A lot has been written lately regarding Northwest Biotherapeutics (NASDAQ:NWBO) - from missing trial data to premature announcement of immature trial data to potential links to illicit stock promotions. All this noise caught my interest so I decided to take a closer look at NWBO, a NASDAQ-listed company developing autologous cell therapies to treat cancer.
After analyzing NWBO's latest 10-K, and then doing a bit more reading of previous filings, I was left with a lot of questions about the arrangements between NWBO and its contract manufacturer Cognate BioServices, as well as the control of both companies by NWBO's CEO.
I emailed a list of questions (see below) to the company. A company representative emailed me back and offered to discuss the questions by phone, but he is unfortunately traveling until next week, he could not arrange for anyone else to speak with me, and has not responded to the actual questions I have posed in writing. If I do receive responses to my questions, I will pass them along as soon as possible.
How much does Northwest pay for manufacturing services?
As best as I can understand from the filings, NWBO has two ongoing clinical trials - a Phase III glioblastoma study that has been recruiting patients for many years and a 60-patient Phase I/II trial of DCVax-Direct® (the phase I portion completed recruitment this week). In 2013, NWBO reported R&D expenses of $43.9 million, $25.4 million of which was due to its contract manufacturer Cognate BioServices (Cognate), according to NWBO's 10-K (See section 9 on Related Party Transactions).
While clinical trials and autologous cell manufacturing are certainly expensive undertakings, these sums seemed extraordinary to me for a small cap company with only two ongoing trials. As a rough comparison, a competitor company also trialing a costly autologous cell therapy, ImmunoCellular Therapeutics (NYSEMKT:IMUC), recruited 278 patients into a Phase II glioblastoma trial during the years 2011 and 2012, reporting trial data in 2013. According to IMUC filings, its R&D expenses for these three years were $5 million, $7.7 million, and $5.3 million, a total of $18 million during the course of that trial.
Not only did NWBO ring up quite a tab with its contract manufacturer during 2013, the company delivered quite a valuable chunk of consideration to Cognate in the first quarter of 2014. As reported on pages 48-49 of its 10-K, for "Milestone and Initiation" payments under four separate contracts with NWBO, Cognate received 5,101,366 shares of NWBO common stock and 2,434,011 warrants with a $4 strike price. Given the range of NWBO share prices ($3.84-$10.64) during the first quarter, this consideration would be worth somewhere between $19.6 million and $70.4 million.
While Cognate appears to have agreed to a 30-month lockup of the shares granted during the first quarter, the lockup did not come for free. Cognate receives an additional 15% warrant coverage for each six months of the lockup.
But that's not all. As excerpted from the 10-K: "the amounts paid by [NWBO] in shares and warrants under each of the Cognate Agreements will be subject to adjustment on a most favored nation basis relative to the terms provided by us to any other investor or creditor during the term of such Agreement..." and "...the lock-up terms are subject to the same most favored nation treatment..."
Is Cognate such a special contract manufacturer to deserve this level of consideration and "most favored nation" status? Let's look at another rough comparison. Progenitor Cell Therapies, a contract manufacturer of similar products to Cognate, is a wholly owned subsidiary of publicly traded NeoStem, Inc. (NASDAQ:NBS). Though NBS does not break out revenues of Progenitor Cell Therapies in its filings, total revenues for NBS in 2012 and 2013 were both approximately $14.5 million per year (assumed to be primarily due to Progenitor operations). And by comparing filings, it would appear that Progenitor does a lot more work for that $14.5 million per year than Cognate provides to NWBO. Progenitor has two GMP facilities and has served over 100 clients (biotech company projects) in its 15 year history. As far as the Cognate business, it's a bit difficult to ascertain how busy the company is from its website. The last news update is from 2009.
While it is very difficult to ascertain from SEC filings, my best guess is that over the three year period from 2011 to 2013, NWBO delivered between $60 million and $100 million worth of equity in addition to tens of millions in cash to Cognate. This is for services along the lines for which IMUC probably paid about $6 million to $10 million over the same three year period (a guess that about 35-55% of IMUC R&D costs were spent on manufacturing). And over the same three year period, NBS total revenues were about $39 million, covering a number of projects for various companies. Granted, this is never an apples-to-apples comparison, but the difference in numbers is staggering.
A closer look at the Northwest-Cognate relationship
As excerpted from the notes on page 47 the latest 10-K: "Ms. Powers [NWBO CEO and Chairperson] has voting and dispositive power over the securities owned by ... Cognate BioServices, Inc." All of Cognate's shares in NWBO are included in the calculation of Ms. Powers' beneficial ownership of NWBO. While I cannot say definitively that Ms. Powers owns Cognate BioServices, it is quite clear she is the beneficial owner of at least a controlling stake of Cognate.
So, in addition to Ms. Powers' regular compensation (which, by the way included 14.2 million in-the-money options granted in 2011 worth about $9.26 million at that time), NWBO has directed tens of millions of dollars of business to a contractor she controls (and appears to own a significant part of) under agreements with "most favored nation" clauses? This disclosure made me want to take a closer look at these contractual relationships.
Can you believe the four agreements for contract manufacturing services between NWBO and Cognate have been granted Confidential Treatment by the SEC? The fees payable under these contracts are redacted in the filings! From that which we can see in the filings, in addition to the high fees and favorable stock grants to Cognate, NWBO is responsible for all of Cognate's capital expenses in the event it needs to scale up and, should NWBO stop certain projects early, $3 or $5 million penalties payable to Cognate.
It is curious to note in the NWBO press release this week announcing the completion of the Phase I portion of its DCVax-Direct® trial that: "[NWBO] and its manufacturing partner, Cognate BioServices, are also expanding the manufacturing capacity for DCVax-Direct." Given that the phase II part of this trial will enroll only 24 patients, as compared to the 36 patients enrolled in phase I, it is not clear why additional scale up activities would be necessary. Perhaps given that NWBO is to pay for all of Cognate's capital expenses, this is just an excuse to shovel more cash and stock to Cognate?
If all this were not bad enough - and remember that is only the first quarter of 2014 - here are a few other tidbits from SEC filings over the past few years:
- In September 2013, NWBO put $4.5 million into a custodian account shared with Cognate (who contributed $2 million). Supposedly, these funds were to be made available for a potential acquisition that did not go forward. So the $4.5 million was directed to Cognate to settled accounts payable. (Page F-14 of latest 10-K)
- In July 2013, NWBO settled $11.6 million of accounts payable to Cognate by delivering 4.7 million shares of common stock. Given the average price during July 2013 of NWBO stock of about $3.55, the value of this payoff was about $16.7 million - an extra $5 million over the amounts due to Cognate. (Page 37 of latest 10-K)
- In October 2012, in a similar fashion, NWBO granted equity to Cognate valued at a $10.6 million to settle a $7.5 million debt. (Page 49 of the 10-K for 2012)
- In November 2011, NWBO granted Cognate 46 million shares (worth about $16.56 million based on approximate trading prices during that month) to settle a $9.2 million debt. (Page 48 of the 10-K for 2011)
In the interest of brevity, I have only highlighted a few of the unusual transactions between Cognate and NWBO. Readers are encouraged to read SEC filings from the past years and investigate more for themselves.
Governing related-party transactions
Of course, just because NWBO and Cognate are considered related parties does not mean that something unethical is going on. But public companies must be very careful to appropriately govern related party transactions and, I believe, be more transparent about the nature of such transactions. Unfortunately, in the case of NWBO, Ms. Powers just so happens to be both the "Principal Executive Officer" as well as the "Principal Financial and Accounting Officer." Strangely, NWBO auditors noted in the 10-K that "[NWBO] audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion." $175,000 in audit fees incurred during 2013 and there is no opinion on internal control? Not a lot of comfort to shareholders, in my opinion.
Life as a development-stage biotech company is hard. Many years of financial losses and a high risk of failure are a part of life in the industry. I am generally sympathetic to biotech companies with ugly balance sheets as a result of financings on unfavorable terms. I understand that sometimes stock is all that these companies have to compensate employees and contractors when cash is in short supply.
But this is no excuse to allow the types of transactions that have transpired at NWBO. How does the board allow the CEO to incur what appears to be wildly overinflated fees from a contractor controlled by the same CEO? And when NWBO can't pay the invoices to that contractor, they compensate with stock grants valued significantly higher than the already inflated expenses.
After doing my homework on NWBO, I thought about possible trading strategies to capitalize on my insight. Given that the CEO controls over 50% of the stock, I came to the conclusion that trying to take a serious position would be difficult. Nonetheless, I did buy (and still hold) 20 put contracts with a strike price of $5 at a cost of $300. It is a small bet to keep me engaged and entertained for a while.
Questions posed to Northwest Biotherapeutics by email
1. Who are the beneficial owners of Cognate BioServices? From NWBO 10-K filings, it could be understood that Ms. Powers owns 100% of Cognate. Is this correct?
2. How many employees (full time equivalent) work for Cognate? Where are they located?
3. How many clients does Cognate have? How many active cell manufacturing projects are being managed by Cognate?
4. Has NWBO put its contract manufacturing up for competitive bidding? What other contractors (for example Progenitor Cell Therapies or Lonza) have you reviewed? Why do you believe it is necessary to grant "most favored nation" status to Cognate contracts?
5. Can you give more detail on how your R&D funds were spent in 2013? For example, break out contract manufacturing costs, clinical trial costs, etc. Or how much spent on one trial versus another?
6. How many products (patients) were manufactured by Cognate for NWBO in 2013? Can you provide more detail about the $25.4 million of fees and costs billed by Cognate in 2013?
7. Over the past few years, NWBO has repeatedly settled its accounts with Cognate by delivering equity at a significant premium. For example, in 2013, you granted about $16.7 million of stock (based on stock prices of the time) to pay a $11.6 million debt to Cognate. Why is it necessary for NWBO to pay a premium?
8. Why have you redacted the costs from the NWBO-Cognate contracts in SEC filings? Given the related party interests in the two companies, this did not seem appropriate. Can you comment on the appropriateness?
9. How many employees does NWBO have?
10. Especially given the sums at stake between NWBO and Cognate, do you think it is appropriate that Ms. Powers serves as both "Principal Executive Officer" as well as the "Principal Financial and Accounting Officer" of NWBO?
11. Why did the company change auditors after 2012?
12. Why do the current auditors express "no opinion" on internal controls at NWBO?
Disclosure: The author holds a very small short position in NWBO and does not intend to initiate any other position within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.