Expert Financial Analysis and Reporting

Investment Perspective

Alimera’s second quarter results threw investors (and me) a sweeping curve ball. I initiated coverage on May 31, 2013 but never recommended purchase, until I upgraded my opinion to a Buy on June 21, 2017. See Alimera Sciences: Iluvien Sales Seem to Have Caught Traction; It Is Time to Buy! (ALIM, Buy, $1.35)  Note that viewing this report requires a subscription to my website SmithOnStocks.com. Throughout this four year period, I consistently felt that Alimera’s sole product Iluvien, was a very good drug that had a meaningful role to play in the treatment of diabetic macular edema. Holding me back was the concern that the launches of the product (Germany and UK in 2013 and US in 2014) would be slow, a circumstance now seen with almost all newly launched products. Adding to my caution was that a long delay in gaining FDA approval due to agency wavering and indecisiveness put the Company in a strained financial position. It was forced to do a series of financings at distressed prices and has never enjoyed a comfortable cash position.

Following the reporting of 1Q, 2017 results, I felt that the time had come to step up. Worldwide sales of Iluvien had showed steady if not spectacular progression: 2013 ($1.9 million), 2014 ($8.4 million), 2015 (22.4 million) and 2016 ($34.3 million). The gross margin on these sales was about 93% which is pretty impressive. In 1Q, 2017, the Company reported that demand increased 34% in the US and 32% internationally. Moreover management stated that it expected these unit growth trends to continue and for the Company to reach positive cash flow for the first time in perhaps 4Q, 2017.I felt it was time to pull the trigger on a buy recommendation.

But Results for 2Q, 2017 Were Not What I Expected

I was taken aback when Alimera reported that US unit demand in 2Q, 2017 was 9% and foreign was flat. This was far below the 30%+ increases in 1Q and management’s guidance that it expected this 30%+ rate to continue throughout 2017.  What is going on?

Iluvien has proven to be a hard product for which to project sales. One important reason is that it is not like an ordinary prescription drug in which a new prescription is written usually for a month and is followed by a string of monthly refills. One Iluvien prescription treats a patient for up to three years before there is the need for another prescription. This can and does make for an erratic sales pattern. I think management is having as much trouble as outside investors in projecting sales so that their projections must be taken with a grain of salt.

There were other reasons for the sharp slowing in unit demand from 1Q, 2017. The international segment demand, primarily in Germany, was suppressed due to a stock out in Germany as a result of a steep increase in demand in the first quarter of this year. The slowing in the US was primarily due to a sharp cutback in sales and marketing in an effort to reach breakeven pretax cash flow. In each quarter of 2016, sales and marketing expense ranged from $7.1 million to $7.5 million. In 1Q, 2017 it was $5.5 million and in 2Q, 2017 it was $5.0 million.

While the unit growth of Iluvien in 2Q, 2017 was disappointing, the Company produced a positive surprise in terms of cash flow. In 2Q, 2017, non GAAP EBITDA was $ 500,000 based on sales of $10.4 million; I was not projecting positive non-GAAP EBITDA until 4Q, 2017. In 1Q, 2016, non-GAAP EBITDA was a loss of $4.4 million on sales of $9.6 million. The reduction in spending caused a slowing in unit demand, but it still worked out that the Company had reached positive EBITDA for the first time in its history and quicker than the Company had guided.

Looking Ahead

The second quarter had two major data points. The first was a slowing in unit demand from 30+% in 1Q, 2017 to 6% in 2Q, 2017 sharply below management guidance that the unit demand seen in 1Q, 2017 was expected to continue through the remainder of 2017; so much for visibility. However, the cost cutting of the Company has moved it closer to profitability than was expected and Iluvien has reached respectable trailing 12 months revenues of $36 million. It is usually a significant investment positive when a Company reaches cash flow breakeven and augurs well for future gains in stock price. Only a small percentage of biopharma companies ever achieve such commercial success so we have to give management credit for driving Alimera to the brink of profitability.

Management expects that US demand going forward will be constrained by the cost reduction effort as was seen in 2Q, 2017 but offered no sound guidance on whether the 9% increase in 2Q is what should be expected going forward. This is after projecting 30+% following the reporting on 1Q, 2017 results. I don’t offer this as a criticism, but rather it just shows how difficult it is to project sales trends for reasons I discussed earlier. My guess and it is a guess is that we will see 15% unit growth or maybe more in the US through the balance of the year. Internationally, I think that we will see a meaningful rebound from the flat unit shipments caused by the German situation. I would guess maybe 15% in 3Q and 20+% in 4Q. In 2018, I am guessing that US unit demand will be 15% and international 20%. If so, worldwide sales in 2017 could reach $37.5 million and $43.6 million in 2018. This isn’t exactly knocking the ball out of the park, but it is respectable.

Management is guiding that it will run the Company on the basis of controlling costs to a level that will result in roughly breakeven on non-GAAP EBITDA. Investments in working capital could be required that might reduce cash by $1 to $2 million per quarter. The Company has a cash position of $26.9 million so that it should have no immediate need for a cash infusion from an equity offering, but it does have to address a significant need for capital by the end of 2018.

Alimera entered into an agreement with Hercules Capital in April 2014 for a loan of up to $35 million that can only be described as predatory. Since then, the loan has been renegotiated four times because of failure to meet covenants and Hercules each time has been given a cash fee for renegotiating, payment for legal expenses and warrants. The latest renegotiation that occurred on October 2016 allows Alimera to borrow an additional $10 million. The first $5 million is subject to Alimera achieving three month trailing revenues of $12 million before June 30, 2017 and the second $5 million is subject to Alimera achieving $15 million in trailing three month revenues before December 31, 2017. It doesn’t look like ALIM will hit either of goals.

As of June 30, 2017 the outstanding balance on the term loan was $33.6 million. Interest on the balance of the term loan accrues at a floating per annum rate that is based on a complex formula plus the prime rate. Currently, the interest rate is 11.5%. In addition, there is also a payment in kind interest rate of 1% on the outstanding loan balance which is added to principal owed. Currently, Alimera is only paying interest with no principal repayment on the loan. The loan is due and payable in 24 equal monthly payments of principal and interest beginning on December 1, 2018 and ending in full on November 1, 2020. Of course, there are prepayment penalties. So, in those two years Alimera could be required to repay somewhere between $35 and $45 million at a monthly rate of roughly $1.5 to $2.0 million.

Investment Recommendation Continues to be Buy

So what am I now recommending to do with the stock? As a starting point, it is never a good thing when a projection is off as much as mine (and management’s) was in 2Q, 2017 on unit demand, i.e. 6% worldwide unit demand versus a projected 30+%. I have reduced my 2017 sales estimate from $43.7 million to $37.5 million. It is usually prudent for an analyst to take a step back from a recommendation when they (I mean me) misses so meaningfully on a sales projection.

On the other hand, the Company has made dramatic improvements in its cash flow situation and has done a very respectable job in building sales. Alimera is not far away from being a cash generating, profitable pharmaceutical company. While I think there is some risk that the Company might have to do another equity financing at distressed prices, if it is successful in meeting its goal of breakeven non-GAAP or pretax operating cash flow, it could avoid this.

I think that the two keys to stock price performance for the balance of the year are the unit demand for Iluvien. If it is in the 15% range in the US and 20% abroad, it will be moderately encouraging.

I think that longer term the prospects for Iluvien are promising. I think that US doctors are becoming more comfortable with the use of long acting, low dose steroids in the eye. This should continue to improve as Alimera produces real life data that suggests that the risk to benefit ration of Iluvien in clinical practice is quite favorable. Internationally, the growth prospects would appear to be very favorable as the company expands its international reach from having sales in three countries currently to perhaps 17 in a year or two. Also, the deal with pSivida that gained the rights to market Iluvien internationally for posterior uveitis could have a very big impact in 2019 and beyond.