Expert Financial Analysis and Reporting

Key Points

• Phase 2 trials are enrolling rapidly.
• Topline results from a trial involving babies of 29 to 34 weeks gestational age should be available in 4Q, 2015. There will be 16 babies on Aerosurf plus nCPAP and 16 babies on nCPAP alone.
• Topline results from a second trial involving babies of 26 to 28 weeks gestational age should be available in 1Q, 2016. There will be 16 babies on Aerosurf plus nCPAP and 16 babies on nCPAP alone.
• A phase 2b trial that will enroll 200 to 250 babies of 26 to 32 weeks gestational should begin in 4Q, 2015 and complete enrollment in mid-2016. Topline data should be available in 4Q, 2016.
• The current cash position of $59 million could result in the Company having $5 to $10 million of cash at year end 2016-after the phase 2b results are announced.
• The phase 2b trial, if successful, will establish proof of concept and should be a huge inflection point for the stock and probably lead to a lucrative partnering deal(s) for international markets.

Investment Opinion

I recommended taking a tax loss on Discovery Laboratories in December 2014 with a view to upgrading the stock in 2015. My reasons were based on the floundering of the Surfaxin launch (the Company decided to cease marketing Surfaxin in March 2016) and the overhang from the need to finance (a financing was completed in July 2015). In the aftermath of the offering I upgraded the stock to Buy. See Discovery Laboratories: What I Intend to Do in the Aftermath of a Disastrous Stock Offering (DSCO, Buy, $0.54). My price target for DSCO if the phase 2b trial of Aerosurf is successful is $2.00 to $3.00 in late 2016 after the topline results are announced.

The investment story for DSCO is now totally based on Aerosurf. I consider this to be one of the most medically and commercially important drug in development by the biotechnology industry. My thoughts are laid out in the June 23 report Discovery Laboratories: An Analysis of Phase 2a Results for Aerosurf and What to do with the Stock (DSCO, $0.81, Neutral).

First Phase 2a Results Were Reported in May, 2015

On May 14, 2015 Discovery Laboratories announced results from the “first in human neonates” phase 2a trial of Aerosurf which enrolled babies of 29 to 34 weeks gestational age. There were 24 patients treated with Aerosurf combined with nCPAP and 24 on nCPAP alone. Aerosurf was administered in three escalating does of 15, 30 and 45 minutes. Remember that the concentration of Aerosurf being delivered is constant and dosing is determined by the duration of the dose. See the June 23 report just referenced for a detailed discussion of the results. Key observations were:

• The primary objective of demonstrating the safety and tolerability of a single exposure of Aerosurf administered in three escalating, inhaled doses was achieved.
• Decreases in oxygen requirements, reduced carbon dioxide levels in the blood and reduced nCPAP failures suggested that Aerosurf was being delivered into the lungs and producing a surfactant like effect.
• The novel and proprietary capillary aerosol generator used to deliver KL-4 surfactant performed satisfactorily in the neonatal intensive care unit (NICU).

The company is following this initial phase 2 a trial with two other phase 2a trials.

Phase 2a Trial in 32 Premature Infants of 29 to 34 Weeks Gestational Age

This trial will enroll 32 premature infants using doses of 60 and 90 minutes. These are higher doses than the 15, 30 and 45 minute doses studied in the first phase 2 a trial. Another differentiation is that physicians are allowed to give a repeat dose.

In the first part of this trial, there were 8 babies on Aerosurf (60 minute dose) plus nCPAP and 8 on nCPAP alone. Enrollment for these 16 babies started in May and was completed in July. This two month enrollment period is encouraging as enrollment in first phase 2a trial was disappointingly slow. The Company attributed this rapid enrollment to greater comfort by physicians that the product is safe (as a result of the first phase 2a trial) and clinical sites gaining more experience with the drug/ device.

I asked management if there were any cases of repeat dosing in the Aerosurf babies and whether there were any incidences of pneumothoraxes. The latter was a closely watched side effect in the first phase 2a trial. Management would not comment on either of these points saying that they will discuss this when all of the results are analyzed. However and very importantly, they noted that the safety monitoring committee would not allow the company to proceed to the next phase of the trial if there were any safety issues.

The next phase of the trial will enroll 8 babies on Aerosurf (90 minute dose) plus nCPAP and 8 on nCPAP alone. Again, repeat doses are allowed. This phase of the trial is already enrolling. I would expect enrollment to be complete in two months or so which suggests October. Topline efficacy and safety data should be available in early 1Q, 2016.

Phase 2a Trial in 32 Premature Infants of 26 to 28 Weeks Gestational Age

Enrollment is expected to begin in August 2015 in a 32 patient phase 2a clinical trial to assess safety and tolerability in younger babies of 26 to 28 weeks gestational age. Both of the prior phase 2a studies were done in babies of 29 to 34 weeks gestational age. There will be two doses used in this trial. The first group studied will be 8 babies on Aerosurf using a 30 minutes dose plus nCPAP and another 8 on nCPAP alone.

This will be followed by 8 babies on Aerosurf using a 45 minute dose plus nCPAP and 8 on nCPAP alone. Repeat dosing will be allowed. I expect the enrollment of this trial to complete in 4Q, 2015. I think that topline results will be released in 1Q, 2016.

The All Important Phase 2b Trial Will Begin in 4Q, 2015

This is the al important trial that will determine proof of concept. If successful, it should provide a substantial boost to the stock price. In a previous report, I have suggested that the price could increase to $2.00 to $3.00 with positive topline data.

This trial will enroll 200 to 250 babies of 26 to 32 weeks gestational age. It will start with babies of 29 to 32 weeks gestational age and then progress to babies of 26 to 28 weeks gestational age. The latter group of babies must be followed until 36 weeks gestational age and this will be the gating factor for completion of the trial. The Company expected to complete enrollment in mid-2016 and I would expect topline results in 4Q, 2016.

This is a well-designed, randomized study that should qualify as one of the two pivotal trials required for approval. If the phase 2b trial is successful, there will likely be an end of phase 2 meeting with the FDA to discuss the phase 3 trial. I think that this phase 3 trial could start in early 2017 and take about 15 months to complete enrollment and analyze results. This point to release of topline results in mid-2018.

Financial

Discovery began 3Q, 2015 with about $59 million (it raised $40 million in a July stock offering). It expects to burn $9 million of cash in 3Q, 2015. At this rate of cash burn, the Company would have about $5 million of cash at the end of 4Q, 2016. This would carry DSCO past the release of topline results for the phase 2b trial. I think that positive phase 2 b results could allow financing at higher stock prices and allow the Company to put together a lucrative partnering deal(s) for international markets. This cash balance is a little thin and allows no margin for error so that I suspect they will do another small equity raise in 2016.

The $30 million loan from Deerfield has been restructured. It was originally supposed to be paid back in equal $10 million installments in February 2017, 2018 and 2019. In the recent offering $5 million has been paid off and there will now be installments of $12.5 million in February of 2018 and 2019. If the market capitalization of DSCO reaches $250 million, the loan can further be stretched out.

In the July equity offering, Discovery received gross proceeds of $40 million. The Company said that one well known (but not yet disclosed) investor bought 40% of the deal and another investor bought 25%. I am curious to find out who these investors are.