MannKind (MNKD)

MannKind is a biopharmaceutical company focused on the discovery, development, and commercialization of therapeutic products for diabetes, cancer, and inflammatory and autoimmune diseases. The company's lead product, the Technosphere Insulin System, meant for the treatment of diabetes, is in a series of pivotal phase III trial in the U.S. This product utilizes MannKind s proprietary dry powder Technosphere formulation of insulin. It is inhaled deep into the lungs using the company s MedTone inhaler. Besides the company s development of Technosphere, MannKind is pursuing efforts aimed at the discovery and development of novel drugs for metabolic and immunological diseases. The company also has early-stage development programs for the treatment of solid-tumor cancers. MannKind initiated phase I trials with its cancer candidates in early 2007. MannKind's corporate headquarters and immunology research operations are located in Valencia, CA. Significant operations, including the Technosphere Insulin research, development and manufacturing are located in Danbury, CT. The company's initial public offering (IPO) took place in late July 2004. As on December 31, 2007, the company had 609 employees.

INVESTMENT THESIS

The unpopularity of overall inhaled insulin program casts shadow on MNKD's Technosphere Insulin program

The future of MannKind Corp. is heavily dependent on the successful development of Technosphere Insulin System (TI), now called Afresa. Technosphere is dry-powder insulin inhaled deep into the lungs via the company's MedTone inhaler. MedTone is a small, easy-to-use pulmonary delivery system. Once inside the lungs, the insulin is absorbed into the bloodstream in rapid fashion. We believe that Technosphere offers distinct advantages over traditional needle-based insulin therapy. The key advantage is the convenience of an inhaled delivery. Diabetes patients using Technosphere will no longer have to worry about a needle injection. Along with convenience, Technosphere offers rapid uptake into the bloodstream. MannKind has developed Technosphere to produce a profile of insulin levels in the bloodstream that approximates the first-phase insulin spike normally seen in healthy individuals following the beginning of a meal.

In mid September 2006, MannKind Corporation announced a small phase III result of Technosphere at the 42nd Annual Meeting of the European Association for the Study of Diabetes (EASD) in Copenhagen. The study included 308 patients with Type II diabetes who where randomized to the mealtime use of either Technosphere Insulin (n=150) or injected insulin (RAA, n=158), plus insulin glargine as basal insulin. Both patient groups achieved statistically significant improvements in HbA1c levels (1.05% in the Technosphere group and 1.30% in the RAA group). Pulmonary function did not differ between the two patient groups after six months of treatment and after the six month withdrawal period. Significantly fewer patients experienced hypoglycemia in the Technosphere group than in the comparable injected RAA patient group. After six months of treatment, the Technosphere patient group experienced a weight loss of 0.76 kg compared with the injected RAA patient group, which saw an increase in weight of 0.23 kg (p=0.0007). As in previous studies, mild cough was observed in a minority of patients treated with Technosphere Insulin. The small phase III results are comparable to the results on Technosphere from a phase IIb trial (study 005).

MannKind is currently conducting several more phase III trials on Technosphere. In early March 2006, the company commenced enrollment of two pivotal 12-month phase III clinical trials, study 009 and study 102. The main objective of these studies is to evaluate the efficacy of TI by assessing changes both in HbA1c levels as well as in blood glucose levels after a standardized meal. Study 009 will enroll 500 Type I patients, and TI will be compared to subcutaneous injections of a rapid acting insulin analog. Study 102 was the subject of a special protocol assessment by the FDA. This trial will compare TI plus basal insulin to subcutaneous injections of premixed insulin (including a rapid-acting insulin analog) in 500 Type II diabetes patients. Patients in both arms of this study will also receive a basal insulin regimen.

Enrollment was completed for the 009 trial in the first quarter of 2007 and for the 102 trial in May 2007. The company reported preliminary top line results of trial 009 in September 2008. A total of 565 patients were studied in sites in the United States, Europe and Latin America. A total of 293 patients received Technosphere Insulin, and 272 patients received insulin aspart. Key findings included:

Comparable reductions in A1C levels

Comparable numbers of patients reaching pre-defined A1C goals

Superior fasting blood glucose levels

Better early post-prandial glucose control

Fewer patients experiencing hypoglycemic events

Weight loss versus weight gain

No adverse effects on pulmonary function

Over the entire 52-week treatment period, Technosphere Insulin was generally well tolerated. No pulmonary neoplasms were reported. Consistent with the results from earlier studies of a shorter duration, after 52 weeks of treatment, there were no between-group differences in pulmonary function measures, including FEV1 (forced expiratory volume in one second), FVC (forced vital capacity), DLCO (carbon monoxide diffusing capacity) and TLC (total lung capacity). All safety data will be further analyzed along with data from the recently completed two-year pulmonary safety study.

In June 2005, the company initiated another pivotal phase III safety trial (Study 030) in the U.S., which will evaluate the pulmonary safety of Technosphere in patients suffering from type I and type II diabetes. The company announced the completion of patient enrolment on September 14, 2006. Results from this two year trial should be available in the 4Q08. Positive results from this trial will help boost investor confidence which has taken a beating from the events of the last few months.

MannKind plans to file the NDA for Technosphere before end of December 2008, but we think it's too aggressive and is unlikely to happen. With the pivotal data available in 4Q08, we believe the company may delay the NDA file to 1H09 and we expect TI approval by the FDA in early 2010. The NDA filing will include data from the 030 trial, a two-year safety study of TI. The company is also currently conducting a non-pivotal label expansion trial for Technosphere results from this trial will be presented after the NDA for the drug is filed with the FDA. However, with the reported occurrence of lung cancer in diabetic patients treated with Exubera, MannKind may want to re-evaluate the data on the drug and conduct a few additional trials demonstrating TI's safety and lack of carcinogenic effect on diabetic patients. We expect positive results from the phase III trials to boost investors' confidence in the company's technology and brighten the company's chances of entering into a commercialization deal for TI.

MannKind recently presented a complete evaluation of the data from the carcinogenicity study in animals administrated with Technosphere Insulin. The results showed no carcinogenic potential for either TI or Technosphere and no evidence of abnormal growth stimulation in the lung. The company found no evidence of any macroscopic tumors in the final long term, six-month transgenic mice study, lending further support to the safety profile of Technosphere. The company has also initiated a six-month study comparing Technosphere to Humalog to demonstrate Technosphere's differentiation and superiority over other insulins. Humalog is a rapid acting analog in type I diabetes patients in whom fasting glucose will be forced using prandial (basal) insulin to achieve near normal level, below 110 milligrams per deciliter. Demonstration of less severe hypoglycemia incidents, with lower severity, in patients treated with Technosphere will be the primary endpoint of the trial. The company is on schedule for the completion of the major construction phase of its Danbury manufacturing plant expansion by the end of 2008.

The diabetes market is crowded, and competition is not favorable for Technosphere Insulin

The diabetes market is perhaps one of the largest opportunities in pharmaceuticals. This is a $174 billion market, with nearly 210 million people affected worldwide. In the U.S. alone, 20.8 million people were diagnosed with diabetes as of 2005, and additional 6.2 million people are living with diabetes without knowing it. At present, traditional needle-based insulin therapy dominates the market.

Competition in the inhaled insulin field, which was crowded with late-stage drugs under development at large-cap pharmaceutical companies six months ago, is virtually nil now. The change in the competitive landscape began with the withdrawal of Exubera from the market by Pfizer in October 2007. This was followed by the discontinuation of the AER-X program by Novo Nordisk (together with Novartis and Aradigm Corp) in January 2008 and then the announcement by Lilly in March 2008 to discontinue the development of the AIR Insulin (co-developed with Alkermes Pharmaceuticals). While Pfizer blamed the pullout on poor sales of the drug (only $12 million in the first three quarters of 2007), Lilly cited the lack of confidence in the regulatory environment and market prospect for an inhaled insulin product.

A further blow to the hopes for the inhaled insulin market were dealt by Pfizer on April 9, 2008 when Pfizer stated that of the 4,740 diabetic patients treated with Exubera, 6 developed lung cancer compared to the development of lung cancer in only 1 patient of the 4,292 who did not take the drug. While the number of cases were too few to conclusively link Exubera to the development of lung cancer, the results still cast a looming shadow over the future of TI. Above all, the regulatory pathway will become a steep climb for MannKind with the FDA likely to ask for more stringent and extensive study data. A post-marketing survey of the patients on TI is also likely. Even if the drug makes it through the approval process and on to the market, convincing physicians to prescribe the drug over other existing, safer therapies will pose a significant challenge for the company.

Finally, in July 2008, the FDA panel of advisors voted 14-2 in favor of longer studies for all diabetes drugs to ensure that treatment with these drugs do not lead to cardiovascular problems. This step was taken after GlaxoSmithKline's Avandia, an oral anti-diabetic drug, was found to be associated with a higher risk of heart problems in patients in 2007. The recommended safety studies could take 5 to 7 years for completion. These studies need to be initiated, but not completed, before filing a diabetes drug's NDA. The FDA is not required to but the agency does usually follow the panel's advise. We believe that if the FDA adopts these new guidelines, MannKind will find itself under additional duress.

During the third quarter of 2007 conference call, MannKind highlighted a host of factors which it believed was responsible for the poor performance of Exubera. Exubera had no clinical advantage over regular therapies and like all other rapid-acting insulin and inhaled insulin, the drug reached the peak plasma concentrations in an hour. In addition, the inhalation device for Exubera was large, complex and required frequent maintenance. Despite ongoing work on a smaller and simpler device, treatment with Exubera was still more expensive and physicians had expressed pulmonary concerns with Exubera treatment. On the other hand, the inhalation device used for TI is simple, easy to use and requires minimal maintenance. Plus, TI achieves peak plasma concentrations in 12 14 minutes and available data from clinical studies have not indicated any pulmonary concerns. The toxicology profile of TI has also been extensively tested by the company. A two-year carcinogenicity study in rats completed in 2007 showed that TI and large doses of Technosphere particle alone were well tolerated after daily inhalation for 104 consecutive weeks. A six-month carcinogenicity study in transgenic mice was also completed recently and the company found no macroscopic indications of carcinogenicity in animals given daily subcutaneous injections of TI or Technosphere particles for 26 consecutive weeks. We like the carcinogenic profile of TI on display so far however, after seeing the latest data on Exubera, we opine that further tests to establish the risk of lung cancers in smokers undergoing treatment with TI may need to be conducted. We also believe that a longer-term study following patients on therapy for 4-5 years could be a requisite for FDA approval of TI.

Pipeline is weak and MNKD has a heavy reliance on Technosphere Insulin

In November 2007, MannKind announced positive preliminary results from the phase Ia trial of MKC-253 in patients with type II diabetes. Final results from the trial were presented at the company's fourth quarter conference call. Steady, rapid absorption of GLP-I, with a T-max of less than 3 minutes, was observed in the 26 adult, healthy, male patients involved in the open-label, dose-escalation, controlled safety and tolerability phase Ia trial. The patients that received one of the higher two doses, 1.05 mgs or 1.5 mgs, blood concentrations of GLP-1 exceeded 100 picomoles per liter. MKC-253 exhibited an encouraging safety profile, with no reports of side effects, such as profuse sweating, nausea and vomiting, associated with such levels of GLP-I. The company also announced the initiation of a second phase I trial of MKC-253 in patients with type II diabetes. Enrollment in the second phase I trial began in January 2008 and we expect to see results from this trial later in 2008. Clinical trial application of MKC-253 has also been cleared by the European Competent Authority.

MKC-253 is a formulation of GLP-1 delivered on Technosphere particles that the company is evaluating for safety, tolerability, and pharmacokinetics. GLP-1 is a hormone secreted in the small intestine and colon in response to food intake. GLP-1 in healthy individuals is known to stimulate insulin secretion and slow gastric emptying. Patients with type II diabetes often exhibit a lower level of GLP-1 secretion. During the fourth quarter of 2007 conference call, the company announced that positive results from the two carcinogenicity studies of TI will also support follow-on Technosphere platform products. As such, we do not expect the company to conduct additional animal studies to support the safety profile of MKC-253.

The company also reported the initiation of an open label phase I study for its cancer immunotherapy product candidate, MKC-1106, in January 2007. The primary objective of this phase I clinical trial is to evaluate the safety, tolerability and pharmacological response in cancer patients with advanced solid malignancy in a variety of tumor types. A measurement objective tumor response is a secondary end point. The company is using an approach different from that used by other cancer immunotherapies. The company's approach for the development of MKC-1106 uses a naked plasma DNA plus peptide based compounds that correspond to tumor-associated antigens that are expressed in a range of solid tumors. This approach addresses several deficiencies, including the reliance of other cancer immunotherapies on the patient's tissues or cells to manufacture to pharmaceutical composition or the limitive immune response afforded by earlier peptide based approaches.

During the fourth quarter of 2007 conference call, the company announced that it has filed an IND for a second cancer candidate, with clinical trials scheduled to begin in the summer of 2008. The candidate will evaluate an immunotherapy regimen targeting a Melin-A and Tyrosine-A antigens in patients with advanced melanoma. In May 2008, MannKind also announced the initiation of a collaborative research arrangement funded through the Leukemia and Lymphoma Society's (LLS) Therapy Acceleration Program (TAP). The TAP funding will support MannKind's efforts to develop a novel and highly selective first-in-class targeted tyrosine kinase inhibitor for the treatment of T-cell leukemia and lymphoma.

MannKind relies heavily on Technosphere Insulin for both its near term and long term growth. Besides Technosphere, there are no other visible candidates in clinical trials. Thin pipeline puts MannKind in a higher risk category than most of its peers. Technosphere is currently in a series of phase III clinical trials. The rate limiting phase III trial is the safety trial study 030, which will evaluate the pulmonary safety of Technosphere in patients suffering from type I and type II diabetes. Results from this two year trial should be available in the second half of 2008. Safety concerns raised with the use of Exubera, however, may force MannKind to conduct additional trials, delaying the approval of TI. Previously we expected TI to be approved in 2009 now we have pushed our time line of approval to mid-2011. We have also adjusted our model to show lower sales of TI upon approval as we expect a slow uptake of the drug upon launch.

Cash burn is a matter of great concern

With no product on the market and no revenue at all, we are very concerned about the company's financial position. In 3Q08, not loss was $69 million ($0.67 per share), compared to $73 million ($0.99 per share) in 3Q07. We estimate total loss for 2008 will be $283 million.

In fiscal 2005, cash burn was $101.2 million. This number increased to over $200 million in 2006 and swelled to $318 million in 2007. As expected, the company raised about $497 million funds in December 2006 by issuing 23 million shares and offering $115 million 3.75% senior convertible notes due in 2013. Although the offering eased the cash burn concern for the time being, this diluted the shareholder base by more than 30%.

As of September 30, 2008, the company had $95.2 million in cash, cash equivalents and marketable securities. Given the high cash burns associated with the development of TI, we had pointed out that MannKind would need to make a sizable offering as early as the second half of 2007 to fund its operating costs. This is precisely what happened when unable to enter into a development and commercialization partnership for TI, the company raised $250 million through a registered direct offering of common stock in October 2007. Under the shelf registration statement filed during the second quarter of 2007, the company can raise an additional $100 million in a future offering. Also, the company entered into a new loan agreement with Al Mann, which provides the company with a credit facility of $350 million. The new credit facility replaces the $150 million credit facility which the company had established in August 2007.

We expect cash burn to stay high in support of Technosphere Insulin's multiple phase III trials and construction expenses at Danbury. In fact, the cash burn may creep even higher if the FDA requires the company to conduct a long-term study of TI, demonstrating that the drug does not lead to a higher risk of cardiovascular problems in patients. While this trial needs to be initiated before an NDA is filed, the company can report the data as and when available after approval. The trial can last from 5 to 7 years and could cost the company hundreds of millions of dollars.

MannKind has currently kept all partnership talks on hold pending the results of the phase III trials of TI. Positive results from the 030 trial towards the end of 2008 may enhance the company's chances of partnering TI but as of now, we are not modeling for the same in our model. If the company does indeed decide to commercialize TI on its own, then it will be responsible for all development, regulatory and marketing costs, which will increase significantly going forward. The commencement of several additional trials with Technosphere along with the expansion in manufacturing operations should lead to a significant increase in cash burn over the next few quarters. Alternatively, MannKind may choose to sell TI to another company keeping in view the rising costs associated with this drug's development or like other companies, discontinue the inhaled insulin program. With the development risk of this class of drugs being ever so high, we do not think the former case is likely to occur as for the latter case, we believe that discontinuation of the TI program will sink the stock and leave MannKind with nothing but 2 early-stage drugs in its pipeline, significant dilution of the shareholder base and a mountain of debt.

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