acquirer could strike a deal in which they set up milestones and allow the Company to conduct the phase 3 trial. As each milestone is met, more cash is injected to allow the Windtree to proceed to the next and so on. There are a number of specialty pharmaceutical companies who might be intrigued by this type of deal.
• Windtree could merge with a shell company that has enough cash to move forward without an immediate partner.

Potential Number of Shares That Could Be Outstanding

Windtree has about 10.3 million shares outstanding. I omit a number of warrants and options that are far out of the money and come up with an additional 18.3 million shares that reasonably could be issued of the stock price were to increase to say $3 or so.

• 2.8 million prefunded warrants
• 7.0 million shares reserved to preferred stock issued in the February 2017 financing
• 7.0 million warrants issued in the February 2017 financing
• 1.5 million stock options

This indicates that the fully diluted share count is roughly 28.6 million shares.

 

 

 

 

 

Tagged as KL-4, Phase 2b trial of Aerosurf, Windtree Therapeutics, WINT + Categorized as Company Reports, LinkedIn