Alexza Pharmaceuticals — Update 30 November 2015

Alexza retained an investment bank (Guggenheim Securities) in September 2015 to examine strategic options (including asset sales or a business combination) to enhance shareholder value and lower the cost of capital for advancing pipeline projects including AZ-007 (Staccato zaleplon). Alexza also secured a $5m loan from its EU and its Latin America collaboration partner, Ferrer Internacional ($3m granted in September 2015; the remainder can be drawn by January 2016) bearing 6% pa interest, to maintain sufficient liquidity to complete the review and secure possible deal(s).

In late October 2015, Alexza and Teva Pharmaceuticals disclosed that they are in discussions to finalize an agreement whereby Alexza will reacquire the US commercial rights for Adasuve from Teva, with a projected target completion date of 1 January 2016. US sales since the March 2014 launch have been tepid (Teva-derived product revenue to Alexza was under $3m) and recent developments at Teva (ie Actavis acquisition) may have deprioritized Adasuve’s position within the firm. Certain aspects remain to be finalized between Teva and Alexza, particularly the treatment of the $25m loan from Teva ('Teva note') to Alexza (which accrues interest at 4%). Nominally, this note was slated to require repayment on dissolution of their business partnership. Alexza is seeking to restructure its terms, which we estimate may involve lengthening of payback terms, debt-for-equity swaps or conversions, and/or issuing special contingent value rights (CVRs) drawing on future Adasuve sales or milestones.

We do not expect that Alexza will need to pay a meaningful upfront-type payment to regain Adasuve rights. This transaction may actually help facilitate Alexza’s ongoing strategic review, as an outright sale or royalty agreement for its entire interest in Adasuve may be more straightforward once the US rights are regained.

Parallel to this strategic review, the company is working on a new Adasuve manufacturing strategy, which it hopes will result in transferring the manufacturing responsibilities to a third-party contract manufacturer(s). In-house manufacturing was not profitable because production volumes did not reach sufficient critical mass to cover COGS. Since the product’s launch in mid-2013, Adasuve has recorded quarterly COGS averaging $4.3m through Q215; quarterly Adasuve product revenue only averaged $0.6m over this period. Outsourcing Adasuve production to parties with a broader manufacturing base should better cover much of the fixed costs associated with pharmaceutical manufacturing.

In Q115, the company requested a longer-term Adasuve production order from collaboration partners (Teva and Ferrer), prior to a planned suspension of internal manufacturing (at its Mountain View, CA, facility). It produced over 110,000 Adasuve units through Q315. It expects this should fulfil end-user demand into mid-2017. In August 2015, Alexza suspended its Adasuve manufacturing operations, reducing its overall staff by about 33 (reducing total employee headcount to 28). If new Adasuve production runs are needed before a third-party manufacturer is secured or required regulatory clearances are met, Alexza can resume manufacturing at its internal facilities to produce new batches of inventory as needed.

Alexza reported Q315 results on 5 November 2015, with product revenue consisting of Adasuve (Staccato-delivered loxapine) sales to its commercial partners (Ferrer and Teva) of $1.06m. Operating results started to show a lower fixed-cost overhead from prior quarters, reflecting the firm’s decision to engage in an efficient campaign-style production of weekly batches before suspending manufacturing operations. The company’s COGS and SG&A (net of D&A) expenses declined q-o-q in Q315, by 11% and 7%, respectively, and we expect continued reductions in COGS and SG&A in Q415 and 2016 given the current cessation of Adasuve production and lower associated expenses.

R&D costs declined q-o-q and y-o-y, as the transfer of the EU marketing authorization application (MAA) for Adasuve to Ferrer in June 2015 reduced Alexza’s ongoing funding commitments for the post-approval studies and regulatory activities required in the EU1 . Going forward, the firm anticipates Q415 R&D costs should decrease from 9M15 run-rates, although it will continue to incur R&D costs relating to the AZ-002 (Staccato alprazolam) Phase IIa study in acute repetitive seizures (ARS). Overall EBITDA loss improved by 21% q-o-q to $6.9m. Adjusted EPS loss, which excludes one-time items including changes in the valuation of the contingent consideration liability to Symphony Allegro2, was $0.48.

Since Ferrer’s last reported European and Latin America update in September 2014, Ferrer indicated in October 2015 that Adasuve is now available in 283 hospital settings in the EU, which is up 77% from one year ago (160 settings), or up from c 260 in November 2014 (as reported in the firm’s Q314 financials). Part of this growth is attributable to the product being launched in more European countries over the past 12 months, including the Czech Republic, Hungary, Latvia, Norway, Poland and Slovakia.

Ferrer indicates that Adasuve end-user unit sales during the first half of 2015 were more than six times the number of ADASUVE units sold in the first half of 2014. However, the significance of this figure in predicting future Ferrer-territory revenue is complicated by the fact that Alexza did not distinguish or break down in its financials how much of its product revenue (which are recorded after product is shipped and accepted by its partners) is assigned to each of its partners. Further, Alexza no longer discloses specific quarterly unit shipments to its partners (although the significance of unit shipments could be obscured by the fact that many of Alexza’s initial shipments included inventory-stocking following product launches in newly approved or promoted territories).

Ferrer expects to launch Adasuve in additional European countries including the United Kingdom, Italy, Netherlands over the next six months; of these Italy and Netherlands can become one of the more material Adasuve EU markets (like Spain, France and Germany). The UK may have limited Adasuve penetration as the product is not likely to gain reimbursement from the national health insurance authority (NICE), as the product does not necessarily fit into the typical 'quality of life' benchmarks that NICE uses for its reimbursement decisions. Ferrer is also working on registration activities for Brazil and Mexico.

Ferrer is in discussions with EU regulatory authorities to potentially expand the European Adasuve label to allow product use in outpatient settings, which can broaden product use and sales. The product has a good safety record since being launched in mid-2013, and any studies that would be needed for label expansion would be driven and funded by Ferrer.

The company’s MD&A indicates that it expects no additional revenue relating to product shipments between Q116 through at least Q217. We anticipate that Q415 will include some residual product revenue relating to final acceptance of production batches from the recently-completed production campaign (consisting of more than 110,000 units, and occurring just prior to the suspension of internal manufacturing). Hence, even with the growth figures cited by Ferrer, Alexza does not expect that inventory replenishment will be needed for at least 18 months. Prior to this recent production campaign, Alexza produced about 135,000 Adasuve units between the July 2013 initial launch in Germany and Austria, and YE14. Thus, approximately 250,000 units are projected to correspond to nearly the first four years of Adasuve product demand.

Teva’s agreement towards reverting Adasuve licensing rights back to Alexza (for presumably little to no upfront payment consideration) could suggest a more subdued long-term sales outlook than we previously assumed. Alexza intends to secure a new US commercialization partner; as the firm expects no new US shipments will be needed before mid-2017, this provides the firm with a reasonable time window to secure a new US partnership deal. We assume the firm will find a new US partner by then, but that there would be no upfront payment (or potential for sales milestones) upon Adasuve out-licensing, and we assume an escalating royalty rate on net sales peaking at 20% (we believe that under the Teva arrangement, the tiered US royalty rate peaked at 25%). We expect the future partner will need to dedicate material marketing resources to promote this hospital-use product and generate buy-in from physicians and hospital administrators and pharmacists to use the product and apply for REMS certification.

Given that new Adasuve shipments are not expected by the company until H217, and that a new US partner, once selected, will need some time before reaching the same familiarity with the US agitation market that Teva had, we are significantly lowering our intermediate term Adasuve sales forecasts. Given the slower than previously anticipated Adasuve sales ramp-up since initial launch, we are also again lowering our peak US and global Adasuve sales forecasts.

In our 2 June 2015 update note, we had lowered our long-term Adasuve sales and market share forecasts from our prior estimates, and, as shown above, we are now further reducing our forecasts. To compare, in our 4 February 2015 Outlook note, we had forecast 2020 global Adasuve sales of $380.5m, which we lowered to $291.9m in our 2 June note, and which we are now lowering again to $228.2m.

The company expects to complete 6 to 8-pt Phase IIa ARS study for AZ-002, in late 2015 or early 2016. This study will determine the electroencephalographic effects of a single dose of AZ-002 compared to placebo. Patients are being exposed to a photostimulus that can provoke a subcortical but harmless seizure, and be dosed with differing single doses of AZ-002, compared to placebo, to determine the doses that can halt this response without provoking excess sedation. The study has been taking longer than the firm expected to complete recruitment, as fewer ARS patients than expected are prone to subcortical seizures from visual photostimuli.

Once the study is completed, Alexza plans to use the data to determine optimal dose ranges for a Phase IIb trial, which could serve as one of the two pivotal trials needed for registration. The Phase IIb may involve the monitoring of patients within dedicated epilepsy monitoring units (EMUs), or if the FDA permits, could be an at-home study where patients self-report the number of seizures after taking drug or placebo.

Alexza’s pipeline includes AZ-007 (Staccato zaleplon), for the treatment of middle-of-the-night (MOTN) awakening associated with insomnia. This program is ready to enter a Phase II study, pending the receipt of funding and/or the outcome of the ongoing strategic review. Alexza continues to have discussions with other parties to partner its rapid-delivery Staccato drug inhalation platform for additional potential therapeutic molecules or indications.

Alexza reported total debt on 30 September 2015 of $67.7m, which includes the $45m private placement debt financing secured in March 2014 (bearing interest at 12.25% pa), as well as a discounted amount of the $25m that was drawn from the Teva note facility. Given $11.3m cash and equivalents, we determine Q315 net debt of $56.4m.

Alexza’s cash burn rate (operating cash flow plus net capex) in Q315 was $7.5m but we expect it to decrease given the suspension in Adasuve manufacturing and other headcount cuts described above. We project a cash burn rate of c $5.7m in both Q415 and Q116. We expect Alexza’s current cash resources, and remaining amounts available under the Ferrer Note, should be sufficient for the company to meet its cash needs into Q216, or through its planned strategic review process. This process can lead to cash infusions to better fund the AZ-002 and AZ-007 programs, as well as new potential US Adasuve license relationships.

In our model, we assume the company will find and secure a new manufacturing partner before Adasuve reshipments are required (which we anticipate to begin in H217). We also believe that Teva will not require or request repayment of the $25m Teva note until 2018 (the original projected repayment date prior to their decision to return US Adasuve rights to Alexza), although this is not assured, and if Teva requires repayment or an equity for debt swap, current shareholders could be subject to significant dilution.

Subject to interest from would-be collaborators or partners, the ongoing strategic review can potentially provide an opportunity for the company and investors to realize upside to the current market value by partnering, selling, or out-licensing aspects from the firm’s pipeline (Adasuve, AZ-002, AZ-007, etc), or even by merging with another company. However, until further clarity, continue to value Alexza as an independent entity pursuing all the above-mentioned current pipeline projects, using our relative net present value (rNPV) approach.

Our base case projects that Alexza will raise $35m in 2016 and in 2017 via debt to pursue its R&D programs, and that Alexza will start a Phase II MOTN awakening study for AZ-007 in H216 (this pushes back our potential AZ-007 launch timing forecast from 2019 to 2020). While our model projects that the upcoming financings will be in the form of long-term debt, the firm could also issue equity capital to meet its funding obligations. We do not include the potential of upfront payments from additional Adasuve territory licensing deals or from possible Staccato technology transactions.

Given our reduced Adasuve market share and sales growth assumptions, our Adasuve-derived revenue (including milestones) contribution to our rNPV has declined to $131.2m, from $220.7m, previously. This effect is offset by a significant reduction in our forecasts for Adasuve COGS and contingency cost component (from $128.0m, to $40.8m), which anticipates significant cost-savings to Alexza through:

Altogether, we assume Alexza will retain a strong interest in Adasuve revenue, but will be able to significantly reduce its cost commitment. Our new rNPV valuation is $77.3m (from $77.7m, previously). After removing $56.4m Q315 net debt, we derive an equity valuation of $20.9m, or $1.04 per share fully diluted3.