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Expert Financial Analysis and Reporting

Alimera: Iluvien Sales are Encouraging but the Company is Financially Stressed (ALIM, $1.79, Neutral)

Investment Perspective

I first started writing reports on Alimera in May of 2013, but have never recommended the stock. I thought then and continue to think that its first and only product Iluvien, has meaningful commercial potential. I think that Iluvien can potentially reach $300+ millions of worldwide sales and if so, Alimera would be very profitable. However, I have been cautious because of concerns for a slow launch (which is now common to almost all product launches) and the strained balance sheet. Since I picked up coverage, the stock has not done well.

Time has passed and I remain interested in Alimera, but I am not quite ready to pull the trigger and go to a buy. Iluvien had a very strong showing in 2Q, 2016 as sales increased 65% year over year to $9.6 million. If sales continue strong, it may be possible that management will achieve its goal of reaching breakeven for operating cash flow in late 2016 or early 2017. This would require Iluvien to reach about $16 million of quarterly sales which compares to the $9.6 million in 2Q, 2016. Obviously, this would be a very positive event for the stock.

The financial situation of the Company has remained stressed and a loan from Hercules Capital taken out in 2014 of $35 million is essentially now in default as Alimera cannot meet certain covenants. Hercules has been a predatory lender that from my perspective has contrived covenants that have required several amendments to the loan agreement with each amendment enriching Hercules. Hercules could call the loan and put Alimera into bankruptcy but if it did so rights to Iluvien would revert to pSivida. This is not going to happen as Hercules would suffer significant losses on the loan. Hercules will probably soon amend the loan agreement for the fourth time since 2014 exacting a bit more vigorish as in the three prior amendments. This has been an ugly financial transaction for Alimera and its shareholders.

Later in this report, I estimate that Alimera may need to raise perhaps $64 million over the next year to retire the Hercules loan and to fund the Company through to potential breakeven cash flow in 2017. It has an at the market facility in place that could being in up to $34 million if the price stays at $1.79 and which might be done with no warrants. The remaining $30 million might have to be done in the public markets and require a deep discount and 50% warrant coverage. Altogether, if the share issuance can be done at $1.79 (current price) Alimera would have to issue around 34 million shares and some warrants. This financing overhang could put further pressure or a lid on the stock price.

In its 2Q, 2016 10-Q, Alimera reports that there are 45 million shares outstanding. However, not included in this are a potential 33 million shares that could be issued to convertible preferred shareholders and options and warrant holders. And then the issuance of $64 million of equity as just discussed could result in another 38 million shares. In 2017, there could be as many as 125 million shares outstanding.

I think that if the Company reaches its goal of breakeven in 2017 and if the Company can raise equity to stabilize the financial situation and get Hercules out of the picture that this could be an interesting investment. At the current price of $1.79, the 2017 market valuation based on the potential for 125 outstanding shares would be $224 million. I could definitely be interested at this market valuation. However, at this point in time, I am remaining on the sidelines. I would like to see more evidence that Iluvien sales are on a strong trend and also to get the financing behind us. It could be the case that an equity offering could put meaningful pressure on the stock, but a successful offering could be the catalyst for me to go to a buy.

Second Quarter Results

Year over year US sales of Iluvien sales increased by 89% to $7.2 million and European sales increased by 15% to $2.3 million; worldwide sales increased 65% to $9.6 million. The strong US growth was importantly helped by the conversion to the permanent J-code, which makes it easier for physicians to gain reimbursement and have confidence that they will be paid. Remember that Iluvien is a device and physicians must purchase it from the Company. A recovery in German sales was responsible for the European gain as UK sales were down due to competitive issues related to Eylea and Ozurdex. However, UK unit sales increased sequentially by 26% over 1Q, 2016 indicating that sales are recovering. The UK and Germany are currently the key EU markets.

Gross margin in the second quarter was 94.2%. Combined operating expenses in 2Q, 2016 were $15.5 million which compared to $14.2 million in 1Q, 2016 and $15.2 million in 2Q, 2015. These expenses should be roughly flat through the second half of 2016. The operating loss in the second quarter was $6.5 million. In order to reach breakeven operating income in late 2016 or early 2017, Iluvien must reach quarterly sales of about $16 million.

About 35% to 40% of operating expenses are in Europe indicating a quarterly level of $5.9 million and a US level of $10.1 million Based on US sales of $7.2 million the US operating loss was $2.9 million in 2Q, 2016 and based on European sales of $2.3 million the operating loss in Europe was $3.6 million.

Outlook for Second Half 2016 and Longer Term

Management is not giving guidance on 2H, 2016 sales. I think that this may be because they are concerned that physicians delayed purchases in 1Q, 2016 until the J-code was issued and this could have pushed some sales from 1Q into 2Q. If so, the surge in 2Q sales might not be repeated in 3Q. Also, Iluvien is a device and is much more difficult to model than is the case for a drug. The first sale of Iluvien is not followed by a second sale for as long three years so there is no recurring purchase pattern to rely on as in the case of prescription drugs. Each dollar of sales is from one entirely new patient and not a repeat patient.

Very encouragingly, Alimera released three year post launch data on 550 patients that have been treated in Europe which was quite. The majority were refractory to standard of care which is anti-VEGF therapy which means that that they had more severe disease than those in the FAME phase 3 study that was the basis for Iluvien approval. Results in this real life patient population mirrored results in the FAME study. It is not always the case that clinical results in the real world are as good as the clinical trial results so this is very encouraging data. Management believes this will drive growth.

Iluvien has major therapeutic advantages over the anti-VEGF products (Lucentis and Eylea) in that it requires just one injection treatment that can last as long as three years versus the requirement for an anti-VEGF injection every six weeks or so. The competitive steroid implant Ozurdex is injected about every three months. In addition, there is a much more stable level of drug in the retina for Iluvien as opposed to peaks and valleys for the anti-VEGFs. Its major marketing disadvantage is a widespread physician fear that corticosteroids can cause increases in intraocular pressure. Alimera has pointed out to physicians that the steady state corticosteroid dose is much lower than an injected dose that has caused side effects. It has also suggested to physicians that they use Ozurdex to see if a particular patient will experience increased intraocular pressure and if this does not occur to switch the patient to Iluvien.

The one reason people would not want to use Iluvien is concern about the side effect profile. The more data and real life experience that is created to quantify this risk and to handle side effects, the more comfortable doctors will get in using it. They may come to believe that Iluvien is different and that the side effect profile is quite different from that associated with steroid use in the past.

Hercules Loan Agreement Has Kept Alimera over a Financial Barrel

The loan agreement with Hercules Capital is a sad example of predatory lending that has had a negative effect on the stock.

In April 2014, Alimera entered into a loan agreement with Hercules for a term loan of up to $35 million. This provided an initial $10 million that was used for working capital and to repay another loan; this was followed by an additional $25 million needed for a milestone payment due to pSivida. The agreement called for interest only payments through November 2015 at a rate of about 11%. Thereafter, Alimera was required to repay the $35 million of principal in monthly payments through May 2018.This agreement was amended in 2015, twice so far in 2016 and needs to be amended still again because Alimera failed to meet certain loan covenants.

A November 2015 amendment extended the interest only payments through May 2017. Beginning in June 2017, Alimera was then required to make 11 equal monthly payments of principal and interest based upon a 30-month amortization schedule followed by a final payment of all remaining outstanding principal and interest in May 2018. Covenants required that Iluvien revenues be at a certain level and that Alimera have liquidity of $20 million of which $10 million was cash.

In January 2016, the revenue threshold covenant was not met by Alimera. This resulted in another loan amendment with Hercules following which Hercules waived the covenant violation. This amended changed the revenue covenant to a rolling three-month calculation measured for the three months ended May 31, 2016. In addition, the amendment increased the liquidity covenant, requiring the Company to keep at least $25 million in liquid assets, with a minimum of $17.5 million in cash.

Alimera failed to meet the liquidity covenant in July 2016 and this resulted in still another waiver from Hercules in which Alimera must keep at least $20 million in liquid assets and a minimum of $12.5 million in cash. In the 2Q, 2016 10-Q, Alimera said that based on its financial forecast for 2016, it projects that it will not be able to meet covenants on the loan and must seek still another waiver or obtain alternative financing. If the Company does not maintain compliance with any of its financial covenants, Hercules could demand immediate repayment in full of the $35 million under the 2014 term loan. As a result, this is classified as a current liability.

Hercules is a vulture lender that seems consistently to have contrived covenants which Alimera cannot meet and this then requires amendments in which Hercules demands another pound or so of financial flesh. Hopefully, Alimera can find a way out of this situation with alternative financing. Hercules does pose a substantial constraint on its actions. However, I can’t see them calling the loan and driving Alimera into bankruptcy. In this event, rights to Iluvien would revert to pSivida, and Alimera would not have sufficient cash to repay the loan in full (probably less than half) and Hercules would suffer substantial losses. I do not see forcing Alimera into bankruptcy as a viable option for Hercules.

Looking at the Current Share Base and Potential Share Issuance

Alimera has 45.1 million basic shares outstanding according to the recent 10-Q, but this does not include the potential for 21.9 million shares to be issued to convertible preferred shareholders and 10.6 million of options and 0.9 million of warrants. These additional 33.4 million shares would bring the potential share count to 78.5 million shares.

Alimera had cash and cash equivalents of $16.6 million at the end of 2Q, 2016. The operational cash burn was $7.5 million in 2Q, 2016 and $6.8 million in 1Q, 2016 and will decrease as Iluvien sales increase. Very roughly, each $1.1 million increase Iluvien sales can reduce the burn rate by $1.0 million. Management is not giving specific sales guidance for 3Q, 2016 and 4Q, 2016. It is hard to predict cash burn without good sales estimates, but it is probably the case that Alimera will run out of cash in early 2017 even if it moves to breakeven from an operational cash standpoint.

Alimera has some substantial financing to do over the next year or so. It probably needs to first raise about $30 million to provide liquidity for operations into 1H, 2017 at which point it hopes to be profitable. After that it needs to retire the Hercules loan which has a current balance of about $34 million. If it were to raise $64 million of cash through equity issuance at the current price of $1.79, it would have to issue 38 million shares.

Alimera does have an at-the-market offering in place under which it can sell up to approximately $34 million of its common stock. At the current price of $1.79 per share, this would require the issuance of about 19 million shares. The stock trades about 1 million shares per day so it might take some time to execute this ATM and this might pressure the stock. If the Company is forced to do a public offering, it would almost certainly be done at a discount and with 50% warrant coverage. I think the odds are high that Alimera will have to do a public offering of $30 million or so and this could depress the price. However, this might be a buying opportunity.

The potential share count with conversion of the preferred stock, options and warrants is now 78.5 million shares. One year from now there could be an additional 38 million shares issued (probably more) from equity financing. So all in we could be looking at as more than 117 million shares outstanding in 2017. For conservatism let’s estimate that there will be 125 million shares. Based on the current market price, this puts the market valuation at about $225 million.

New Indications for Iluvien

Alimera is also discussing future trials of Iluvien in other retinal diseases, i.e. retinal vein occlusion or non-proliferative diabetic retinopathy. Alimera believes that this can be addressed with just one trial. Given current cash constraints, optimistically such a trial might start in 2017 or 2018 and results might be available in 2019 or 2020. It would probably cost $15 to $20 million to run those trials.

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