Expert Financial Analysis and Reporting

PURPOSE OF REPORT

Biotechnology investing is characterized by long periods of steady, sometimes frightening declines followed by periods of euphoria. We have been in a deep bear market for emerging biotechnology stocks for over a year that has taken a heavy toll on stock prices. It looks like this may be starting to turn as a number of companies in and outside of my universe have begun to respond positively (often dramatically) to favorable news. This report summarizes my thinking on six current recommendations. I also highlight five other stocks that I could upgrade at some point in the next year or so.

For those of you who have been following my work, you will know that I focus on the stocks of companies that can potentially be homeruns, but involve substantial risk. In my own portfolio, these stocks are usually 7% to 10% of my overall investment portfolio. I must point out that two of my current recommendations, Northwest Biotherapeutics and Windtree Therapeutics, potentially could go bankrupt if soon to be reported key clinical trials fail, but in my opinion the extraordinary potential and probability for success warrants this risk.

My focus is on the potential of products under development and the commercial potential if the programs are successful. As long as my opinion does not change, I am reluctant to and usually do not try to call near term movements in stocks for the simple reason that I can’t do it with any success. In my judgment, trading these stocks too often results in getting caught up in euphoria or despair and results in buying high and selling low.

CURRENT RECOMMENDATIOS

Antares (ATRS, Buy, 1.35): The disappointing slow launch of Otrexup and the Complete Response Letter (CRL) on the AB rated generic to EpiPen badly damaged the stock. I have been steadfast in my recommendation because of the amazingly broad pipeline of which these two products are important components, but only part of the story. I now expect Otrexup to gradually increase sales and perhaps reach breakeven in some quarter of 2017. I also think that the AB rated generic to EpiPen could also be approved in 2017. The stock has begun to move recently following the flap over Mylan’s price gouging on EpiPen. See the report "Are Mylan's Woes A Potential Positive for AB Rated Generic to EpiPen?"

Importantly, these two products are only parts of a compelling pipeline made up of five partnered products and two proprietary products. There will be more to come beyond these seven as the technology base of Antares allows for rapid development of both partnered and proprietary products. Please refer to my April 22, 2016 report "An Outstanding Product Pipeline Promises Dramatic Growth Through 2022" for a detailed discussion of the pipeline which puts these products into the perspective of a sales and earnings model.

My 2018 price target is $5.70 without an AB EpiPen launch and $6.60 with a launch. This is based on applying a 15x P/E ratio to projected 2019 EPS. These projections are laid out in the report I just cited. As an additional part of the investment thesis, I think that by 2020 there is a strong possibility that Teva will acquire Antares at a price significantly higher than my 2018 price target.

Cytokinetics (CYTK, Buy $9.25) The stock is up significantly from March 23, 2016 when Amgen’s R&D chief at the Cowen brokerage conference expressed unbridled enthusiasm for omecamtiv mecarbil. See the report "Amgen’s R&D Chief Expresses Great Optimism About Omecamtiv Mecarbil for Treating Congestive Heart Failure".  On August 31, 2016 Amgen announced as expected that it was beginning a phase 3 trial. I think that the potential for omecamtiv mecarbil largely justifies the current market valuation of $435 million. However, CYTK has two other products in late stage development, each of which independently could also justify much of the valuation.

First up is tirasemtiv. Topline data on the VITALITY-ALS phase 3 trial of tirasemtiv in ALS should be reported in 2H, 2017 and if the trial is successful, approval and marketing could commence in 2018. This is a binary outcome with huge potential for the stock if it is successful. With a successful outcome, I think that investors could see tirasemtiv as a $1 billion blockbuster in the US. At this point in time, CYTK has retained all US marketing rights while licensing some rights abroad.

The third product, CK-107 is an under-appreciated molecule. It is in phase 2 for the orphan disease spinal muscular atrophy (SMA) and has just started a phase 2 in chronic obstructive pulmonary disease (COPD). It is possible that a phase 3 trial in spinal muscular atrophy (SMA) could begin in 2017 or early 2018. Obviously, there is no data on the potential in COPD, but if it does improve quality of life (as is the therapeutic goal) for such patients, this would be a huge opportunity given the broad prevalence of COPD. I can argue that much of the current market valuation for Cytokinetics could also be justified by prospects for CK-107 alone. In the event that tirasemtiv fails and the Company concludes that this was due to inability to tolerate side effects, CK-107 with a better side effect profile might be advanced into an ALS trial.

Finally, in looking at the current cash position and taking into account potential but probable milestone payments, the effective cash balance is about $250 million. This is a very solid cash position relative to the cash burn.

Agenus (AGEN, Buy, $6.24)

I think that the Agenus technology platform in immune-oncology is coveted by major biopharma companies eager to get a meaningful position in checkpoint modulation and cancer vaccines, arguably the most exciting areas of cancer research. The Company has a strong cash position of $148 million which can fund the Company through 2H, 2017, but I think that licensing deals and milestone payments can bring in substantial additional amounts of money. I believe that Agenus very likely be acquired at a very substantial premium to the current price potentially in the next three years. See the report "Its Market Leading Position in Immuno-Oncology Makes it A Compelling Investment Story".

Repligen (RGEN, Buy, $32.64)

Repligen has one of the best business models that I have seen in my several years as an analyst not only in health care, but across all industries. Most of the Company’s revenues are recurring, have long life cycles and enjoy strong protection from competition. I estimate that the intrinsic growth rate of existing products is perhaps 15% to 20%. However, the Company has strong cash flow which allows it to take advantage of an abundance of acquisition opportunities as well as to capitalize on great potential for geographic expansion.

I am estimating that 2016 sales will increase 27% to $104 million. The Company is guiding to 2016 non-GAAP EPS of $0.42 to $0.48 and my non-GAAP EPS estimate for 2017 is $0.55. See my most recent report  "Very Strong Growth in Sales and Earnings Continues"  for further information on current trends. The valuation seems extremely high as the P/E ratio on my 2017 EPS estimates is 57 and the current market capitalization $1.1 billion so that the ratio of 2017 estimated sales to current market capitalization is 8.6 (also quite high). Obviously, the stock is highly valued on the basis of a 15% to 20% growth rate even is the rate is highly sustainable. This suggests that the market expects something beyond that. I think that there is the expectation that sales and EPS can be dramatically increased or the Company will be acquired or both.

The Company earlier this year raised $111 million in a convertible offering which gives the Company a $180 million war chest. Acquisitions are an integral part of Repligen’s growth strategy and the Company has had great success with the acquisitions it has made. To date, these have been relatively small. With this war chest, the Company is positioned to make one or maybe two really large acquisitions or perhaps a much larger number of smaller ones. This could lead to a dramatic acceleration in sales and earnings growth from the 15% to 20% rate expected from the current product line. I think this is what the market is looking at.

Windtree Therapeutics (WINT, $2.06)

The market valuation of Windtree is amazingly low at about $17 million when one considers that management expects that it will be reporting phase 2b data on Aerosurf in 1Q, 2017. The therapeutic goal of Aerosurf is to reduce the rate of intubation and mechanical ventilation in premature babies suffering from surfactant deficiency. If achieved, this would create enormous medical and economic value. In my opinion, it is one of the most medically meaningful drug development efforts in biotechnology. If the phase 2b results are viewed as positive, Aerosurf would be poised for a pivotal phase 3 trial. The phase 2b trial would then comprise one of two clinical trials that would be required for registration and marketing.

Trials with Aerosurf have endpoints that are reached within days or a week or two following enrollment. Hence a phase 3 trial can be quickly executed. A phase 3 trial could begin in mid-2017 and report topline results in 2H, 2018 or early 2019. In the event that phase 2b results of Aerosurf are viewed as encouraging and replicable in a phase 3 trial, I think that Windtree Company could quickly be valued by investors at perhaps a market value of $300 million in anticipation of an acquisition. The fully diluted share count at this valuation might be 15 million (the current 10-Q shows 8.3 million shares outstanding) which produces a best case upside of $15 per share.

The cash position is precarious. The Company ended 1Q, 2016 with $20.3 million of cash. The 2Q cash burn was $8.3 million and at this rate, the Company would run out of cash about midway through 1Q, 2017. The Company has guided that the cash would fund operations through Q1, 2017 and after the reporting of phase 2b Aerosurf data. If the data is disappointing there would be a very good chance of bankruptcy.

I believe that the chances for success with the Aerosurf Phase 2b trial warrant holding the stock. At least, that is what I am doing.

Northwest Biotherapeutics (NWBO, $0.39)

At this stock price investors are assigning an extremely high probability (certainty) that the DCVax-L phase 3 trial in newly diagnosed glioblastoma will fail. However, this dismal view ignores strong signals of activity in the phase 1/2 trial and in the information arm of the phase 3 trial. The downside in the event of failure could be bankruptcy, but in my opinion there is astronomical upside if the trial succeeds and I think there is a reasonable chance for success. I think this risk profile strongly argues in favor of buying rather than selling the stock. For more details, see the just released report “My Hypothesis as to Why the Company Has Been Silent on Its Clinical Trial Programs and Why DCVax-L Might Succeed in its Phase 3 Trial”.

STOCKS THAT I MIGHT UPGRADE

Derma Sciences (DSCI, $4.68)

I am close to upgrading this stock to a Buy. My sense is that the BioD acquisition could provide the critical mass needed to make this an attractive growth situation. There are two important things holding me back. The first is that I need to do more work to understand the dynamics of the human amnion tissue market and this is crucial to the analysis. Second, I don’t yet have a relationship with the new management team. If I can rectify these two shortcomings, I could very well upgrade. However, I wanted to let you know my thinking in the event that you want to conduct independent research.

Derma has gone through a dramatic repositioning in the wake of the failure of its biotechnology wound healing product, aclerastide in a phase 3 trial last year. In late July, it announced the acquisition of BioD, a company that creates products for regenerative medicine from human amnion tissue (Human amniotic membrane forms the lining of the fetal environment during gestation, separating the developing fetus from the mother in utero). DSCI had previously licensed two products, AmnioExcel and AmnioMatrix, from BioD and now it has acquired the entire company. DSCI made an upfront payment of $21.3 million ($13.8 million cash) and based on performance of BioD could pay a second payment of $30 million and another of $27 million bringing the total transaction price to $78 million.

The BioD acquisition is a large one in the context of the size of DSCI as it is added to the Advanced Wound Care portfolio. Trailing 12 month sales of BioD are $22 million which compares to $43 million for all other AWC products. This acquisition could be a game changer as it brings critical mass to AWC and makes the Company a factor in the fast growing regenerative medicine market whose products are based on human amnion tissues. I am very intrigued by this acquisition, but I need to do more work.

In addition to this acquisition, DSCI sold part of its Comvita stake for $7.6 million; this is the New Zealand supplier of Manuka honey for Medihoney. It also sold its first aid division (a part of Traditional Wound Care) which brought in $10 million of cash. Interestingly, shareholders of BioD made an investment as they bought $2.3 million of stock. As of June 30 Derma Sciences' had cash, cash equivalents and short term investments of $44 million compared with $40.8 it now has approximately $52 million of cash on hand.

During the 1Q, conference call, management guided for 2016 sales of $89.1 million, an increase of 5.4% from 2015. It expected Advanced wound care sales of $47.2 million, up 13% and traditional wound care products sales of $41.9 million, a decline of 2%.The expectation was for sales to become progressively stronger as the year progressed. The expected operating cash burn for 1H, 2016 was $7.5 million and the expectation was for the Company to generate $1 million of cash flow in 2H, 2016. The actual cash burn in 1H, 2016 was $4.5 million due to the sale of the Comvita stake.

Management gave guidance in a different way during the 2Q, conference call. It gave proforma guidance assuming that BioD had been part of DSCI for the entire year instead of less than a half year. It said that with BioD included in this way sales would be $97.3 million in 2016 versus $86.4 million for 2015, an increase of 13%. It re-confirmed 1Q guidance that its existing AWC products would reach $47.2 million (up 13%) and stated that BioD sales would be $24.3 million up 30% bringing proforma AWD sales to $71.5 million for 2016. With the sale of the first aid division Traditional Wound Care is projected to have pro forma sales of $26 million in 2016. The stagnant TWC business has shrunk from 51% of sales in 2015 to 27% in proforma 2016 sales.

AWC products are the critical component of DSCI. Management predicted that pro forma AWC sales (with BioD) would be $71.5 million in 2016 and would have a gross margin of 65% which would lead to gross profits of $46.5 million. This compares to AWC sales of $41.8 million and gross profits of $21.0 million in 2015. Gross profits for AWC on a pro forma basis are projected to double. AWC is now 73% of total sales and its growth in 2016 is projected at 13%. If the 13% trend continues, total sales growth in 2017 including traditional wound care would be 10%.

Management has not given any guidance on pro forma earnings for 2016 nor has it given any information on operating costs at BioD. However, it seems probable the Company will show an operating profit of $2 or $ 3 million for 2016 on a proforma basis using a back of the envelope calculation. This translates into toughly $0.06 per share. I think this would be highly encouraging to investors.

Based on management guidance, the stock is currently selling at a market capitalization to 2016 sales ratio of 1.3 and market capitalization to Advanced Wound Care sales ratio of 1.7. If you view DSCI as a specialty pharma company, the stock appears very cheap on this basis.

The Company is searching for a new CEO having fired Ed Quilty for his failed foray into biotechnology. Barry Wolfenson, who was number two in the Company, just resigned. I thought that they were competent executives who did a good job in building the Company but they paid the price for the big, failed bet on aclerastide.

AMAG Pharmaceuticals (AMAG, $22.58)

The key to a decision by me to upgrade the stock is gaining confidence on the timing of approval of the Makena auto-injector. It is very important that it is introduced at a time that will allow it to replace most Makena single vial dosages prior to generics becoming established. It is also important that it gains Orphan Drug designation, which would provide seven years of market exclusivity.

A lot has to go right for AMAG to meet these objectives and slippage in the timeline for approval would have a major impact on the stock. This causes me to remain on the sidelines. Please refer to my in-depth report "Initiation of Research on a Complex but Potentially Very Interesting Investment Situation" for more detailed analysis.

Alimera (ALIM, $1.49)

I think that management has done a reasonable good job in its launch of Iluvien, its only product. There are two things that I am watching on Alimera as explained in my August 8 report "Iluvien Sales are Encouraging but the Company is Financially Stressed". The trajectory of the launch may be different for Iluvien than for a drug and this makes it difficult to assess the launch. Iluvien is a device that is sold and then lasts for as long as three years. There are no recurring sales as is the case with prescription drugs which leads to continuing revenues. I have some concern that encouraging second quarter sales were the result of physicians warehousing patients from the first quarter as they awaited a J-code that made reimbursement easier and more secure. It could be that second quarter sales were somewhat inflated by this. I will be watching third quarter and fourth quarter Iluvien sales with great interest.

Alimera also has a very strained balance sheet. The recent equity offering that brought in a little under $25 million was somewhat less than I was hoping for. They may have to go to market one more time although management seems to feel that this raise will take the Company to cash flow break even.

pSivida (PSDV, $3.79)

The first major investment issue for pSivida is that its success is closely tied to the commercial launch of Iluvien which is being conducted by Alimera. The second is the clinical development of Medidur for the treatment of posterior uveitis which affects 175,000 people in the US and causes 30,000 cases of blindness each year making it the third leading cause of blindness. The first of two phase 3 trials of Medidur was very successful, the second should complete this year and an NDA filing is projected for mid-2017.

pSivida is entitled to receive about 20% net profits on a country by country basis from sales of Iluvien whose launch is being handled worldwide by Alimera. Managed care has become a major hurdle in the key US market for almost all new product launches and viewed against this background, Alimera has done OK with the launch. It looks like the launch could be on track to bring Alimera into profitability, but I still have concerns about the dynamics of the launch and the strained financial condition. See my report of August 8 "Iluvien Sales are Encouraging but the Company is Financially Stressed" for more details.

It has been rumored that Alimera is seeking a buyer. If so and they find a buyer that has strong marketing and financial resources, this could be a major positive for pSivida. In the unlikely event that Alimera had to declare bankruptcy, Iluvien rights would revert to pSivida. This could be a quite positive event for PSDV in the long term although near term disruption would be an issue. I may be too cautious in not upgrading PSDV now.

pSivida announced in December 2015 that the first phase 3 trial of Medidur was successful. Enrollment of the second phase 3 is expected to complete in mid-calendar 2016. With favorable results, the Company may file for approval in the US in mid- 2017. In late December, 2015, they filed for European approval on the basis of the first phase 3 trial.

The first phase 3 trial was a 129 patient, multi-center, randomized and double-blinded trial. The primary endpoint of prevention of recurrence of disease at six months was highly statistically significant with p less than 0.00000001 on an intent to treat analysis. In patients treated with Medidur, 18.4% of patients had recurrence of posterior uveitis versus 78.6% on control. Safety results were also encouraging as the major safety concern is elevated intraocular pressure In the Medidur treated groups 27.6% of Medidur-treated eyes compared to 16.7% of control eyes had experienced an increase in intraocular pressure (IOP) above 21 mmHg for at least one observation. This was comparable to what was seen with Iluvien phase 3 trials.

I am interested in an investigator-sponsored study of the use of a Durasert implant for severe knee osteoarthritis.

Caladrius (CLBS, $4.77)

I am interested in Caladrius Biosciences primarily because of the potential for its PCT cell therapy manufacturing business. PCT has a rapidly growing sales base that had $13 million of sales in 2014 and $23 million in 2015. Management is projecting $30 million in 2016. Sales at mid-2016 were on track to reach $30 million at about $15.7 million. These are all revenues from third parties and do not include any development work on internal products being developed by Caladrius.

In March 2016, 19.9% of PCT was sold to Hitachi Chemical for $19.4 million. This valued PCT at $97 million which compares to the current market capitalization of about $33 million. This disparity reflects the market’s concern about the weak cash position. This situation has some parallels to Repligen which has been an exceptional stock. Repligen exited the biotechnology business to focus on bioprocessing. See my December 12, 2012 report  “Initiating Coverage with a Buy”

I don’t think that PCT will emerge as attractive a business model as Repligen whose products are incorporated into the manufacturing process of a product and are used throughout the life of the product. PCT will likely develop a manufacturing process through phase 1 and 2 and perhaps phase 3. However, once a product is commercialized, the owner of the product will probably want to take over most of the manufacturing and use PCT as a second source. If so, PCT will not enjoy the long life cycles of Repligen’s products. Still, this still looks like a very good business model with the extensive amount of research going on in cell based therapies. According to the alliance for regenerative medicine, at the end of 2015, there were 632 regenerative medicine clinical trials underway with 63 Phase III trials and 376 Phase II trials. 62% and 83% increases over 2014 respectively. I am intrigued with the prospects for PCT.

The Company will also take advantage of its manufacturing assets and clinical knowhow to develop certain cell based therapies to the proof of concept stage and then license them to larger companies to conduct the much more expensive regulatory trials. This approach could allow Caladrius to develop a broad portfolio of licensed products. Potentially the expense incurred will be recouped in licensing fees and CLBS will also benefit by providing manufacturing for the product. Caladrius will not be involved in expensive clinical development expenses and will receive a royalty if the products are eventually commercialized.

The current cash position is strained as the Company ended 2Q, 2016 with $18 million of cash and issued guidance that indicates that 2H, 2016 cash burn will be $10 to $13 million. Clearly the Company needs to raise capital and I estimate that if they raised $20 million in an equity offering that it could double the fully diluted share count to 114 million. Because of the strained cash position, I remain on the sidelines for now.

COMPANIES I AM MONITORING WITH NO PLANS TO UPGRADE IN THE NEAR FUTURE

Celldex (CLDX, $3.60)

Refer to my August 14 report "Update Based on 2Q, 2016 Conference Call".  There is just not any meaningful news flow until mid-2017 or later. The current lead product is glembatumumab, which is being developed for triple negative breast cancer. There were not many patients treated in earlier trials as the Company took the usual biotechnology strategy of jumping quickly into a potential registrational trial. Also, there is tremendous development effort going on in triple negative breast cancer that makes it difficult to recruit patients and raises competitive concerns. The Company has a solid cash position and good technology so I continue to follow the Company.

Chimerix (CMRX, $4.77)

I had thought that there was a good chance of approval for brincidofovir for the treatment of disseminated adenovirus infections based on the open label AdVise trial. At the same time as AdVise, the Company did a large retrospective study to try to determine what survival rates were in patients treated with standard of care. The survival rates for brincidofovir in the AdVise trial were encouraging but unfortunately, the results from the retrospective study were unclear. Consequently, Chimerix will have to do another study which delays the potential approval of brincidofovir from 2017 to 2019 or 2020. See  the report "Thinking on the Stock in the Aftermath of Results from the AdVise Trial".

As with Celldex, I just don’t see much news flow for the next year with the possible exception of news on a BARDA contract for use of brincidofovir against smallpox. It has a solid cash position.

ImmunoCellular Therapeutics (IMUC, $0.12)

I think that IMUC’s dendritic cell vaccines ICT-107 has shown strong signals of efficacy in newly diagnosed glioblastoma. I also think that the phase 3 trial now underway is well designed, although we may not see any results for two years or more. The problem is that the market is extremely skeptical on cancer vaccines and IMUC is being valued as if there is a high probability of failure. The trial will take another two years to complete and the cash position is too low to fund the trial to completion. IMUC will have to do additional transactions at its current low market valuation to complete the trial. While I am on the sidelines for now, I do think that there is a reasonable chance for success in this trial that would cause an explosive stock move so I continue to follow the Company. See my latest report  "Is There an Investment Case to be Made".

Kite Therapeutics (KITE, $56.91)

I have completed 99% of an in-depth report on KITE. The report is quite extensive and I am publishing it in parts with the first part to be published shortly. I am interested to its technology, but I think that CAR-T is over-hyped and the stock looks over-valued.

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