Unilife Releases OrbiMed Loan Covenants: Is Default Imminent? by Jordan S. Terry, Stone Street Advisors

In May, we explained how Unilife Corp (NASDAQ:UNIS)– with the helping hand of the SEC – was able to file the OrbiMed credit agreement and leave out very important details, particularly what financial performance it had to achieve to avoid triggering an event of default/covenant breach:

Unilife

As far as we know, we are the only observers to find this unacceptable, as it allows Unilife Corp (NASDAQ:UNIS) to severely impair analysts’ and investors’ ability to evaluate the firm’s default risk and valuation.

As such, we filed a Freedom of Information Act request with the SEC to force UNIS to reveal these very material facts (and others), which was fairly promptly denied:

Unilife

We found this to be astoundingly unacceptable and thus filed an appeal with the SEC, which was again denied:

Unilife

We responded by gently reminding the SEC that its mission is to protect investors, not to protect filers’ commercially sensitive information. Almost four months later, on 9/29, Unilife Corp (NASDAQ:UNIS) filed an amended 10-q along with an unredacted credit agreement showing the financial covenants:

Unilife

Thus far the SEC will neither confirm nor deny whether our FOIA request and appeal led them to compel Unilife Corp (NASDAQ:UNIS) to release the unredacted credit agreement, but we can see no reason why the company would release it otherwise, and thus we consider this a victory for investors and market participants in general.

When I initially wrote this article on Seeking Alpha, I used GAAP/accrual revenue instead of cash received from customers because it was easier to explain, and I didn’t think it made much difference in the ultimate analysis. In hindsight, I should have stuck with convention from the credit and royalty agreements which is a cash receipts from customers definition of revenue, and for that, I apologize.

In any case, cash or accrual, the conclusion doesn’t change much, if at all. UNIS FY 2014 cash from customers came in at $23.7mm, less cash receipts through 6 months of $10.787mm for the 1st 6 months of the FY, or $12.9mm, meaning the company has to generate AT LEAST $27.1mm of ‘net sales’ before 12/31/2014. On the last (q4/FY 2014) call, CEO Shortall said they have another $25-30mm in milestone payments coming in for FY (not CY) 2015, so let’s be generous and assume they’ll hit half that in CY14, half in CY15. That’d put Unilife at somewhere in the $25mm range for CY2014, $30mm if you want to be generous, but at least $10mm short of the $40mm they have to hit for covenant compliance. He also said they’ve begun product sales but provided essentially zero useful information regarding cash this is generating for the remainder of FY2014. The call was on 9/9, meaning the company would have a pretty good idea of how 2015q1 went already (they mentioned the ATM facility usage in August) and some decent visibility into how q2 was shaping up. I’m not sure how anyone could interpret the change in content/tone on this last call to be positive…

If Unilife misses the $40mm in ‘net sales,’ as seems at least fairly likely from the information Unilife has publicly released (vague promises on the last conference call notwithstanding), the loan commitment is immediately terminated and the full unpaid amount of the loans must be repaid.

Unilife Corp (NASDAQ:UNIS) had $10.8 million in total (including restricted) cash as of 6/30/2014. In August, they completed the ATM facility and raised another $12.4 million. During this period and subsequently, they’ve burned and generated an unknown amount of cash. Unilife’s operating expenses are running over $15 million per quarter and are unlikely to decrease especially given Unilife ’ significantly increased headcount. Absent some unexpected material revenue (enough to cover two quarters of OpEx and meet the minimum revenue base threshold) in the second half of 2014, it seems unlikely Unilife will be able to maintain the $5 million minimum liquidity covenant in the credit agreement, which would also trigger an event of default.

In either (both) situation(s), absent a lifeline from OrbiMed (i.e. an amendment to the credit agreement), another lender, a fresh equity issuance (distressed new equity?) and/or relatively massive, unexpected revenue, given all information the company has made available, we find it more likely than not that Unilife will NOT be able to maintain covenant compliance and will thus find itself in default. Absent a miracle or two and/or amendment by OrbiMed, Unilife will not be able to repay the loan and OrbiMed will be able to exercise its rights to appropriate the collateral by which the loan is secured (which broadly includes all of Unilife ’ assets including IP).

If Unilife defaults by breaching either/both of these covenants, the value of the equity is effectively zero.

Is it possible that Unilife will generate enough revenue and maintain sufficient liquidity to maintain covenant compliance at year-end? Yes, although we do not have any evidence besides vague promises, which, with history as our guide, do not mean much, if anything.

In our balanced view, Unilife Corp (NASDAQ:UNIS) is at serious risk of defaulting on the OrbiMed loan within the next few months, which would render Unilife equity almost entirely worthless by any reasonable measure. Holders of Unilife stock must be prepared for the strong possibility of an imminent loss of 100% of their investment should UNIS fail to pull off the implausible feat of covenant compliance as of 12/31/2014.

As always,

CAVEAT EMPTOR