Expert Financial Analysis and Reporting

Overview

Windtree held a conference call on October 25 to update investors on the status of the phase 2a trial of Aerosurf and to discuss a trial that investigated the distribution of Aerosurf in the lungs of non-human primates. Management has consistently underestimated the time that it will take to complete the phase 2a trial. The previous guidance was that it would complete in 3Q, 2016 but enrollment has been slower than expected.

The implication for the critically important phase 2b trial that is now underway is that it will now complete enrollment in mid-2017 as opposed to prior guidance of 1Q, 2017 and that the trial will now only enroll babies of 29 to 34 weeks gestational age (GA) whereas previously it was intended to also enroll babies of 26 to 28 weeks GA. This report analyzes the implications for the Company and the stock in light of the delay and phase 2b trial design change.

Phase 2a Trial Delayed

Let me just remind you on some details of the phase 2a trial. The first part enrolled babies of 29 to 34 weeks GA This segment was completed and safety was established which enabled the Company to extend the trial to younger babies of 26 to 28 weeks GA. Meanwhile, the Company started a phase 2b trial by enrolling babies of 29 to 34 weeks GA with the intention of enrolling babies of 26 to 28 weeks GA after the phase 2a was completed.

The phase 2a trial segment in babies of 26 to 28 weeks was designed to enroll cohorts dosed for 30, 45 and 60 minutes and potentially a fourth at 90 minutes. The enrollment was slower than expected with two important reasons being cited. Because of the fragility of these babies physicians often go straight to intubation and mechanical ventilation skipping nCPAP. Also, it is difficult to expeditiously get parental consent. The second cohort using 30 minute dosing only completed enrollment in September and the third cohort (as a guess) might complete in early 2017. At this point, it is not clear if the cohort at 90 minutes will need to be completed.

Implications for Phase 2b Study

The phase 2b study was planned to be a randomized study of 240 patients with 180 patients in the 29 to 34 weeks GA and 60 in the 26 to 28 weeks GA. The planned completion date was 1Q, 2017. The 29 to 34 week GA group has already been enrolling and the plan was to enroll babies of 26 to 28 weeks after the phase 2a study in that age group was completed. The delay has caused a rethinking on the part of management. The new trial plan is enroll 240 babies of 29 to 34 weeks GA instead of 180 and to not enroll any babies of 26 to 28 weeks GA. This will delay the completion of enrollment until mid-2017 so that topline data will be available in perhaps the August to September of 2017 period; this is my guess as management has not provided specific guidance. Results from this trial should give a clear insight into whether a phase 3 trial should be undertaken.

Cash Position is Precarious

Windtree has about $12 million of cash and has given guidance that this will last until the end of February 2017. This suggests a burn rate of a little under $3 million per month, but management suggests that they may further reduce this. Let me guess that for the period from March 1, 2017 until the possible reporting of phase 2b data on September 1 that the cash consumed be about $15 million. The Company will also need a cash cushion of say $4 million so that the amount of capital that the Company will need to raise in order for management and investors to see topline results is something less than $19 million. Stringent cost cutting may be able to reduce the amount to $15 million.

There is also a debt overhang as Windtree is scheduled to repay Deerfield $12.5 million in early 2018 and another $12.5 million in early 2019. Windtree only has a market capitalization of $22 million so the capital requirements are foreboding.

Non-Human Primate Study is Very Encouraging

The Company also reported on a study in non-human primate (whose lungs are comparable to humans) that was intended to determine if Aerosurf was being distributed broadly throughout the lungs. Sophisticated imaging techniques produced encouraging data. The Company seems to have mastered the technology needed to deliver the proper sized aerosolized KL-4 particles (active pharmaceutical ingredient of Aerosurf) throughout the lung. While the disappointing news on the trial delay dominates investor sentiment at the moment, this is an extremely encouraging study. While it is not a requirement for registration, it will be important for regulatory review.

Investment Thesis-Where Do We Go From Here?

I have consistently said that I believe that Aerosurf has the potential to be one of the most important medical advances now being pursued by the biotechnology industry and has blockbuster potential. The FDA seems also to believe that Aerosurf is an important potential drug as it has granted it breakthrough status. I think that trials to date have given encouraging evidence that the product is safe. We also know that its active ingredient KL-4 is an effective drug because it is already approved as a liquid surfactant. The unanswered question is whether KL-4 can be aerosolized and when delivered can be somewhat evenly distributed throughout the lungs. The non-human primate study is extremely encouraging in that regard. It sure looks to me that there is a very good chance that Aerosurf eventually will be approved and will become a major success.

The question is whether current Windtree shareholders will reap the benefits. I think that any reasonable investor looking at Windtree has to be extremely concerned as to whether the Company can raise the cash needed to get to the time period at which we can see phase 2b results. With success in that trial, market value should rise dramatically and collaboration and licensing deals would be probable. Remember that I estimate that getting to that time point will require about $15 to $20 million of cash and with only a $22 million market capitalization and a $25 million debt overhang, it may be difficult to raise that amount of money.

Investors can not dismiss the possibility that Windtree could go insolvent, but I don’t think this is a near term prospect. The Company has some very solid institutional investors in the stock, the most important of which is Baker Brothers, a well-respected investor) which is shown to own about 3% of the stock. However, in the last offering Baker Brothers bought a pre-funded warrant that doesn’t show up in the 3% figure. My guess is that Baker Brothers owns well over 10%. I don’t think that Baker Brothers and other current institutional investors will let the Company go bankrupt before the phase 2b results are known. Of course, it the phase 2b results are decidedly negative (not likely in my opinion), bankruptcy would be a high probability.

I think there is an empirical factor that supports my view that the Company will be supported by its institutional investors. Management could have elected to end the phase 2b trial with just 180 babies enrolled of 29 to 34 weeks GA. This would likely have allowed topline to be reported in January or February as originally planned. However the Company has elected to expand the trial to 240 babies of 29 to 34 weeks GA and therefore report topline results in August or September. I think that management would only have made such a decision if it were confident in institutional investor support. However, their funding is likely to be at a meaningful discount to the current price.

My bottom line is that the Company will somehow get the cash needed to see topline results in phase 2b and I believe there is a strong probability that the results will be favorable. If so, I think that the Company would then start a confirmatory phase 3 trial in 2018 enrolling only babies of 29 to 34 weeks GA and we could see topline results in 2019. Success in phase 2b should lead to a substantial increase in market value that could open the door to collaborations and licensing deals that could provide substantial funding and significantly increase market value.

What am I doing with the stock? I am going to realize a tax loss with the intention of repurchasing the stock sometime after 30 days. I would like to see some path that would fund the Company into late 2017 and this might be the catalyst for my coming back in on the stock.