UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
WASHINGTON,
D.C. 20549
FORM
10-Q
|
x
|
QUARTERLY
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF
1934
|
For
the
quarterly period ended September 30, 2006
or
| o |
TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF
1934
|
For
the
transition period from
to
Commission
file number 000-26422
DISCOVERY
LABORATORIES, INC.
(Exact
name of registrant as specified in its charter)
|
Delaware
|
94-3171943
|
|
|
(State
or other jurisdiction of
incorporation
or organization)
|
(I.R.S.
Employer
Identification
Number)
|
|
|
2600
Kelly Road, Suite 100
|
||
|
Warrington,
Pennsylvania 18976-3622
|
||
|
(Address
of principal executive offices)
|
(215)
488-9300
(Registrant’s
telephone number, including area code)
__________________
Indicate
by check mark whether the registrant (1) has filed all reports required to
be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements
for
the past 90 days. YES x NO
o
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of “accelerated
filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.
|
Large
accelerated filer o
|
Accelerated
filer x
|
Non
-accelerated filer o
|
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES o NO x
As
of
November 6, 2006, 64,273,681 shares of the registrant’s common stock, par value
$0.001 per share, were outstanding.
Table
of Contents
PART
I - FINANCIAL INFORMATION
Page
|
Item
1. Financial Statements
|
|||
|
CONSOLIDATED
BALANCE SHEETS -
|
|||
|
As
of September 30, 2006 (unaudited) and December 31, 2005
|
1
|
||
|
CONSOLIDATED
STATEMENTS OF OPERATIONS (unaudited) -
|
|||
|
For
the Three Months Ended September 30, 2006 and 2005
|
|||
|
For
the Nine Months Ended September 30, 2006 and 2005
|
2
|
||
|
CONSOLIDATED
STATEMENTS OF CASH FLOWS (unaudited) -
|
|||
|
For
the Nine Months Ended September 30, 2006 and 2005
|
3
|
||
|
Notes
to Consolidated Financial Statements
|
4
|
||
|
Item
2. Management’s Discussion and Analysis of Financial Condition and Results
of Operations
|
12
|
||
|
Item
3. Quantitative and Qualitative Disclosures about Market Risk
|
28
|
||
|
Item
4. Controls and Procedures
|
28
|
||
PART
II - OTHER INFORMATION
| Item 1. Legal Proceedings |
29
|
||
| Item 1A. Risk Factors |
30
|
||
| Item 2. Unregistered Sales of Equity Securities and Use of Proceeds |
36
|
||
| Item 3. Defaults Upon Senior Securities |
36
|
||
| Item 4. Submission of Matters to a Vote of Security Holders |
36
|
||
| Item 5. Other Information |
36
|
||
| Item 6. Exhibits |
37
|
||
| Signatures |
38
|
||
i
Unless
the context otherwise requires, all references to “we,” “us,” “our,” and the
“Company” include Discovery Laboratories, Inc., and its wholly-owned, presently
inactive subsidiary, Acute Therapeutics, Inc.
FORWARD-LOOKING
STATEMENTS
This
Quarterly Report on Form 10-Q contains “forward-looking statements” within the
meaning of Section 27A of the Securities Act of 1933 and Section 21E of the
Securities Exchange Act of 1934. The forward-looking statements are only
predictions and provide our current expectations or forecasts of future events
and financial performance and may be identified by the use of forward-looking
terminology, including the terms “believes,” “estimates,” “anticipates,”
“expects,” “plans,” “intends,” “may,” “will” or “should” or, in each case, their
negative, or other variations or comparable terminology, though the absence
of
these words does not necessarily mean that a statement is not forward-looking.
The forward-looking statements include all matters that are not historical
facts
and include, without limitation: statements concerning our research and
development programs and planning for and timing of any clinical trials;
the
possibility, timing and outcome of submitting regulatory filings for our
products under development; plans to seek collaboration arrangements and
strategic alliances with pharmaceutical companies or others to develop,
manufacture and market products; the research and development of particular
compounds and technologies; the period of time for which our existing resources
will enable us to fund our operations; and anticipated cost savings and
accounting charges arising out of our recent workforce reductions and corporate
restructuring.
We
intend
that all forward-looking statements be subject to the safe-harbor provisions
of
the Private Securities Litigation Reform Act of 1995. Forward-looking statements
are subject to many risks and uncertainties which could cause our actual
results
to differ materially from any future results expressed or implied by the
forward-looking statements. Examples of the risks and uncertainties include,
but
are not limited to:
| · |
the
risk that financial conditions may change;
|
| · |
risks
relating to the progress of our research and development;
|
| · |
the
risk that we will not be able to raise additional capital or enter
into
additional collaboration agreements (including strategic alliances
for our
aerosol and Surfactant Replacement Therapies);
|
| · |
risks
that the FDA or other regulatory authorities may not accept any
applications we file;
|
| · |
risks
that the FDA or other regulatory authorities will not approve the
marketing and sale of a drug product even after acceptance of an
application we file for any such drug product;
|
| · |
risks
that the FDA or other regulatory authorities may delay consideration
of
any applications that we file;
|
| · |
risks
relating to the ability of our third party materials, drug substance
and
device suppliers and development partners to provide us with adequate
supplies of materials, drug substance and devices to support manufacture
of drug product for initiation and completion of any of our clinical
studies;
|
| · |
risks
relating to our drug manufacturing
operations;
|
| · |
risks
relating to the integration of our manufacturing operations into
our
existing operations;
|
| · |
risks
relating to the transfer of our manufacturing technology to third-party
contract manufacturers;
|
| · |
risks
relating to our ability and the ability of our collaborators and
development partners to develop and successfully commercialize products
that will combine our drug products with innovative aerosolization
technologies;
|
| · |
risks
relating to the significant, time-consuming and costly research,
development, pre-clinical studies, clinical testing and regulatory
approval for any products that we may develop independently or in
connection with our collaboration arrangements;
|
| · |
the
risk that we or our marketing partners will not succeed in developing
market awareness of our products;
|
| · |
the
risk that we or our marketing partners will not be able to attract
or
maintain qualified personnel;
|
| · |
risks
relating to the development of competing therapies and/or technologies
by
other companies;
|
| · |
risks
relating to our recent workforce reductions and corporate
restructuring:
|
| · |
risks
relating to the impact of litigation that
has been and may be brought against the Company and its officers
and
directors; and
|
| · |
other
risks and uncertainties detailed in Part II, Item 1A: Risk Factors
and
elsewhere in our Annual Report on Form 10-K for the year ended December
31, 2005, and those described from time to time in our future reports
filed with the Securities and Exchange Commission (SEC).
|
ii
Except
to
the extent required by applicable laws or rules, we do not undertake to update
any forward-looking statements or to publicly announce revisions to any of
the
forward-looking statements, whether as a result of new information, future
events or otherwise.
iii
PART
I - FINANCIAL INFORMATION
ITEM
1. FINANCIAL
STATEMENTS
DISCOVERY
LABORATORIES, INC. AND SUBSIDIARY
Consolidated
Balance Sheets
(in
thousands, except per share data)
|
September
30,
|
December
31,
|
||||||
|
2006
|
2005
|
||||||
|
(Unaudited)
|
|||||||
|
ASSETS
|
|||||||
|
Current
Assets:
|
|||||||
|
Cash
and cash equivalents
|
$
|
18,893
|
$
|
47,010
|
|||
|
Restricted
cash
|
830
|
647
|
|||||
|
Available-for-sale
marketable securities
|
–
|
3,251
|
|||||
|
Prepaid
expenses and other current assets
|
278
|
560
|
|||||
|
Total
Current Assets
|
20,001
|
51,468
|
|||||
|
Property
and equipment, net of accumulated depreciation
|
4,604
|
4,322
|
|||||
|
Other
assets
|
216
|
218
|
|||||
|
Total
Assets
|
$
|
24,821
|
$
|
56,008
|
|||
|
LIABILITIES
& STOCKHOLDERS’ EQUITY
|
|||||||
|
Current
Liabilities:
|
|||||||
|
Accounts
payable and accrued expenses
|
$
|
6,867
|
$
|
7,540
|
|||
|
Credit
facility, current portion
|
8,500
|
8,500
|
|||||
|
Capitalized
leases and note payable, current portion
|
1,922
|
1,568
|
|||||
|
Total
Current Liabilities
|
17,289
|
17,608
|
|||||
|
Capitalized
leases and note payable, non-current portion
|
2,867
|
3,323
|
|||||
|
Other
liabilities
|
622
|
239
|
|||||
|
Total
Liabilities
|
20,778
|
21,170
|
|||||
|
Stockholders’
Equity:
|
|||||||
|
Common
stock, $0.001 par value; 180,000 shares authorized; 62,725
and 61,335 shares issued, and 62,374
and 61,022 shares outstanding
at
September 30, 2006 and December 31, 2005, respectively.
|
63
|
61
|
|||||
|
Additional
paid-in capital
|
247,648
|
240,028
|
|||||
|
Unearned
portion of compensatory stock options
|
(58
|
)
|
(230
|
)
|
|||
|
Accumulated
deficit
|
(240,453
|
)
|
(201,965
|
)
|
|||
|
Treasury
stock (at cost); 351 and 313 shares at September 30, 2006 and December
31,
2005, respectively.
|
(3,157
|
)
|
(3,054
|
)
|
|||
|
Accumulated
other comprehensive loss
|
—
|
(2
|
)
|
||||
|
Total
Stockholders’ Equity
|
4,043
|
34,838
|
|||||
|
Total
Liabilities & Stockholders’ Equity
|
$
|
24,821
|
$
|
56,008
|
|||
See
notes to consolidated financial
statements
1
DISCOVERY
LABORATORIES, INC. AND SUBSIDIARY
Consolidated
Statements of Operations
(Unaudited)
(in
thousands, except per share data)
|
Three
Months Ended
|
Nine
Months Ended
|
||||||||||||
|
September
30,
|
September
30,
|
||||||||||||
|
2006
|
2005
|
2006
|
2005
|
||||||||||
|
Revenues:
|
|||||||||||||
|
Contracts
and Grants
|
$
|
-
|
$
|
20
|
$
|
-
|
$
|
105
|
|||||
|
Expenses:
|
|||||||||||||
|
Research
& Development
|
5,204
|
5,676
|
18,728
|
16,660
|
|||||||||
|
General
& Administrative
|
2,723
|
4,817
|
15,429
|
13,182
|
|||||||||
|
Restructuring
Charge
|
-
|
-
|
4,805
|
-
|
|||||||||
|
Total
Operating Expenses
|
7,927
|
10,493
|
38,962
|
29,842
|
|||||||||
|
Operating
Loss
|
(7,927
|
)
|
(10,473
|
)
|
(38,962
|
)
|
(29,737
|
)
|
|||||
|
Other
income / (expense):
|
|||||||||||||
|
Interest
and other income
|
291
|
328
|
1,468
|
884
|
|||||||||
|
Interest
expense
|
(362
|
)
|
(261
|
)
|
(994
|
)
|
(695
|
)
|
|||||
|
Other
income / (expense), net
|
(71
|
)
|
67
|
474
|
189
|
||||||||
|
Net
Loss
|
$
|
(7,998
|
)
|
$
|
(10,406
|
)
|
$
|
(38,488
|
)
|
$
|
(29,548
|
)
|
|
|
Net
loss per common share -
Basic
and diluted
|
$
|
(0.13
|
)
|
$
|
(0.19
|
)
|
$
|
(0.62
|
)
|
$
|
(0.56
|
)
|
|
|
Weighted
average number of common
shares
outstanding - basic and diluted
|
62,312
|
54,476
|
61,703
|
52,844
|
|||||||||
See
notes to consolidated financial
statements
2
DISCOVERY
LABORATORIES, INC. AND SUBSIDIARY
Consolidated
Statements of Cash Flows
(Unaudited)
(in
thousands)
|
Nine
Months Ended
|
|||||||
|
September
30,
|
|||||||
|
2006
|
2005
|
||||||
|
Cash
flows from operating activities:
|
|||||||
|
Net
loss
|
$
|
(38,488
|
)
|
$
|
(29,548
|
)
|
|
|
Adjustments
to reconcile net loss to net cash used
in
operating activities:
|
|||||||
|
Depreciation
|
685
|
585
|
|||||
|
Stock-based
compensation expense / 401(k) match
|
4,891
|
468
|
|||||
|
Loss
on disposal of property and equipment
|
—
|
16
|
|||||
|
Changes
in:
|
|||||||
|
Prepaid
expenses and other current assets
|
282
|
(35
|
)
|
||||
|
Accounts
payable and accrued expenses
|
(673
|
)
|
(1,100
|
)
|
|||
|
Other
assets
|
2
|
13
|
|||||
|
Other
liabilities
|
383
|
(105
|
)
|
||||
|
Net
cash used in operating activities
|
(32,918
|
)
|
(29,706
|
)
|
|||
|
Cash
flows from investing activities:
|
|||||||
|
Purchase
of property and equipment
|
(967
|
)
|
(667
|
)
|
|||
|
Restricted
cash
|
(183
|
)
|
(1
|
)
|
|||
|
Purchases
of marketable securities
|
(4,631
|
)
|
(30,110
|
)
|
|||
|
Proceeds
from sales or maturity of marketable securities
|
7,884
|
24,408
|
|||||
|
Net
cash provided by / (used in) investing activities
|
2,103
|
(6,370
|
)
|
||||
|
Cash
flows from financing activities:
|
|||||||
|
Proceeds
from issuance of securities, net of expenses
|
2,903
|
45,402
|
|||||
|
Proceeds
from credit facility
|
—
|
2,571
|
|||||
|
Equipment
financed through capital lease obligation
|
1,130
|
757
|
|||||
|
Principal
payments under capital lease obligation
|
(1,232
|
)
|
(669
|
)
|
|||
|
Purchase
of treasury stock
|
(103
|
)
|
—
|
||||
|
Net
cash provided by financing activities
|
2,698
|
48,061
|
|||||
|
Net
increase / (decrease) in cash and cash equivalents
|
(28,117
|
)
|
11,985
|
||||
|
Cash
and cash equivalents – beginning of period
|
47,010
|
29,264
|
|||||
|
Cash
and cash equivalents - end of period
|
$
|
18,893
|
$
|
41,249
|
|||
|
Supplementary
disclosure of cash flows information:
|
|||||||
|
Interest
paid
|
$
|
964
|
$
|
612
|
|||
|
Non-cash
transactions:
|
|||||||
|
Unrealized
gain/(loss) on marketable securities
|
2
|
(2
|
)
|
||||
See
notes to consolidated financial
statements
3
Notes
to Consolidated Financial Statements (unaudited)
Note
1 – The Company and Basis of Presentation
The
Company
Discovery
Laboratories, Inc. (the Company) is a biotechnology company developing its
proprietary surfactant technology as Surfactant Replacement Therapies (SRT)
for
respiratory disorders. Surfactants are produced naturally in the lungs and
are
essential for breathing. The Company’s technology produces a
precision-engineered surfactant that is designed to closely mimic the essential
properties of natural human lung surfactant. The Company believes that through
this technology, pulmonary surfactants have the potential, for the first time,
to be developed into a series of respiratory therapies for patients in the
neonatal intensive care unit (NICU), critical care unit and other hospital
settings, to treat conditions for which there are few or no approved therapies
available.
The
Company’s SRT pipeline is initially focused on the most significant respiratory
conditions prevalent in the NICU. The Company’s lead product is Surfaxin®
(lucinactant). The Company has filed a New Drug Application (NDA) with the
U.S.
Food and Drug Administration (FDA) for Surfaxin for the prevention of
Respiratory Distress Syndrome (RDS) in premature infants and has received two
Approvable Letters from the FDA in connection with this NDA. In addition, the
Company recently announced preliminary results for its Phase 2 clinical trial
investigating the use of Surfaxin for the prevention and treatment of
Bronchopulmonary Dysplasia (BPD) in premature infants. The Company is also
developing Aerosurf™, its proprietary SRT in aerosolized form administered
through nasal continuous positive airway pressure (nCPAP), for the prevention
and treatment of infants at risk for respiratory failure. The Company is
preparing to initiate Phase 2 clinical studies with Aerosurf, potentially
obviating the need for endotracheal intubation and conventional mechanical
ventilation.
As
part
of the Company’s ongoing efforts to address the various respiratory conditions
affecting pediatric, young adult and adult patients in the critical care and
other hospital settings, the Company believes that its SRT will also potentially
address Acute Lung Injury (ALI), Acute Respiratory Distress Syndrome (ARDS),
cystic fibrosis and other respiratory conditions.
The
Company is implementing a business strategy that includes: (i) undertaking
actions intended to gain regulatory approvals for Surfaxin for the prevention
of
RDS in premature infants in the United States, including (A) preparing to attend
a meeting with the FDA in December 2006, with respect to which, in September
2006, we submitted an information package to the FDA addressing questions raised
in the second Approvable Letter, which focused on the
Chemistry,
Manufacturing and Controls (CMC)
portion
of our NDA, (B) preparing our response to the second Approvable Letter, and
(C)
completing analysis and remediation of recent manufacturing issues (discussed
in
“Management’s
Discussion and Analysis of Financial Condition and Results of Operations -
Plan
of Operations”); (ii) investing in development of SRT pipeline programs,
including Aerosurf, which uses the aerosol-generating technology rights that
we
have licensed through a strategic alliance with Chrysalis Technologies, a
division of Philip Morris USA Inc. (Chrysalis); (iii) continued investment
in our quality systems and our manufacturing capabilities at our manufacturing
facility in Totowa, New Jersey that was acquired by the Company in December
2005
to produce surfactant drug products to meet anticipated clinical and commercial
requirements of Surfaxin (if approved) as well as pre-clinical, clinical and
future commercial needs of the Company’s SRT product candidates (if approved)
and, potentially, investing in additional facilities to be built or acquired
by
the Company in the future; and (iv) seeking investments of additional
capital and potentially entering into collaboration agreements and strategic
partnerships for the development and commercialization of the Company’s SRT
product candidates.
Basis
of Presentation
The
accompanying unaudited consolidated financial statements have been prepared
in
accordance with accounting principles generally accepted in the United States
for interim financial information in accordance with the instructions to Form
10-Q. Accordingly, they do not include all of the information and footnotes
required by accounting principles generally accepted in the United States for
complete financial statements. In the opinion of management, all adjustments
(consisting of normally recurring accruals) considered for fair presentation
have been included. Operating results for the three and nine month period ended
September 30, 2006 are not necessarily indicative of the results that may be
expected for the year ending December 31, 2006. For further information, refer
to the consolidated financial statements and footnotes thereto included in
the
Company’s Annual Report on Form 10-K for the year ended December 31,
2005.
4
All
of
the Company’s product candidates currently under development are subject to
license agreements that will require the payment of future
royalties.
Certain
prior period balances have been reclassified to conform to the current period
presentation.
Recent
Accounting Pronouncements
In
July
2006, the Financial Accounting Standards Board (FASB) issued FASB Interpretation
No. 48, "Accounting for Uncertainty in Income Taxes, an interpretation of FASB
Statement No. 109," (FIN 48). FIN 48 prescribes a
recognition
threshold and measurement attribute for the financial statement recognition
and
measurement of a tax position taken or expected to be taken in a tax return.
FIN 48 is effective for fiscal years beginning after December 15, 2006.
The company does
not
believe that the adoption of FIN 48 will have a material impact on their
financial statements.
Note
2 – Working Capital
Cash
is
required to fund the Company’s working capital needs, to purchase capital
assets, and to pay debt service, including principal and interest payments.
The
Company does not currently have any source of operating revenue and will require
significant amounts of cash to continue to fund operations, clinical trials
and
research and development efforts until such time, if ever, that one of the
Company’s products receives regulatory approval for marketing and begins to
generate sales. Since the Company has not generated any revenue from the sale
of
any products, the Company has primarily relied upon the capital markets and
debt
financings as its primary sources of funding. The Company will continue to
be
opportunistic in accessing the capital markets to obtain financing on terms
satisfactory to the Company. The Company plans to fund its future cash
requirements through:
| · |
the
issuance of equity and debt
financings;
|
| · |
payments
from potential strategic collaborators, including license fees and
sponsored research funding;
|
| · |
sales
of Surfaxin, if approved;
|
| · |
sales
of the Company’s other product candidates, if
approved;
|
| · |
capital
lease financings; and
|
| · |
interest
earned on invested capital.
|
Receipt
of a second Approvable Letter and the occurrence of manufacturing issues in
April 2006 (discussed
in “Management’s
Discussion and Analysis of Financial Condition and Results of Operations -
Plan
of Operations”) caused the Company to modify its expectations concerning the
timing of potential FDA approval and commercial launch of Surfaxin. The related
decline in the market value of the Company’s common stock has made it more
difficult to obtain equity and debt financing on terms that would be beneficial
to the Company in the long term. In June 2006, the Company engaged Jefferies
& Company, Inc., the New York-based investment banking firm, to assist the
Company in identifying and evaluating strategic alternatives intended to enhance
the future growth potential of the Company’s SRT pipeline and maximize
shareholder value. The Company is evaluating multiple strategic alternatives
including, but not limited to, potential business alliances, commercial and
development partnerships, financings, business combinations and other similar
opportunities. No assurances can be given that this evaluation will lead to
any
specific action or transaction.
After
taking into account the recently implemented cost containment measures and
the
restructuring of the Company’s credit facility with PharmaBio Development Inc.
d/b/a NovaQuest (PharmaBio), an investment group of Quintiles Transnational
Corp. (discussed
in“Management’s
Discussion and Analysis of Financial Condition and Results of Operations -
Liquidity and Capital Resources”), and before taking into account any strategic
alternatives, potential financings or amounts that may be potentially available
through the new Committed Equity Financing Facility (CEFF) entered into with
Kingsbridge Capital Limited (Kingsbridge), a private investment group, in April
2006 (discussed
in “Management’s
Discussion and Analysis of Financial Condition and Results of Operations -
Liquidity and Capital Resources”), the Company believes that its current working
capital is sufficient to meet planned activities into mid-2007. Use of the
CEFF
is subject to certain conditions, including a limitation on the total number
of
shares of common stock that may be issued by the Company under the CEFF
(approximately 10.6 million shares were available for issuance under the CEFF
as
of September 30, 2006). In addition, during the eight trading day pricing period
for a draw down, if the volume weighted average price of the Company’s common
stock (VWAP) for any one trading day is less than the greater of (i) $2.00
or
(ii) 85 percent of the closing price of the Company’s common stock for the
trading day immediately preceding the beginning of the draw down period, the
VWAP from that trading day will not be used in calculating the number of shares
to be issued in connection with that draw down, and the draw down amount for
that pricing period will be reduced by one-eighth of the draw down amount that
the Company had initially specified. (Also, see discussion in Subsequent Events,
Note 10) The Company anticipates using the CEFF, when available, to support
working capital needs in 2006 and 2007.
5
Note
3 – Net Loss Per Share
Net
loss
per share is computed based on the weighted average number of common shares
outstanding for the periods. Common shares issuable upon the exercise of options
and warrants are not included in the calculation of the net loss per share
as
their effect would be anti-dilutive.
Note
4 – Stock-Based Employee Compensation
The
Company has a stock-based employee compensation plan. Prior to January 1, 2006,
the Company accounted for this plan under the recognition and measurement
provisions of APB Opinion No. 25, Accounting
for Stock Issued to Employees,
(Opinion 25) and related interpretations, as permitted by FASB Statement No.
123, Accounting
for Stock-Based Compensation.
Generally, no stock-based employee compensation cost was recognized in the
statements of operations, as options granted under the plan had an exercise
price equal to the market value of the underlying common stock on the date
of
the grant. Effective January 1, 2006, the Company adopted the fair value
recognition provisions of FASB Statement No. 123(R), Share-Based
Payment,
using
the modified-prospective-transition method. Under that transition method,
compensation cost recognized in the three and nine months ended September 30,
2006 includes: (a) compensation cost for all share-based payments granted prior
to, but not yet vested as of January 1, 2006, based on the grant date fair
market value estimated in accordance with the original provisions of Statement
123, and (b) compensation cost for all share-based payments granted subsequent
to January 1, 2006, based upon the grant-date fair value estimated in accordance
with the provisions of Statement 123(R). Results from prior periods have not
been restated.
As
a
result of adopting Statement 123(R) on January 1, 2006, the Company’s net loss
for the three and nine months ended September 30, 2006 was $0.9 million (or
$0.02 per share) and $4.1 million (or $0.06 per share), respectively, higher
than if it had continued to account for share-based compensation under Opinion
25. For the three and nine months ended September 30, 2006, $0.3 million and
$1.2 million of compensation expense was classified as research and development
and $0.6 million and $2.9 million of compensation expense was classified as
general and administrative.
For
comparative purposes, the following table illustrates the effect on net loss
and
net loss per share if the Company had applied the fair value recognition
provisions of Statement 123(R) to options granted under the Company’s stock
option plan for the three and nine months ended September 30, 2005. For purposes
of this pro forma disclosure, the value of the option is estimated using a
Black-Scholes-Merton
option-pricing formula that
uses
the September 30, 2005 assumptions set forth under “Stock Incentive Plan” below
and amortized to expense over the options’ vesting periods.
|
Three
Months Ended
|
Nine
Months Ended
|
||||||
|
September
30,
|
September
30,
|
||||||
|
(in
thousands, except per share data)
|
2005
|
2005
|
|||||
|
Net
loss, as reported
|
$
|
(10,406
|
)
|
$
|
(29,548
|
)
|
|
|
Net
loss per share, as reported
|
$
|
(0.19
|
)
|
$
|
(0.56
|
)
|
|
|
Add:
Stock-based employee compensation expense included in reported net
loss
|
—
|
—
|
|||||
|
Deduct:
Total stock-based employee compensation expense determined under
fair
value based method for all awards
|
(1,163
|
)
|
(5,796
|
)
|
|||
|
Pro
forma net loss
|
$
|
(11,569
|
)
|
$
|
(35,344
|
)
|
|
|
Pro
forma net loss per share
|
$
|
(0.21
|
)
|
$
|
(0.67
|
)
|
|
6
Stock
Incentive Plan
The
Company’s 1998 Stock Incentive Plan (the Plan) is shareholder-approved and
currently allows for the grant of stock options and shares of our common stock
to its eligible employees, officers, consultants, independent advisors and
non-employee directors for up to 11,207,000 shares of our common stock. At
September 30, options to purchase 9,554,000 shares were outstanding, and
1,653,000 shares remain available for issuance under the Plan. The Company
believes that such awards better align the interests of its eligible
participants with those of its shareholders. Option awards are granted with
an
exercise price equal to or greater than the closing sale price per share of
the
Company’s common stock on the Nasdaq Global Market on the option grant date.
Although the terms of any award vary, option awards generally vest based upon
three years of continuous service and have 10-year contractual
terms.
The
fair
value of each option award is estimated on the date of grant using the
Black-Scholes-Merton option-pricing formula that uses assumptions noted in
the
following table. Expected volatilities are based upon the Company’s historical
volatility and other factors. The Company also uses historical data and other
factors to estimate option exercises and employee terminations within the
valuation model. The risk-free interest rates are based upon the U.S. Treasury
yield curve in effect at the time of the grant.
|
September
30, 2006
|
September
30, 2005
|
|||
|
Expected
volatility
|
101%
|
77%
|
||
|
Expected
term
|
5
years
|
3.5
years
|
||
|
Risk-free
rate
|
5.0%
|
4.1%
|
||
|
Expected
dividends
|
--
|
--
|
A
summary
of option activity under the Plan as of September 30, 2006 and changes during
the period is presented below:
(in
thousands, except for weighted-average data)
|
Options
|
Shares
|
Weighted-Average
Exercise Price
|
Weighted-Average
Remaining Contractual Term
|
Aggregate
Intrinsic Value
|
|||||||||
|
Outstanding
at January 1, 2006
|
8,440
|
$
|
6.28
|
||||||||||
|
Granted
|
904
|
7.08
|
|||||||||||
|
Exercised
|
(8
|
)
|
3.15
|
||||||||||
|
Forfeited
or expired
|
(60
|
)
|
6.97
|
||||||||||
|
Outstanding
at March 31, 2006
|
9,276
|
$
|
6.35
|
7.3
|
$
|
15,050
|
|||||||
|
Vested
at March 31, 2006
|
6,769
|
$
|
6.63
|
6.9
|
$
|
10,650
|
|||||||
|
Exercisable
at March 31, 2006
|
7,548
|
$
|
6.23
|
6.8
|
$
|
14,199
|
|||||||
7
|
Outstanding
at March 31, 2006
|
9,276
|
$
|
6.35
|
||||||||||
|
Granted
|
1,664
|
2.20
|
|||||||||||
|
Exercised
|
(2
|
)
|
1.53
|
||||||||||
|
Forfeited
or expired
|
(1,140
|
)
|
7.69
|
||||||||||
|
Outstanding
at June 30, 2006
|
9,798
|
$
|
5.50
|
7.4
|
$
|
476
|
|||||||
|
Vested
at June 30, 2006
|
6,898
|
$
|
6.13
|
6.8
|
$
|
360
|
|||||||
|
Exercisable
at June 30, 2006
|
7,491
|
$
|
5.86
|
6.8
|
$
|
360
|
|||||||
|
Outstanding
at June 30, 2006
|
9,798
|
$
|
5.50
|
||||||||||
|
Granted
|
355
|
1.82
|
|||||||||||
|
Exercised
|
(25
|
)
|
0.47
|
||||||||||
|
Forfeited
or expired
|
(574
|
)
|
$
|
8.10
|
|||||||||
|
Outstanding
at September 30, 2006
|
9,554
|
$
|
5.22
|
7.3
|
$
|
584
|
|||||||
|
Vested
at September 30, 2006
|
6,456
|
$
|
5.92
|
6.5
|
$
|
377
|
|||||||
|
Exercisable
at September 30, 2006
|
7,048
|
$
|
5.65
|
6.5
|
$
|
377
|
|||||||
Based
upon application of the Black-Scholes-Merton option-pricing formula described
above, the weighted-average grant-date fair value of options granted during
the
nine months ended September 30, 2006 was $2.54. The total intrinsic value of
options exercised during the nine months ended September 30, 2006 was $79,000.
A
summary
of the status of the Company’s nonvested shares issuable upon exercise of
outstanding options and changes during the three and nine month periods are
presented below:
(in
thousands, except for weighted-average data)
|
Option
Shares
|
Weighted-Average
Grant-Date Fair Value
|
||||||
|
Nonvested
at January 1, 2006
|
1,907
|
$
|
3.68
|
||||
|
Granted
|
904
|
4.70
|
|||||
|
Vested
|
(252
|
)
|
4.55
|
||||
|
Forfeited
|
(53
|
)
|
5.15
|
||||
|
Nonvested
at March 31, 2006
|
2,506
|
$
|
3.89
|
||||
|
Granted
|
1,664
|
1.68
|
|||||
|
Vested
|
(910
|
)
|
2.00
|
||||
|
Forfeited
|
(360
|
)
|
4.61
|
||||
|
Nonvested
at June 30, 2006
|
2,900
|
$
|
2.08
|
||||
|
Granted
|
355
|
1.37
|
|||||
|
Vested
|
(125
|
)
|
2.56
|
||||
|
Forfeited
|
(32
|
)
|
3.26
|
||||
|
Nonvested
at September 30, 2006
|
3,098
|
$
|
2.66
|
||||
As
of
September 30, 2006, there was $6.3 million of total unrecognized compensation
cost related to nonvested share-based compensation arrangements granted under
the Plan. That cost is expected to be recognized over a weighted-average vesting
period of 2.11 years.
Note
5 – Comprehensive Loss
Total
comprehensive loss was $8.0 million and $38.5 million for the three months
and
nine months ended September 30, 2006, respectively, and $10.4 million and $29.6
and for the three and nine months ended September 30, 2005. Total comprehensive
loss consists of the net loss and unrealized gains and losses on marketable
securities.
8
Note
6 – Restricted Cash
There
are
cash balances that are restricted as to use and the Company discloses such
amounts separately on the Company’s balance sheets. There are two primary
components of Restricted Cash: (a) a cash security deposit in the amount of
$600,000 securing a letter of credit in the same amount related to the Company’s
lease agreement dated May 26, 2004 for office space in Warrington, Pennsylvania,
and (b) a cash security deposit in the amount of approximately $175,500 securing
a letter of credit in the same amount issued to support two “Bond to Discharge
Lien” filed in Passaic County, New Jersey, in connection with an ongoing
contractor dispute arising out of work done at the Company’s manufacturing
facility in Totowa, New Jersey. Beginning in March 2008, the security deposit
and the letter of credit related to the lease agreement will be reduced to
$400,000 and will remain in effect through the remainder of the lease term.
Subject to certain conditions, upon expiration of the lease in November 2009,
the letter of credit will expire. Both letters of credit are secured by cash
and
are recorded in the Company’s balance sheets as “Restricted Cash.”
Note
7 – Q2 2006 Restructuring Charge
In
April
2006, the Company reduced its staff levels and reorganized corporate management
to lower the Company’s cost structure and re-align its operations with changed
business priorities. These actions were taken in response to the Company’s
revised expectations concerning the timing of potential FDA approval and
commercial launch of Surfaxin for the prevention of RDS in premature infants
following the April 2006 Surfaxin process validation stability failure.
The
reduction in workforce totaled 52 employees, representing approximately 33%
of
the Company’s workforce, and was focused primarily on the Company’s commercial
infrastructure, the development of which is no longer in the Company’s near-term
plans. Included in the workforce reduction were three senior executives. All
affected employees were eligible for certain severance payments and continuation
of benefits. The Company expects to realize annual expense savings of
approximately $8.1 million from the reduction in work force and related
operating expenses. Additionally, certain commercial programs were discontinued
and related costs will no longer be incurred. Such commercial program expenses
totaled approximately $5.0 million for the fourth quarter of 2005 and first
quarter of 2006.
The
Company incurred a restructuring charge of $4.8 million in the second quarter
of
2006 associated with staff reductions and the close-out of certain commercial
programs, which was accounted for in accordance with Statement of Financial
Accounting Standards No. 146 “Accounting
for Costs Associated with Exit or Disposal Activities”
and is
identified separately on the Statement of Operations as Restructuring Charge.
This charge included $2.5 million of severance and benefits related to staff
reductions and $2.3 million for the termination of certain commercial programs.
As
of
September 30, 2006, payments totaling $3.5 million had been made related to
these items and $1.3 million were unpaid. Of the $1.3 million that was unpaid
as
of September 30, 2006, $1.0 million was included in accounts payable and accrued
expenses and $0.3 million was classified as a long-term liability. A
reconciliation of these amounts is set forth in the table below:
9
|
(in
thousands)
|
Severance
and Benefits Related
|
Termination
of Commercial Programs
|
Total
|
|||||||
|
Restructuring
Charge - Q2 2006
|
$
|
2,497
|
$
|
2,308
|
$
|
4,805
|
||||
|
Payments
/ Adjustments
|
(2,227
|
)
|
(1,028
|
)
|
(3,255
|
)
|
||||
|
Liability
as of June 30, 2006
|
270
|
1,280
|
1,550
|
|||||||
|
Payments
/ Adjustments - Q3 2006
|
(80
|
)
|
(129
|
)
|
(209
|
)
|
||||
|
Liability
as of September 30, 2006
|
$
|
190
|
$
|
1,151
|
$
|
1,341
|
||||
Note
8 – Treasury Stock
Occasionally,
certain members of the Company’s management and certain consultants, pursuant to
terms set forth in the Company’s Amended and Restated 1998 Stock Incentive Plan,
tender shares of the Company’s common stock held by such persons in lieu of cash
for payment for the exercise of certain stock options previously granted to
such
parties. There were no such shares tendered during the nine months ended
September 30, 2006.
As
a
result of the reduction in staff in the second quarter of 2006, for the nine
months ended September 30, 2006, 37,382 shares of unvested restricted stock
awards were cancelled and recorded as treasury stock.
Note
9 – Litigation
In
connection with the shareholder class actions filed in the United States
District Court for the Eastern District of Pennsylvania against the Company
in
May 2006 and consolidated in June 2006 under the caption “In re: Discovery
Laboratories Securities Litigation”, a Consolidated Amended Complaint was filed
by the Mizla Group, the lead plaintiffs, on August 9, 2006, individually and
on
behalf of a class of the Company’s investors who purchased the Company’s
publicly traded securities between March 15, 2004 and June 6, 2006. The
complaint names as defendants the Company, the Company’s Chief Executive
Officer, Robert J. Capetola and the Company’s former Chief Operating Officer,
Christopher J. Schaber. On September 14, 2006, the Company’s counsel filed a
Motion to Dismiss the Consolidated Amended Complaint and on November 1, 2006,
the court dismissed the Consolidated Amended Complaint, without prejudice,
and
granted plaintiffs leave
to
file an amended Consolidated Amended Complaint by November 30, 2006. The Company
has no information as to whether the plaintiffs plan to file an amended
complaint with the court.
Two
shareholder derivative complaints filed in May and June 2006, respectively,
in
the United States District Court for the Eastern District of Pennsylvania
against the Company’s Chief Executive Officer, Robert J. Capetola, and the
Company’s directors remain subject to a stipulation agreement between the
parties providing that the Company is not required to respond to these
consolidated complaints until 60 days following defendants’ answer or a
dispositive ruling on a motion to dismiss filed in response to the consolidated
amended complaint in the class actions, described above.
If
any of
these actions proceed, the Company intends to vigorously defend them. The
potential impact of such actions, all of which generally seek unquantified
damages, attorneys’ fees and expenses is uncertain. Additional actions based
upon similar allegations, or otherwise, may be filed in the future. There can
be
no assurance that an adverse result in any such proceedings would not have
a
potentially material adverse effect on the Company’s business, results of
operations and financial condition.
The
Company has from time to time been involved in disputes arising in the ordinary
course of business, including in connection with the termination of its
commercial programs (discussed in Note 7, above). Such claims, with or without
merit, if not resolved, could be time-consuming and result in costly litigation.
While it is impossible to predict with certainty the eventual outcome of such
claims, the Company believes they are unlikely to have a material adverse effect
on its financial condition or results of operations. However, there can be
no
assurance that the Company will be successful in any proceeding to which it
may
be a party.
10
Note
10
– Subsequent Events
Restructuring
of Quintiles Loan
On
October 25, 2006, the Company and PharmaBio agreed to restructure the existing
$8.5 million credit facility (PharmaBio loan) that was scheduled to mature
on
December 31, 2006. Under the restructuring, the maturity date of the loan has
been extended by 40 months, from December 31, 2006 to April 30, 2010. Beginning
October 1, 2006, interest on the loan will accrue at the prime lending rate
of
Wachovia Bank, N.A., subject to change when and as such rate changes, compounded
annually. Prior to October 1, 2006, interest accrued at a rate equal to the
greater of 8% or the prime rate plus 2% and was payable quarterly. All unpaid
interest, including interest payable with respect to the quarter ending
September 30, 2006, will now be payable on the maturity date of the loan. The
Company may repay the loan, in whole or in part, at any time without prepayment
penalty or premium. For further discussion,
see “Management’s
Discussion and Analysis of Financial Condition and Results of Operations -
Liquidity and Capital Resources.”
In
consideration of PharmaBio’s agreement to restructure the loan, the Company and
PharmaBio entered into a Warrant Agreement, pursuant to which PharmaBio has
the
right to purchase 1,500,000 shares of the Company’s common stock at an exercise
price equal to $3.5813 per share. The Warrant Agreement has a seven-year term
and is exercisable, in whole or in part, for cash, cancellation of a portion
of
our indebtedness under the PharmaBio loan, or a combination of the foregoing,
in
an amount equal to the aggregate purchase price for the shares being purchased
upon any exercise. In connection with the issuance of the warrant, the Company
expects to recognize deferred financing costs as an intangible asset of
approximately $1.9 million, to be amortized to interest expense ratably over
the
extended term of the loan.
Amendment
to Capital Lease Financing Arrangement with GECC
In
connection with the restructuring of the PharmaBio loan, on October 25, 2006,
the Company and the Life Science and Technology Finance Division of General
Electric Capital Corporation (GECC) entered into an Amendment No. 5 and Consent
(GECC Amendment) to the Master Security Agreement dated December 20, 2002
between the Company and GECC. Under the GECC Amendment, GECC consented to the
execution and delivery by the Company of the Security Agreement to PharmaBio
and, in consideration of the consent and other amendments to the Master Security
Agreement, the Company granted to GECC a security interest in substantially
all
of the Company’s assets, with certain exceptions.
During
the month of October 2006, the Company received financing under the Master
Security Agreement in the amount of $378,945 in connection with the purchase
of
property and equipment. GECC’s obligation to finance purchases of property and
equipment under the Master Security Agreement expired October 31, 2006; however,
GECC has agreed in the near term to discuss the Company’s financing needs on a
month to month basis. For further discussion,
see “Management’s
Discussion and Analysis of Financial Condition and Results of Operations -
Liquidity and Capital Resources.”
Financing
pursuant to the CEFF
In
October 2006, the Company completed a financing pursuant to the CEFF resulting
in proceeds of $2.3 million from the issuance of 1,204,867 shares of the
Company’s common stock at an average price per share, after the applicable
discount, of $1.91.
The
Company is currently completing a financing pursuant to the CEFF and expects
to
realize proceeds of $3.0 million from the issuance of approximately 1.4 million
shares of the Company’s common stock at an average price per share, after the
applicable discount, of approximately $2.20.
11
| ITEM 2. |
MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
|
“Management’s
Discussion and Analysis of Financial Condition and Results of Operations” should
be read in connection with our accompanying Consolidated Financial Statements
(including the notes thereto) appearing elsewhere herein.
OVERVIEW
We
are a
biotechnology company developing our proprietary surfactant technology as
Surfactant Replacement Therapies (SRT) for respiratory diseases. Surfactants
are
produced naturally in the lungs and are essential for breathing. Our technology
produces a precision-engineered surfactant that is designed to closely mimic
the
essential properties of natural human lung surfactant. We believe that through
this technology, pulmonary surfactants have the potential, for the first time,
to be developed into a series of respiratory therapies for patients in the
neonatal intensive care unit (NICU), critical care unit and other hospital
settings, to treat conditions for which there are few or no approved therapies
available.
Our
SRT
pipeline is initially focused on the most significant respiratory conditions
prevalent in the NICU. Our lead product is Surfaxin® (lucinactant). We have
filed a New Drug Application (NDA) with the U.S. Food and Drug Administration
(FDA) for Surfaxin for the prevention of Respiratory Distress Syndrome (RDS)
in
premature infants and have received two Approvable Letters in connection with
this NDA.
In
addition, we recently announced preliminary results from a Phase 2 clinical
trial investigating the use of Surfaxin for the prevention and treatment of
Bronchopulmonary Dysplasia (BPD) in premature infants,
a
debilitating and chronic lung disease typically affecting premature infants
who
have suffered RDS.
We are
also developing Aerosurf™, a proprietary SRT in aerosolized form administered
through nasal continuous positive airway pressure (nCPAP), for the treatment
of
infants at risk for respiratory failure. We are planning to initiate Phase
2
clinical studies with Aerosurf, potentially obviating the need for endotracheal
intubation and conventional mechanical ventilation.
As
part
of our ongoing efforts to address the various respiratory conditions affecting
pediatric, young adult and adult patients in the critical care and other
hospital settings, in March 2006 we announced preliminary results of a Phase
2
clinical trial to address Acute Respiratory Distress Syndrome (ARDS). We believe
our SRT will also potentially address Acute Lung Injury (ALI), Acute Respiratory
Distress Syndrome (ARDS), cystic fibrosis and other respiratory
conditions.
Following
receipt of our second Approvable Letter and the occurrence in April 2006 of
our
previously announced manufacturing issues, we revised our expectations
concerning the timing of potential FDA approval and commercial launch of
Surfaxin for the prevention of RDS in premature infants. In June 2006, we also
determined to voluntarily withdraw the Marketing Authorization Application
(MAA)
that we had filed with the European Medicines Agency (EMEA) for clearance to
market Surfaxin for the prevention and rescue treatment of RDS in premature
infants in Europe. On September 28, 2006, we filed a briefing package with
the
FDA and requested a meeting. The purpose of this meeting is to clarify the
issues identified by the FDA in the second Approvable Letter and reach agreement
with the FDA on the appropriate path to potentially gain approval of Surfaxin
for the prevention of RDS in premature infants. The FDA has notified us that
a
meeting has been scheduled for December 21, 2006. For further discussion, see
“Management’s Discussion and Analysis of Financial Condition and Results of
Operations - Plan of Operations.”
To
respond to the anticipated financial impact of our revised timing for potential
FDA approval and commercial launch in the U.S. of Surfaxin for the prevention
of
RDS in premature infants, we have lowered our cost structure and re-aligned
our
operations to address our business priorities. In May 2006, we announced a
reorganized management and a workforce reduction primarily affecting our
commercial infrastructure, the development of which is no longer in our
near-term plans. We also concluded our Phase 2 clinical trial of Surfaxin for
the prevention and treatment of BPD in premature infants and announced
preliminary results in October 2006. For a discussion of these events, see
“Management’s Discussion and Analysis of Financial Condition and Results of
Operations - Results of Operations - Q2 2006 Restructuring Charge” and “Plan of
Operations - Research and Development.”
12
In
addition, our revised expectations concerning the timing of potential FDA
approval have had a significant impact on our business strategy. We are now
implementing a business strategy which includes:
| · |
taking
actions intended to gain regulatory approvals for Surfaxin for the
prevention of RDS in premature infants in the United States, preparing
to attend the meeting with the FDA in December 2006, addressing questions
raised in the second Approvable Letter, which focused on the CMC
portion of our NDA, and preparing
our response to the second Approvable Letter and completing the
comprehensive investigation, analysis and remediation of our recent
manufacturing issues;
|
| · |
investing
in the continued development of SRT pipeline programs, including
Aerosurf,
which uses the aerosol-generating technology rights that we have
licensed
through a strategic alliance with Chrysalis Technologies, a division
of
Philip Morris USA Inc. (Chrysalis);
|
| · |
continued
investment in our quality systems and our manufacturing capabilities
at
our manufacturing operation in Totowa, New Jersey, which we acquired
in
December 2005 to produce surfactant drug products to meet anticipated
clinical and commercial requirements (if approved) of Surfaxin as
well as
pre-clinical, clinical and future commercial needs (if approved)
of our
SRT product candidates. We are implementing a manufacturing strategy
for
the continued development of our SRT portfolio, including life cycle
management of Surfaxin, potential new formulations, and expansion
of our
aerosol SRT products, beginning with Aerosurf. Our strategy also
includes,
where appropriate, contracting with third-party manufacturers and
potentially building or acquiring additional manufacturing capabilities
for the production of our precision-engineered surfactant drug and
drug
device combination products; and
|
| · |
raising
additional working capital and potentially securing additional strategic
partnerships for the development and commercialization of our proprietary
SRT product candidates, including Surfaxin. We have engaged Jefferies
& Company, Inc., the New York-based investment banking firm, to assist
us in identifying and evaluating strategic alternatives intended
to
enhance the future growth potential of our surfactant replacement
therapy
pipeline and maximize shareholder value. We are evaluating multiple
strategic alternatives including, but not limited to, potential business
alliances, commercial and development partnerships, financings, business
combinations and other similar opportunities, although no assurances
can
be given that this evaluation will lead to any specific action or
transaction.
|
Since
our
inception, we have incurred significant losses and, as of September 30, 2006,
we
had an accumulated deficit of $240.5 million (including historical results
of
predecessor companies). The majority of our expenditures to date have been
for
research and development activities and, during 2005 and the first half of
2006,
also include significant general and administrative, primarily
pre-commercialization activities. Research and development expenses represent
costs incurred for scientific and clinical personnel, clinical trials,
regulatory filings and developing manufacturing capabilities. We expense
research and development costs as they are incurred. General and administrative
expenses consist primarily of Surfaxin pre-launch commercialization sales and
marketing (which were discontinued following our corporate reorganization
announced in May 2006), executive management, financial, business development,
legal and general corporate activities and related expenses. See “Management’s
Discussion and Analysis of Financial Condition and Results of Operations -
Plan
of Operations.”
Historically,
we have funded our operations with working capital provided principally through
public and private equity financings, debt arrangements and strategic
collaborations. As of September 30, 2006, we had: (i) cash of $19.7 million;
(ii) approximately 10.6 million shares potentially available for issuance under
the CEFF with Kingsbridge for future financings (not to exceed $47.8 million),
subject to the terms and conditions of the agreement; (iii) a capital equipment
lease financing arrangement with General Electric Capital Corporation (GECC)
which was available through October 31, 2006, of which an aggregate of $7.5
million was drawn during the life of the facility and, after giving effect
to
principal payments, $5.0 million of which was still payable (after taking into
account an additional $378,945 drawn in October 2006); and (iv) a $8.5 million
loan from PharmaBio Development Inc. d/b/a NovaQuest (PharmaBio), an investment
group of Quintiles Transnational Corp., which, after a recent restructuring,
is
due and payable, together with all accrued interest, on April 30, 2010. See
“Management’s Discussion and Analysis of Financial Condition and Results of
Operations - Liquidity and Capital Resources.”
13
RESEARCH
AND DEVELOPMENT
Research
and development expenses for the three and nine months ended September 30,
2006
were $5.2 million and $18.7 million, respectively, and for the three and nine
months ended September 30, 2005 were $5.7 million and $16.7 million,
respectively. These costs are charged to operations as incurred and are tracked
by category rather than by project. Research and development costs consist
primarily of expenses associated with research and pre-clinical operations,
manufacturing development, clinical and regulatory operations and other direct
clinical trials activities.
These
cost categories typically include the following expenses:
Research
and Pre-Clinical Operations
Research
and pre-clinical operations, primarily conducted at our operations located
in
California, reflects activities associated with research prior to the initiation
of any potential human clinical trials as well as analytical chemistry
activities to support the continued development of Surfaxin. Pre-clinical
activities predominantly represent projects associated with the development
of
aerosolized and other related formulations of our precision-engineered lung
surfactant and engineering of aerosol delivery systems to potentially treat
a
range of respiratory disorders prevalent in the NICU and the hospital. Research
and pre-clinical operations costs primarily reflect expenses incurred for
personnel, consultants, facilities and research and development arrangements
with collaborators (including a research funding and option agreement with
The
Scripps Research Institute which expired in February 2005).
Manufacturing
Development
Manufacturing
development primarily reflects costs incurred to develop current good
manufacturing practices (cGMP) manufacturing capabilities in order to provide
clinical and commercial scale drug supply. Manufacturing development activities
include (1) costs associated with operating our manufacturing facility in
Totowa, New Jersey (which we acquired from our then-contract manufacturer,
Laureate Pharma, Inc. (Laureate) in December 2005) to support the production
of
clinical and anticipated commercial drug supply for the Company’s SRT programs,
such as employee expenses, depreciation, the purchase of drug substances,
quality control and assurance activities, and analytical services; and
(2) continued investment in the Company’s quality assurance and analytical
chemistry capabilities, including implementation of enhancements to quality
controls, process assurances and documentation requirements that support the
production process and expanding the operations to meet production needs for
our
SRT pipeline in accordance with cGMP. In addition, manufacturing activities
include expenses associated with our ongoing comprehensive investigation,
analysis of the April 2006 Surfaxin process validation stability failure and
remediation of the Company’s related manufacturing issues.
Unallocated
Development -- Clinical and Regulatory Operations
Clinical
and regulatory operations reflect the preparation, implementation and management
of our clinical trial activities in accordance with current good clinical
practices (cGCPs). Included in unallocated clinical development and regulatory
operations are costs associated with personnel, supplies, facilities, fees
to
consultants, and other related costs for clinical trial implementation and
management, clinical quality control and regulatory compliance activities,
data
management and biostatistics.
Direct
Expenses -- Clinical Trials
Direct
expenses of clinical trials include patient enrollment costs, external site
costs, expense of clinical drug supply and external costs such as contract
research consultant fees and expenses.
The
following summarizes our research and development expenses by the foregoing
categories for the three and nine months ended September 30, 2006 and 2005:
14
|
(
in thousands)
|
Three
Months Ended
September
30,
|
Nine
Months Ended
September
30,
|
|||||||||||
|
Research
and Development Expenses:
|
2006(1)
|
2005
|
2006(1)
|
2005
|
|||||||||
|
Research
and pre-clinical operations
|
$
|
470
|
$
|
448
|
$
|
1,538
|
$
|
1,803
|
|||||
|
Manufacturing
development
|
2,341
|
2,950
|
7,732
|
6,997
|
|||||||||
|
Unallocated
development - clinical and regulatory operations
|
1,753
|
1,874
|
6,291
|
5,356
|
|||||||||
|
Direct
clinical trial expenses
|
640
|
404
|
3,167
|
2,504
|
|||||||||
|
Total
Research and Development Expenses
|
$
|
5,204
|
$
|
5,676
|
$
|
18,728
|
$
|
16,660
|
|||||
(1)
Included in research and development expenses for the three and nine months
ended September 30, 2006 is a charge of $0.3 million and $1.2 million associated
with stock-based employee compensation in accordance with the provisions of
FAS
No. 123(R).
Due
to
the significant risks and uncertainties inherent in the clinical development
and
regulatory approval processes, the nature, timing and costs of the efforts
necessary to complete projects in development are not reasonably estimable.
Results from clinical trials may not be favorable and data from clinical trials
are subject to varying interpretation and may be deemed insufficient by the
regulatory bodies reviewing applications for marketing approvals. As such,
clinical development and regulatory programs are subject to risks and changes
that may significantly impact cost projections and timelines.
Currently,
none of our drug product candidates are available for commercial sale. All
of
our potential products are in regulatory review, clinical or pre-clinical
development. The status and anticipated completion date of each of our lead
SRT
programs are discussed in “Management’s Discussion and Analysis of Financial
Condition and Results of Operations - Plan of Operations,” below. Successful
completion of development of our SRT is contingent on numerous risks,
uncertainties and other factors, some of which are described in detail in the
section entitled “Risk Factors.”
Development
risk factors include, but are not limited to:
| · |
Completion
of pre-clinical and clinical trials of our product candidates with
the
scientific results that are sufficient to support further development
and/or regulatory approval;
|
| · |
Receipt
of necessary regulatory approvals;
|
| · |
Obtaining
adequate supplies of surfactant active drug substances on commercially
reasonable terms;
|
| · |
Obtaining
capital necessary to fund our operations, including our research
and
development efforts, manufacturing requirements and clinical
trials;
|
| · |
Obtaining
strategic partnerships and collaboration agreements for the development
of
our SRT pipeline, including
Surfaxin;
|
| · |
Performance
of our third-party collaborators and suppliers on whom we rely for
supply
of drug substances and related services necessary to manufacture
our SRT
drug product candidates, including
Surfaxin;
|
| · |
Timely
resolution of the Chemistry, Manufacturing and Controls (CMC) and
cGMP-related matters at our manufacturing operations in Totowa, New
Jersey
with respect to Surfaxin and our other SRTs presently under development,
including those we have identified in connection with our recent
process
validation stability failures and matters that were noted by the
FDA in
its inspectional reports on Form FDA 483;
|
| · |
Successful
manufacture of SRT drug product candidates, including Surfaxin, at
our
operations in New Jersey;
|
| · |
Successful
development and implementation of a manufacturing strategy for the
Chrysalis aerosolization device and related materials to support
clinical
studies and commercialization of Aerosurf;
and
|
| · |
Obtaining
additional manufacturing operations, for which we presently have
limited
resources.
|
Because
these factors, many of which are outside our control, could have a potentially
significant effect on our activities, the success, timing of completion, and
ultimate cost of development of any of our product candidates is highly
uncertain and cannot be estimated with any degree of certainty. The timing
and
cost to complete drug trials alone may be impacted by, among other
things:
| · |
Slow
patient enrollment;
|
15
| · |
Long
treatment time required to demonstrate
effectiveness;
|
| · |
Lack
of sufficient clinical supplies and
material;
|
| · |
Adverse
medical events or side effects in treated
patients;
|
| · |
Lack
of compatibility with complimentary
technologies;
|
| · |
Lack
of effectiveness of the product candidate being tested;
and
|
| · |
Lack
of sufficient funds.
|
If
we do
not successfully complete clinical trials, we will not receive regulatory
approval to market our SRT products. If we do not obtain and maintain regulatory
approval and generate revenues from the sale of our products, such a failure
would have a material adverse effect on our value, financial condition and
results of operations.
CORPORATE
PARTNERSHIP AGREEMENTS
Chrysalis
Technologies, a Division of Philip Morris USA Inc.
In
December 2005, we entered into a strategic alliance with Chrysalis to develop
and commercialize aerosol SRT to address a broad range of serious respiratory
conditions, such as ALI, neonatal respiratory failure, chronic obstructive
pulmonary disorder, asthma, cystic fibrosis and others. The alliance unites
two
complementary respiratory technologies - our precision-engineered surfactant
technology with Chrysalis’ novel aerosolization device technology that is being
developed to enable the delivery of therapeutics to the deep lung.
Chrysalis
has developed a proprietary aerosol generation technology that is being designed
with the potential to enable targeted upper respiratory or deep lung delivery
of
therapies for local or systematic applications. The Chrysalis technology is
designed to produce high-quality, low velocity aerosols for possible deep lung
aerosol delivery. Aerosols are created by pumping the drug formulation through
a
small, heated capillary wherein the excipient system is substantially converted
to the vapor state. Upon exiting the capillary, the vapor stream quickly cools
and slows in velocity yielding a dense aerosol with a defined particle size.
The
defined particle size can be readily controlled and adjusted through device
modifications and drug formulation changes.
The
alliance focuses on therapies for hospitalized patients, including those in
the
NICU, pediatric intensive care unit (PICU) and the adult intensive care unit
(ICU), and can be expanded into other hospital applications and ambulatory
settings. We and Chrysalis are utilizing our respective capabilities and
resources to support and fund the design and development of integrated
drug-device systems that can be uniquely customized to address specific
respiratory diseases and patient populations. Chrysalis is responsible for
developing the design for the aerosol device platform, patient interface and
disposable dose packets. We are responsible for aerosolized SRT drug
formulations, clinical and regulatory activities, and the manufacturing and
commercialization of the drug-device products. We have exclusive rights to
Chrysalis’ aerosolization technology for use with pulmonary surfactants for all
respiratory diseases and conditions in hospital and ambulatory settings.
Generally, Chrysalis will receive a tiered royalty on product sales: the base
royalty generally applies to aggregate net sales of less than $500 million
per
contract year; the royalty generally increases on aggregate net sales in excess
of $500 million per contract year, and generally increases further on aggregate
net sales of alliance products in excess of $1 billion per contract
year.
Our
lead
neonatal program utilizing the Chrysalis technology is Aerosurf, an aerosolized
formulation administered via nCPAP to treat premature infants in the NICU at
risk for RDS. We are planning an adult program utilizing the Chrysalis
technology to develop aerosolized SRT administered as a prophylactic for
patients in the hospital at risk for ALI.
Laboratorios
del Dr. Esteve, S.A.
In
December 2004, we restructured our strategic alliance with Esteve for the
development, marketing and sales of our products in Europe and Latin America.
Under the revised alliance, we regained full commercialization rights in key
European markets, Central America and South America for SRT, including Surfaxin
for the prevention of RDS in premature infants and the treatment of ARDS in
adults. Esteve will focus on Andorra, Greece, Italy, Portugal, and Spain, and
now has development and marketing rights to a broader portfolio of potential
SRT
products. Esteve will pay us a transfer price on sales of Surfaxin and other
SRT. We will be responsible for the manufacture and supply of all of the covered
products and Esteve will be responsible for all sales and marketing in the
revised territory. Esteve has agreed to make stipulated cash payments to us
upon
its achievement of certain milestones, primarily upon receipt of marketing
regulatory approvals for the covered products. In addition, Esteve has agreed
to
contribute to Phase 3 clinical trials for the covered products by conducting
and
funding development performed in the revised territory.
16
In
October 2005, Esteve sublicensed the distribution rights to Surfaxin in Italy
to
Dompe Farmaceutici S.p.A. (Dompe), a privately owned Italian company. Under
the
sublicense agreement, Dompe will be responsible for sales, marketing and
distribution of Surfaxin in Italy.
PLAN
OF OPERATIONS
We
have
incurred substantial losses since inception and expect to continue to expend
substantial amounts for continued product research, development, manufacturing,
and general business activities. We anticipate that during the next 12 to 24
months:
Research
and Development
We
will
focus our research, development and regulatory activities in an effort to
develop a pipeline of potential SRT for respiratory diseases. The drug
development, clinical trial and regulatory process is lengthy, expensive and
uncertain and subject to numerous risks including, without limitation, the
applicable risks discussed in the “Risk Factors” section herein and those
contained in our most recent Annual Report on Form 10-K.
Our
major
research and development projects include:
SRT
for Neonatal Intensive Care Unit
|
In
order to address the most prevalent respiratory disorders affecting
infants in the NICU, we are conducting several NICU therapeutic programs
targeting respiratory conditions cited as some of the most significant
unmet medical needs for the neonatal community.
|
Surfaxin
for the Prevention of RDS in Premature Infants
In
April
2006, we received a second Approvable Letter from the FDA for Surfaxin for
the
prevention of RDS in premature infants. Specifically, the FDA requested certain
information primarily focused on the CMC section of the NDA. The information
predominately involves the further tightening of active ingredient and drug
product specifications and related controls. Consistent with previous reviews,
the FDA did not have any clinical or statistical comments. Also in April,
ongoing analysis of data from Surfaxin process validation batches that were
manufactured as a requirement for our NDA indicated that certain stability
parameters had not been achieved. As a result of this process validation
stability failure, three new process validation batches will have to be
manufactured and submitted to ongoing process validation stability
testing.
On
September 28, 2006, we submitted an information package and requested a meeting
with the FDA. The information package covered certain key CMC matters contained
in the second Approvable Letter and provided information concerning our
comprehensive investigation into the April 2006 Surfaxin process validation
stability failure and our efforts to remediate the related manufacturing issues.
The purpose of the meeting is to clarify the issues identified by the FDA in
the
second Approvable Letter and reach agreement with the FDA on the appropriate
path to potentially gain approval of Surfaxin for the prevention of RDS in
premature infants. The FDA has notified us that a meeting has been scheduled
for
December 21, 2006.
Although
our comprehensive investigation into the process validation stability failure
is
ongoing, we have developed and analyzed substantial data and believe that we
will be able to remediate the Surfaxin manufacturing issues to our satisfaction
and, to meet FDA requirements for our NDA, expect to manufacture new process
validation batches prior to year-end 2006. Once we have achieved satisfactory
Surfaxin process validation stability testing over an acceptable period
(currently contemplated to be six months) and have finalized our response to
the
second Approvable Letter, we will submit to the FDA our formal response to
the
second Approvable Letter. The FDA will then advise us if it will accept the
submitted response to the second Approvable Letter as a “complete” response and
the time frame in which it will complete its review of the NDA.
17
In
September 2006, we announced that, although our comprehensive investigation
is
ongoing, we believe we have identified a most probable root cause of the process
validation stability failures. Our investigation continues, however, and may
identify other contributing factors or causes for the process validation
stability failure. The investigation is being conducted in compliance with
FDA
cGMP requirements and covers, among other things, analysis of manufacturing
processes; equipment and process validation; manufacturing components; drug
substances manufacturers; review and assessment of out-of-specification and
deviation reports; analytical methods and method validation; and change control
documentation.
As part
of the investigation, in addition to a variety of audits, tests and experiments,
we have manufactured three “investigation batches” of Surfaxin
that have passed the critical release specification assays, with stability
monitoring ongoing. These investigation batches are not designated as process
validation batches but are expected to provide significant data that will
support comprehensive investigation report and a corrective action and
preventative action (CAPA) plan.
In
October 2004, we filed an MAA with the EMEA for clearance to market Surfaxin
for
the prevention and rescue treatment of RDS in premature infants in Europe.
At
the time of the Surfaxin process validation stability failure, we had responded
to the Day 180 List of Outstanding Issues from the Committee for Medicinal
Products for Human Use (CHMP) and had met with the EMEA to discuss our response.
Because our manufacturing issues would not be resolved within the regulatory
time frames mandated by the EMEA, we determined in June 2006 to voluntarily
withdraw the MAA for Surfaxin for the prevention and rescue treatment of RDS
in
premature infants. We plan in the future to have further discussions with the
EMEA and develop a strategy to potentially gain approval for Surfaxin in
Europe.
Surfaxin
for BPD in Premature Infants
In
October 2006, we announced preliminary results of our recently completed Phase
2
clinical trial of Surfaxin for the prevention and treatment of BPD. The BPD
Phase 2 clinical trial was a double-blind, controlled trial designed to enroll
up to 210 very low birth weight premature infants born at risk for developing
BPD. Total enrollment in the trial was 136 premature infants who received either
Surfaxin standard dose (175 mg/kg), Surfaxin low dose (90 mg/kg), or sham air
as
a control. The study’s objective was to determine the safety and tolerability of
administering Surfaxin as a therapeutic approach for the prevention and
treatment of BPD and was not powered to determine statistically significant
differences in outcomes. Key preliminary findings observed in this Phase 2
BPD
trial include: a positive acute pharmacological response to Surfaxin therapy
evidenced by a reduction in supplemental oxygen and ventilatory support; a
lower
incidence of death or BPD in patients receiving the Surfaxin standard dose
compared with control (57.8% vs. 65.9%, respectively); a higher survival rate
through 36 weeks post-menstrual age (PMA) in patients receiving the Surfaxin
standard dose compared with control (88.9% vs. 84.1%, respectively); a reduction
in duration of mechanical ventilation (approximately four less days) and need
for supplemental oxygen in patients receiving the Surfaxin standard dose
compared with control; and Surfaxin therapy was generally safe and well
tolerated with generally no differences between the Surfaxin treatment groups
and the control group in common complications of prematurity. By chance, infants
assigned to the Surfaxin low dose treatment group were significantly sicker,
with more pre-existing medical risk factors, such that the data from this
treatment group cannot be easily interpreted and no meaningful conclusions
can
be drawn. We believe that the foregoing results suggest that Surfaxin may
potentially represent a novel therapeutic option for infants at risk for BPD.
Comprehensive
analysis of the data from this trial is ongoing. Following this analysis, in
collaboration with our Steering Committee and Investigators, we expect to
present the study results to the medical community and submit the data for
publication in a peer review journal. Presently there are no approved therapies
for this disease. The FDA previously granted us Orphan Drug Status and Fast
Track designations for Surfaxin for the prevention and treatment of
BPD.
18
Aerosurf,
Aerosolized SRT
|
Aerosurf
is our precision-engineered aerosolized SRT administered via nCPAP
intended to treat premature infants at risk for respiratory failure.
In
September 2005, we completed and announced the results of our first
pilot
Phase 2 clinical study of Aerosurf, which was designed as an open
label,
multicenter study to evaluate the feasibility, safety and tolerability
of
Aerosurf delivered using a commercially-available aerosolization
device
via nCPAP for the prevention of RDS in premature infants administered
within 30 minutes of birth over a three hour duration. The study
showed
that it is feasible to deliver Aerosurf via nCPAP and that the treatment
was generally safe and well
tolerated.
|
In
December 2005, we entered into a strategic alliance with Chrysalis. The alliance
unites two highly complementary respiratory technologies - our
precision-engineered surfactant technology with Chrysalis’ novel aerosolization
device technology that is being developed to enable the delivery of therapeutics
to the deep lung. Through this alliance, we gained exclusive rights to their
aerosolization technology for use with pulmonary surfactants for all respiratory
diseases. Our lead neonatal program utilizing the Chrysalis technology is
Aerosurf administered via nCPAP to treat premature infants in the NICU at risk
for neonatal respiratory disorders. We are presently collaborating with
Chrysalis on the development of a prototype aerosolization device to deliver
Surfaxin to patients in the NICU and, if successful, plan to initiate a pilot
Phase 2 clinical study of Aerosurf utilizing the Chrysalis aerosolization
technology in the middle of 2007. This timeline may be affected by any delay
in
our joint development activities related to the aerosolization device or by
our
efforts to remediate our manufacturing issues, discussed above.
SRT
for Critical Care and Hospital Indications
In
March
2006, we completed and announced preliminary results of a Phase 2 clinical
trial
for the treatment of ARDS in adults using our precision-engineered surfactant
delivered via bronchoscopic segmental lavage (Surfactant Lavage). The ARDS
Phase
2 clinical trial was an open-label, controlled, multi-center, international
study of Surfactant Lavage for the treatment of ARDS in adults that was designed
to enroll up to 160 patients. Total enrollment in the trial was 124 patients.
The
objective of the Surfactant Lavage was to restore functional surfactant levels
in the patients’ lungs, thereby improving oxygenation in order to remove
critically ill patients from mechanical ventilation sooner. Following our
analysis of this trial, we plan to submit the data for publication in a peer
review journal. We plan to seek potential partners, with which we can apply
the
scientific and clinical observations generated from this trial to support the
design of potential future trials to treat ARDS.
We
are
also evaluating the development of aerosol formulations of SRT to potentially
address ALI, cystic fibrosis, and other respiratory conditions. In December
2005, we entered into a strategic alliance with Chrysalis to develop and
commercialize aerosolized SRT to address a broad range of serious respiratory
conditions. Our lead adult program utilizing the Chrysalis technology is the
development of aerosolized SRT administered as a prophylactic for patients
in
the hospital at risk for ALI. Given our current priority to focus on developing
the SRT pipeline for the NICU, we will be assessing the timing and further
prioritization of these adult programs.
Manufacturing
Surfaxin
is a complex drug and, unlike many drugs, contains four active ingredients.
Surfaxin is aseptically manufactured at our facility as a sterile, liquid
suspension. The manufacturing process to produce Surfaxin is complex, must
be
conducted in a sterile environment, and requires ongoing monitoring of the
stability and conformance to product specifications of each of the four active
ingredients.
19
We
will
invest in and support our manufacturing strategy for the production of our
precision-engineered SRT to meet anticipated clinical needs and, if approved,
commercial needs in the United States, Europe and other markets:
Manufacturing
- New Jersey Operations
In
December 2005, we purchased the manufacturing operations of Laureate (our
contract manufacturer at that time) that are critical to the production of
Surfaxin and our SRT clinical programs. This facility is our only validated
clinical facility in which we produce clinical grade material of our drug
substance. We will use this pharmaceutical manufacturing and development
facility for the production of Surfaxin and for the development and new
formulations of Surfaxin and the development of aerosol formulations including
Aerosurf. In connection with our acquisition of the facility, we entered into
a
transitional services arrangement under which Laureate agreed to provide us
with
certain limited manufacturing-related support services through December 2006.
In
July 2006, we terminated the arrangement and have transitioned the Laureate
support activities to our facility.
In
April
2006, ongoing analysis of data from Surfaxin process validation batches that
were manufactured as a requirement for our NDA indicated that certain stability
parameters had not been achieved. As a result of this process validation
stability failure, we will have to manufacture new process validation batches
and submit them to ongoing process validation stability testing. Although our
comprehensive investigation is ongoing, we have developed and analyzed
substantial data and believe that we will be able to remediate the Surfaxin
manufacturing issues to our satisfaction and, to meet FDA requirements for
our
NDA, expect to manufacture new process validation batches prior to year-end
2006. Once we have achieved satisfactory Surfaxin process validation stability
testing over an acceptable period (currently contemplated to be six months)
and
have finalized our response to the second Approvable Letter, we will submit
to
the FDA our formal response to the second Approvable Letter. The FDA will then
advise us if it will accept the submitted response to the second Approvable
Letter as a “complete” response and the time frame in which it will complete its
review of the NDA. We will continue to invest in manufacturing and regulatory
activities intended to gain FDA approval, including in support of our response
to the second Approvable Letter and the continuing comprehensive investigation
and remediation of our recent manufacturing issues.
Longer-Term
Manufacturing Capabilities
We
view
the acquisition of our New Jersey manufacturing facility as an initial step
of
our manufacturing strategy for the continued development of our SRT portfolio,
including life cycle management of Surfaxin, potential new formulations, and
expansion of our aerosol SRT products, beginning with Aerosurf. The lease for
our New Jersey manufacturing facility extends through December 2014. In addition
to the customary terms and conditions, the lease contains an early termination
option, beginning in December 2009. The early termination option can only be
exercised by the landlord upon a minimum of two years prior notice and, in
the
earlier years, payment to us of significant early termination amounts, subject
to certain conditions. Taking into account this early termination option for
our
Totowa, New Jersey, facility, our long-term strategy includes, where
appropriate, contracting with third-party manufacturers and potentially building
or acquiring additional manufacturing capabilities for the production of our
precision-engineered surfactant drug products.
Aerosol
Devices and Related Componentry
For
our
planned clinical trials, we intend on utilizing third-party contract
manufacturers, suppliers and assemblers for the aerosolization devices and
related componentry for our aerosol SRT product candidates.
See
the
applicable risks discussed in the “Risk Factors” section herein and those
contained in our most recent Annual Report on Form 10-K.
20
General
and Administrative
We
intend
to invest in general and administrative resources primarily to support our
legal
requirements, intellectual property portfolios (including building and enforcing
our patent and trademark positions), our business development initiatives,
financial systems and controls, management information technologies, and general
management capabilities.
We
will
need to generate significant revenues from product sales, related royalties
and
transfer prices to achieve and maintain profitability. Through September 30,
2006, we had no revenues from any product sales, and had not achieved
profitability on a quarterly or annual basis. Our ability to achieve
profitability depends upon, among other things, our ability to develop products,
obtain regulatory approval for products under development and enter into
agreements for product development, manufacturing and commercialization. In
addition, our results are dependent upon the performance of our strategic
partners and suppliers. Moreover, we may never achieve significant revenues
or
profitable operations from the sale of any of our products or technologies.
Through
September 30, 2006, we had not generated taxable income. On December 31, 2005,
net operating losses available to offset future taxable income for Federal
tax
purposes were approximately $187.0 million. The future utilization of such
loss
carryforward may be limited pursuant to regulations promulgated under Section
382 of the Internal Revenue Code. In addition, we had a research and development
tax credit carryforward of $3.8 million at December 31, 2005. The Federal net
operating loss and research and development tax credit carryforwards expire
beginning in 2009 through 2024.
RESULTS
OF OPERATIONS
The
net
loss for the three and nine month periods ended September 30, 2006 was $8.0
million (or $0.13 per share) and $38.5 million (or $0.62 per share),
respectively. The net loss for the three and nine month periods ended September
30, 2005 was $10.4 million (or $0.19 per share) and $29.5 million (or $0.56
per
share), respectively.
On
January 1, 2006, we adopted Financial Accounting Standards No. 123(R) (FAS
123(R)) using the modified prospective method, which resulted in the recognition
of stock compensation expenses in the statement of operations during the three
and nine months ended September 30, 2006 without adjusting the prior year three
and nine month periods. The net loss for the three and nine months ended
September 30, 2006 includes $0.9 million (or $0.02 per share) and $4.1 million
(or $0.06 per share), respectively, of stock-based compensation expenses as
a
result of our adoption of FAS 123(R). Additionally, included in the GAAP net
loss for the nine months ended September 30, 2006 is a restructuring charge
of
$4.8 million, or $0.08 per share, related to the staff reductions and the
close-out of certain commercial programs in the second quarter of 2006.
Excluding these charges, the net loss for the three and nine months ended
September 30, 2006 was $7.1 million (or $0.11 per share) and $29.6 million
(or
$0.48 per share), respectively.
Revenues
Revenue
for the three and nine months ended September 30, 2006 was $0. Revenue for
the
three and nine months ended September 30, 2005 was $20,000 and $105,000,
respectively. The revenue in 2005 was associated with our corporate partnership
agreement with Esteve to develop, market and sell Surfaxin in Southern Europe.
Research
and Development Expenses
Research
and development expenses for the three and nine months ended September 30,
2006
were $5.2 million and $18.7 million, respectively, and for the three and nine
months ended September 30, 2005 were $5.7 million and $16.7 million,
respectively. Research and development cost consist primarily of expenses
associated with research and pre-clinical operations, manufacturing development,
clinical and regulatory operations and other direct clinical trial activities.
The change as compared to the same prior year periods primarily
reflects:
| (i) |
manufacturing
development activities (included in research and development expenses)
include (1) costs associated with operating our manufacturing facility
in
Totowa, New Jersey (which we acquired from our then-contract manufacturer,
Laureate in December 2005) to support the production of clinical
and
anticipated commercial drug supply for the Company’s SRT programs, such as
employee expenses, depreciation, the purchase of drug substances,
quality
control and assurance activities, and analytical services; and
(2) continued investment in the Company’s quality assurance and
analytical chemistry capabilities, including implementation of
enhancements to quality controls, process assurances and documentation
requirements that support the production process and expanding the
operations to meet production needs for our SRT pipeline in accordance
with cGMP. In addition, manufacturing activities include expenses
associated with our ongoing comprehensive investigation, analysis
of the
April 2006 Surfaxin process validation stability failure and remediation
of the Company’s related manufacturing issues. Expenses related to
manufacturing development activities for the three and nine months
ended
September 30, 2006 were $2.3 million and $7.7 million, respectively,
as
compared to $3.0 million and $7.0 million for the three and nine
months
ended September 30, 2005, respectively. The increase in expenses
for the
nine months ended September 30, 2006 is primarily associated with
the
ownership of our manufacturing operation in Totowa, New Jersey, which
we
purchased from Laureate Pharma, Inc. (our contract manufacturer at
that
time) in December 2005. Expenditures in 2005 for manufacturing activities
included improvements and enhancements to Laureate’s Totowa, New Jersey
facility in response to the FDA inspectional observations on Form
FDA 483.
Additionally, there was a charge of $0.1 million and $0.3 million
for the
three and nine months ended September 30, 2006, respectively, associated
with stock-based employee compensation in accordance with the provisions
of SFAS No. 123R.
|
21
| (ii) |
research
and development activities, excluding manufacturing development
activities, were $2.9 million and $11.0 million for the three and
nine
months ended September 30, 2006, respectively, as compared to $2.7
million
and $9.7 million for the three and nine months ended September 30,
2005,
respectively. These costs are primarily associated with clinical
trial
implementation and management, clinical quality control and regulatory
compliance activities, data management and biostatistics, the development
of aerosolized and other related formulations of our precision-engineered
lung surfactant and engineering of aerosol delivery systems, including,
among other things: (A) regulatory activities associated with Surfaxin
for
the prevention of RDS in premature infants; (B) clinical activities
for
the Phase 2 trial for ARDS in adults and the Phase 2 trial for BPD
in
premature infants; and (C) development activities related to Aerosurf
for
neonatal respiratory disorders. Additionally, there were charges
of $0.2
million and $1.2 million for the three and nine months ended September
30,
2006, respectively, associated with stock-based employee compensation
in
accordance with the provisions of SFAS No.
123R.
|
General
and Administrative Expenses
General
and administrative expenses for the three and nine months ended September 30,
2006 were $2.7 million and $15.4 million, respectively, and for the three and
nine months September 30, 2005, were $4.8 million and $13.2 million,
respectively. General and administrative expenses in 2006 include, but are
not
limited to, the costs of executive management, cost to defend the recently
dismissed class action lawsuit, evaluating various strategic business
alternatives, financial and legal management and other administrative
costs.
The
decrease in general and administrative expenses as compared to the same prior
year periods primarily reflects, the discontinuance of commercial activities
in
the second quarter of 2006 to respond to the April 2006 Approvable Letter and
Surfaxin process validation stability failure. For the three and nine months
ended September 30, 2006, costs associated with these commercial activities
were
$0 million and $5.9 million, respectively, as compared to $2.7 million and
$7.2
million for the three and nine months ended September 30, 2005, respectively.
The costs associated with the discontinuance of commercial activities are a
component of the Q2 2006 restructuring charge. Additionally, there is a charge
of $0.6 million and $2.9 million for the three and nine months ended September
30, 2006, respectively, associated with stock-based employee compensation in
accordance with the provisions of SFAS No. 123R.
Q2
2006 Restructuring Charge
In
April
2006, we reduced our staff levels and reorganized corporate management to lower
our cost structure and re-align our operations with changed business priorities.
These actions were taken in response to our revised expectations concerning
the
timing of potential FDA approval and commercial launch of Surfaxin for the
prevention of RDS in premature infants following the April 2006 Surfaxin process
validation stability failure.
22
The
reduction in workforce totaled 52 employees, representing approximately 33%
of
our workforce, and was focused primarily on our commercial infrastructure,
the
development of which is no longer in our near-term plans. Included in the
workforce reduction were three senior executives. All affected employees were
eligible for certain severance payments and continuation of benefits. We expect
to realize annual expense savings of approximately $8.1 million from the
reduction in work force and related operating expenses. Additionally, certain
commercial programs were discontinued and related costs will no longer be
incurred. Such commercial program expenses totaled approximately $5.0 million
for the fourth quarter of 2005 and first quarter of 2006.
We
incurred a restructuring charge of $4.8 million in the second quarter of 2006
associated with staff reductions and the close-out of certain commercial
programs, which was accounted for in accordance with Statement of Financial
Accounting Standards No. 146 “Accounting
for Costs Associated with Exit or Disposal Activities”
and is
identified separately on the Statement of Operations as Restructuring Charge.
This charge included $2.5 million of severance and benefits related to staff
reductions and $2.3 million for the termination of certain commercial programs.
As
of
September 30, 2006, payments totaling $3.5 million had been made related to
these items and $1.3 million were unpaid. Of the $1.3 million that was unpaid
as
of September 30, 2006, $1.0 million was included in accounts payable and accrued
expenses and $0.3 million was classified as a long-term liability.
Other
Income/(Expense)
Other
income and (expense) for the three and nine months ended September 30, 2006
was
($71,000) and $474,000, respectively, compared to $67,000 and $189,000 for
the
three and nine months ended September 30, 2005.
Included
in other income for the nine months ended September 30, 2006 was $280,000 of
proceeds from the sale of our Commonwealth of Pennsylvania research and
development tax credits.
Interest
income for the three and nine months ended September 30, 2006 was $0.3 million
and $1.2 million, respectively, compared to $0.3 million and $0.9 million for
the three and nine months ended September 30, 2005. The
increase is primarily due to a general increase in earned market interest rates.
Interest
expense for the three and nine months ended September 30, 2006 was ($0.4)
million and ($1.0) million, respectively, compared to ($0.3) million and ($0.7)
million for the three and nine months ended September 30, 2005. The increase
is
primarily due to interest expense associated with our credit facility and
capital lease financing arrangements. See “Management’s Discussion and Analysis
of Financial Condition and Results of Operations - Liquidity and Capital
Resources.”
LIQUIDITY
AND CAPITAL RESOURCES
Working
Capital
Cash
is
required to fund our working capital needs, to purchase capital assets, and
to
pay our debt service, including principal and interest payments. We do not
currently have any source of operating revenue and will require significant
amounts of cash to continue to fund our operations, our clinical trials and
our
research and development efforts until such time, if ever, that one of our
products has received regulatory approval for marketing. Because we have
not
generated any revenue from the sale of any products, we have primarily
relied
on
the capital markets and debt financings as our source of funding. We will
continue to be opportunistic in accessing the capital markets to obtain
financing on terms satisfactory to us. We plan to fund our future cash
requirements through:
| · |
the
issuance of equity and debt financings;
|
| · |
payments
from potential strategic collaborators, including license fees and
sponsored research funding;
|
| · |
sales
of Surfaxin, if approved;
|
23
| · |
sales
of our other product candidates, if
approved;
|
| · |
capital
lease financings; and
|
| · |
interest
earned on invested capital.
|
Receipt
of a second Approvable Letter and the occurrence of manufacturing issues in
April 2006 (discussed
in “Management’s
Discussion and Analysis of Financial Condition and Results of Operations -
Plan
of Operations”) caused us to modify our expectations concerning the timing of
potential FDA approval and commercial launch of Surfaxin. The related decline
in
market value of our common stock has made it more difficult to obtain equity
and
debt financing on terms that would be beneficial to us in the long term. We
have
engaged Jefferies & Company, Inc., the New York-based investment banking
firm, to assist us in identifying and evaluating strategic alternatives intended
to enhance the future growth potential of our SRT pipeline and maximize
shareholder value. We are evaluating multiple strategic alternatives including,
but not limited to, potential business alliances, commercial and development
partnerships, financings, business combinations and other similar opportunities.
No assurances can be given that this evaluation will lead to any specific action
or transaction.
After
taking into account the recently implemented cost containment measures and
the
restructuring of the PharmaBio loan and before taking into account any strategic
alternatives, potential financings or amounts that may be potentially available
through the CEFF, we believe that our current working capital is sufficient
to
meet planned activities into mid-2007. Use of the CEFF is subject to certain
conditions, including a limitation on the total number of shares of common
stock
that we may issue under the CEFF (approximately 10.6 million shares were
available for issuance under the CEFF as of September 30, 2006). In addition,
during the eight trading day pricing period for a draw down, if the VWAP for
any
one trading day is less than the greater of (i) $2.00 or (ii) 85 percent of
the
closing price of our common stock for the trading day immediately preceding
the
beginning of the draw down period, the VWAP from that trading day will not
be
used in calculating the number of shares to be issued in connection with that
draw down, and the draw down amount for that pricing period will be reduced
by
one-eighth of the draw down amount we had initially specified. We anticipate
using the CEFF, when available, to support working capital needs in 2006 and
2007.
We
will
need additional financing from investors or collaborators to complete research
and development, manufacturing, and commercialization of our current product
candidates under development, and satisfy debt obligations. Working capital
requirements will depend upon numerous factors, including, without limitation,
the progress of our research and development programs, clinical trials, the
timing and cost of obtaining regulatory approvals, remediation of manufacturing
issues, costs implementing programs related to our response to the second
Approvable Letter, including tightening of active ingredient and drug product
specifications and related quality controls, levels of resources that we devote
to the further development of manufacturing and product development
capabilities, the cost of drug substances, devices and materials used in our
manufacturing activities, technological advances, status of competitors, ability
to establish collaborative arrangements and strategic partnerships with other
organizations, the ability to defend and enforce intellectual property rights,
litigation and regulatory activities, and the establishment of additional
strategic or licensing arrangements with other companies or acquisitions.
Cash,
Cash Equivalents and Marketable Securities
As
of
September 30, 2006, we had cash, cash equivalents, restricted cash and
marketable securities of $19.7 million, as compared to $50.9 million as of
December 31, 2005, a decrease of $31.2 million. The decrease primarily consists
of cash used in operating and investing activities of $34.1 million, offset
by
$2.2 million of proceeds from a financing pursuant to the CEFF that resulted
in
the issuance of 1,078,519 shares of our common stock and $0.7 million of
proceeds from the exercise of stock options and warrants.
In
October 2006, we completed a financing pursuant to the CEFF resulting in
proceeds of $2.3 million from the issuance of 1,204,867 shares of our common
stock at an average price per share, after the applicable discount, of
$1.91.
We
are
currently completing a financing pursuant to the CEFF and expect to realize
proceeds of $3.0 million from the issuance of approximately 1.4 million shares
of our common stock at an average price per share, after the applicable
discount, of approximately $2.20.
24
Committed
Equity Financing Facility
In
April
2006, we entered into a new Committed Equity Financing Facility (CEFF) with
Kingsbridge Capital Limited (Kingsbridge), a private investment group, in which
Kingsbridge committed to purchase, subject to certain conditions, the lesser
of
up to $50 million or up to 11,677,047 shares of our common stock. Our previous
Committed Equity Financing Facility, entered into with Kingsbridge in July
2004
(2004 CEFF) and which had capital of up to $47.6 million available,
automatically terminated on May 12, 2006, the date on which the SEC declared
effective the registration statement filed in connection with the new CEFF.
We
currently have approximately 8.0 million shares available for issuance under
the
CEFF for future financings (not to exceed $42.5 million in gross
proceeds).
This
CEFF
allows us to raise capital, subject to certain conditions that we must satisfy,
at the time and in amounts deemed suitable to us, during a three-year period
that began on May 12, 2006. We are not obligated to utilize the entire $50
million available under this CEFF.
The
purchase price of the shares sold to Kingsbridge will be at a discount ranging
from 6 to 10 percent of the volume weighted average of the price of our common
stock (VWAP) for each of the eight trading days following our election to sell
shares, or “draw down” under the CEFF. The discount on each of these eight
trading days will be determined as follows:
|
VWAP*
|
%
of VWAP (Applicable Discount)
|
|||
|
Greater
than $10.50 per share
|
94%
|
(6)%
|
||
|
Less
than or equal to $10.50 but greater than $7.00 per share
|
92%
|
(8)%
|
||
|
Less
than or equal to $7.00 but greater than or equal to $2.00 per
share
|
90%
|
(10)%
|
||
_____
*
As such
term is set forth in the Common Stock Purchase Agreement.
During
the eight trading day pricing period for a draw down, if the VWAP for any one
trading day is less than the greater of (i) $2.00 or (ii) 85 percent of the
closing price of our common stock for the trading day immediately preceding
the
beginning of the draw down period, the VWAP from that trading day will not
be
used in calculating the number of shares to be issued in connection with that
draw down, and the draw down amount for that pricing period will be reduced
by
one-eighth of the draw down amount we had initially specified.
Our
ability to require Kingsbridge to purchase our common stock is subject to
various limitations. Each draw down is limited to the lesser of 2.5 percent
of
the closing price market value of our outstanding shares of our common stock
at
the time of the draw down or $10 million. Unless Kingsbridge agrees otherwise,
a
minimum of three trading days must elapse between the expiration of any draw
down pricing period and the beginning of the next draw down pricing period.
In
addition, Kingsbridge may terminate the CEFF under certain circumstances,
including if a material adverse effect relating to our business continues for
ten trading days after notice of the material adverse effect.
In
connection with the new CEFF, we issued a Class C Investor Warrant to
Kingsbridge to purchase up to 490,000 shares of our common stock at an exercise
price of $5.6186 per share, which is fully exercisable beginning October 17,
2006 and for a period of five years thereafter. The warrant must be exercised
for cash, except in limited circumstances.
In
connection with the new CEFF, we issued a Class C Investor Warrant to
Kingsbridge to purchase up to 490,000 shares of our common stock at an exercise
price of $5.6186 per share, which is fully exercisable beginning October
17,
2006 and for a period of five years thereafter. The warrant must be exercised
for cash, except in limited circumstances.
In
May
2006, we entered into a financing pursuant to the CEFF resulting in proceeds
of
$2.2 million from the issuance of 1,078,519 shares of our common stock at an
average price per share, after the applicable discount, of $2.03.
In
October 2006, we completed a financing pursuant to the CEFF resulting in
proceeds of $2.3 million from the issuance of 1,204,867 shares of our common
stock at an average price per share, after the applicable discount, of
$1.91.
25
We
are
currently completing a financing pursuant to the CEFF and expect to realize
proceeds of $3.0 million from the issuance of approximately 1.4 million shares
of our common stock at an average price per share, after the applicable
discount, of approximately $2.20.
In
2004
and in connection with the 2004 CEFF, we issued a Class B Investor warrant
to
Kingsbridge to purchase up to 375,000 shares of our common stock at an exercise
price equal to $12.0744 per share. The warrant, which expires in January 2010,
must be exercised for cash, except in limited circumstances, for total proceeds
equal to approximately $4.5 million, if exercised. As of September 30, 2006,
the
Class B Investor Warrant had not been exercised in whole or in part.
Potential
Financings under the October 2005 Universal Shelf Registration
Statement
In
October 2005, we filed a universal shelf registration statement on Form S-3
with
the SEC for the proposed offering, from time to time, of up to $100.0 million
of
our debt or equity securities. In December 2005, we completed a registered
direct offering of 3,030,304 shares of our common stock to select institutional
investors resulting in gross proceeds to us of $20.0 million.
The
universal shelf registration statement may permit us, from time to time, to
offer and sell up to an additional approximately $80.0 million of equity or
debt
securities. There can be no assurance, however, that we will be able to complete
any such offerings of securities. Factors influencing the availability of
additional financing include the progress of our research and development
activities, investor perception of our prospects and the general condition
of
the financial markets, among others.
Debt
Facilities
Credit
Facility with PharmaBio, an Investment Group of Quintiles Transnational Corp.
We
entered into a collaboration arrangement with Quintiles Transnational Corp.
(Quintiles), in 2001, to provide certain commercialization services in the
United States for Surfaxin for the prevention of RDS in premature infants and
Meconium Aspiration Syndrome in full-term infants. In connection with the
commercialization agreement, PharmaBio, Quintiles strategic investment group,
extended to us a secured, revolving credit facility of $8.5 to $10.0 million
to
fund pre-marketing activities associated with the launch of Surfaxin in the
United States. The facility was renegotiated in November 2004. At September
30,
2006, $8.5 million was outstanding under the credit facility. On October 25,
2006, we and PharmaBio agreed to restructure the existing $8.5 million credit
facility (PharmaBio loan) that was scheduled to mature on December 31, 2006.
Under the restructuring, the maturity date of the PharmaBio loan has been
extended by 40 months, from December 31, 2006 to April 30, 2010. Prior to
October 1, 2006, interest accrued at a rate equal to the greater of 8% or the
prime rate plus 2% and was payable quarterly. Beginning on October 1, 2006,
interest on the loan will accrue at the prime lending rate of Wachovia Bank,
N.A., subject to change when and as such rate changes, compounded annually.
All
unpaid interest, including interest payable with respect to the quarter ending
September 30, 2006, will now be payable on April 30, 2010, the maturity date
of
the PharmaBio loan. We may repay the loan, in whole or in part, at any time
without prepayment penalty or premium.
In
connection with the restructuring, on October 25, 2006, we and PharmaBio entered
into a Second Amended and Restated Loan Agreement (Loan Agreement) and a Second
Amended and Restated Security Agreement (Security Agreement). Pursuant to the
Loan Agreement, we have issued to PharmaBio a Second Amended and Restated
Promissory Note (Note), which replaces and supersedes the note dated as of
December 10, 2001 as amended and restated as of November 3, 2004. Our obligation
to PharmaBio under the Note, the Loan Agreement and the Security Agreement
are
secured by an interest in substantially all of our assets, subject to limited
exceptions set forth in the Security Agreement (the PharmaBio
Collateral).
26
On
October 25, 2006, in consideration of PharmaBio’s agreement to restructure the
loan, we and PharmaBio entered into a Warrant Agreement, pursuant to which
PharmaBio has the right to purchase 1,500,000 shares of our common stock, par
value $0.001 per share, at an exercise price equal to $3.5813 per share, which
represents a 30% premium over the VWAP (as reported by Bloomberg, L.P.) of
our
common stock for the ten trading days immediately preceding the date of the
Warrant Agreement. The warrants granted under the Warrant Agreement have a
seven-year term and are exercisable, in whole or in part, for cash, cancellation
of a portion of our indebtedness under the Loan Agreement, or a combination
of
the foregoing, in an amount equal to the aggregate purchase price for the shares
being purchased upon any exercise. Under the Warrant Agreement, we have agreed
to file a registration statement with the SEC within 45 days of October 25,
2006
with respect to the resale of the shares issuable upon exercise of the warrants.
The warrants were issued to PharmaBio in a private transaction exempt from
registration pursuant to Section 4(2) of the Securities Act of 1933, as
amended.
Capital
Lease and Note Payable Financing Arrangements with General Electric Capital
Corporation
Our
capital lease financing arrangements have been primarily with the Life Science
and Technology Finance Division of General Electric Capital Corporation (GECC)
pursuant to a Master Security Agreement dated December 20, 2002 (Master Security
Agreement). The Master Security Agreement, which previously had been extended,
expired October 31, 2006; however, GECC has agreed in the near term to discuss
our capital financing needs on a month to month basis. We are also considering
alternative capital financing arrangements. There is no assurance, however,
that
we will receive additional financing from GECC or secure an alternate source
to
finance our capital lease needs in the future.
Under
the
Master Security Agreement, we purchased capital equipment, including
manufacturing, information technology systems, laboratory, office and other
related capital assets and subsequently finance those purchases through capital
leases. The capital leases are secured by the related assets. Laboratory and
manufacturing equipment is financed over 48 months and all other equipment
is
financed over 36 months. Interest rates vary in accordance with changes in
the
three and four year treasury rates. As of September 30, 2006, $4.8 million
is
outstanding ($1.9 million classified as current liabilities and $2.9 million
as
long-term liabilities) and $1.5 million remained available for future use,
subject to certain conditions. In October 2006, we drew an additional $378,945
in connection with the purchase of property and equipment.
In
connection with the restructuring of the PharmaBio loan, on October 25, 2006,
we
and GECC entered into an Amendment No. 5 and Consent (GECC Amendment) to the
Master Security Agreement, pursuant to which GECC consented to our execution
and
delivery of the Security Agreement to PharmaBio and, in consideration of the
consent and other amendments to the Master Security Agreement, we granted to
GECC, as additional collateral under the Master Security Agreement, a security
interest in the PharmaBio Collateral. We, GECC and PharmaBio also entered into
an Intercreditor Agreement, pursuant to which GECC agreed to subordinate its
security interest in the PharmaBio Collateral to PharmaBio’s security interest
in the PharmaBio Collateral. GECC retains a first priority security interest
in
the property and equipment financed under the Master Security Agreement, which
are not a part of the PharmaBio Collateral. Under the GECC Amendment, GECC
will
release its security interest in the PharmaBio Collateral upon (a) receipt
by us
of FDA approval for Surfaxin for the prevention of RDS in premature infants
or
(b) the occurrence of certain milestones to be agreed. If the parties are unable
to agree on milestones or if we elect to prepay all of our indebtedness to
GECC
at a time when GECC holds a security interest in the PharmaBio Collateral,
we
may do so without prepayment penalty.
Lease
Agreements
We
maintain facility leases for our operations in Pennsylvania, New Jersey and
California.
We
maintain our headquarters in Warrington, Pennsylvania. The facility is 39,594
square feet and serves as the main operating facility for clinical development,
regulatory, sales and marketing, and administration. The lease expires in
February 2010 with total aggregate payments of $4.6 million.
We
lease
a 21,000 square foot pharmaceutical manufacturing and development facility
in
Totowa, New Jersey that is specifically designed for the production of sterile
pharmaceuticals in compliance with cGMP requirements. The lease expires in
December 2014 with total aggregate payments of $1.4 million ($150,000 per year).
The lease contains an early termination option, first beginning in December
2009. The early termination option can only be exercised by the landlord upon
a
minimum of two years prior notice and payment of significant early termination
amounts to us, subject to certain conditions.
27
In
August
2006, we extended the lease on our office and laboratory space in Doylestown,
Pennsylvania. We reduced our leased space from approximately 11,000 square
feet
to approximately 5,600 square feet. We maintain the Doylestown facility for
the
continuation of analytical laboratory activities under a lease that expires
in
May 2007, and is subject to extensions on a monthly basis.
We
lease
office and laboratory space in Mountain View, California. The facility is 16,800
square feet and houses our aerosol and formulation development operations.
The
lease expires in June 2008 with total aggregate payments of
$804,000.
Future
Capital Requirements
Unless
and until we can generate significant cash from our operations, we expect to
continue to require substantial additional funding to conduct our business,
including our manufacturing and research and product development activities
and
to repay our indebtedness. Our operations will not become profitable before
we
exhaust our current resources; therefore, we will need to raise substantial
additional funds through additional debt or equity financings or through
collaborative ventures with potential corporate partners. We may in some cases
elect to develop products on our own instead of entering into collaboration
arrangements and this would increase our cash requirements. Other than our
CEFF
with Kingsbridge, we currently do not have any contractual arrangements under
which we may obtain additional financing.
On
June
20, 2006, we announced that we had engaged Jefferies & Company, Inc., the
New York-based investment banking firm, to assist us in identifying and
evaluating strategic alternatives intended to generate additional funds and
enhance the future growth potential of our surfactant replacement therapy
pipeline and maximize shareholder value. We are considering multiple strategic
alternatives, including, but not limited to, potential business alliances,
commercial and development partnerships, financings, business combinations
and
other similar opportunities. No assurances can be given that this evaluation
will lead to any specific action or transaction.
If
a
transaction involving the issuance of additional equity and debt securities
is
concluded, such a transaction may result in additional dilution to our
shareholders. We cannot be certain that additional funding will be available
when needed or on terms acceptable to us, if at all. If we fail to receive
additional funding or enter into business alliances or other similar
opportunities, we may have to reduce significantly the scope of or discontinue
our planned research, development and manufacturing activities, which could
significantly harm our financial condition and operating results.
| ITEM 3. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK |
Our
exposure to market risk is confined to our cash, cash equivalents and available
for sale securities. We place our investments with high quality issuers and,
by
policy, limit the amount of credit exposure to any one issuer. We currently
do
not hedge interest rate or currency exchange exposure. We classify highly liquid
investments purchased with a maturity of three months or less as “cash
equivalents” and commercial paper and fixed income mutual funds as “available
for sale securities.” Fixed income securities may have their fair market value
adversely affected due to a rise in interest rates and we may suffer losses
in
principal if forced to sell securities that have declined in market value due
to
a change in interest rates.
| ITEM 4. | CONTROLS AND PROCEDURES |
(a)
Evaluation of disclosure controls and procedures
Our
management, including our Chief Executive Officer and Chief Financial Officer,
do not expect that our disclosure controls or internal control over financial
reporting will prevent all error and all fraud. A control system, no matter
how
well designed and operated, can provide only reasonable, not absolute, assurance
that the control system’s objectives will be met. Further, the design of a
control system must reflect the fact that there are resource constraints, and
the benefits of controls must be considered relative to their costs. Because
of
the inherent limitations in all control systems, no evaluation of controls
can
provide absolute assurance that all control issues and instances of fraud,
if
any, within the Company have been detected. These inherent limitations include
the realities that judgments in decision-making can be faulty and that
breakdowns can occur because of simple error or mistake. Controls can also
be
circumvented by the individual acts of some persons, by collusion of two or
more
people, or by management override of the controls. The design of any system
of
controls is based in part on certain assumptions about the likelihood of future
events, and there can be no assurance that any design will succeed in achieving
its stated goals under all potential future conditions. Over time, controls
may
become inadequate because of changes in conditions or deterioration in the
degree of compliance with policies or procedures. Because of the inherent
limitations in a cost-effective control system, misstatements due to error
or
fraud may occur and not be detected. In designing and evaluating the disclosure
controls and procedures, our management recognized that any controls and
procedures, no matter how well designed and operated, can provide only
reasonable assurance of achieving the desired control objectives and management
necessarily was required to apply its judgment in evaluating the cost-benefit
relationship of possible controls and procedures.
28
Our
Chief
Executive Officer and Chief Financial Officer have evaluated the effectiveness
of the design and operation of
our
disclosure controls and procedures (as defined in Rule 13a-15(e)
and
Rule 15d-15(e) of the Exchange Act) as of the end of the period covered by
this
Quarterly Report
on Form
10-Q.
Based
on this
evaluation,
the
Chief Executive Officer and Chief Financial Officer
concluded that as
of the
end of the period covered by this report,
the
disclosure controls and procedures were
effective in their
design to ensure that
information
required
to be disclosed in
the
reports that
we
file
or
submit
under
the
Exchange Act
is
recorded, processed, summarized and reported within the time periods specified
in the SEC’s rules and forms.
(b) Changes
in internal controls
There
were no changes in internal controls over financial reporting or other factors
that could materially affect those controls subsequent to the date of our
evaluation, including any corrective actions with regard to significant
deficiencies and material weaknesses.
PART
II – OTHER INFORMATION
| ITEM 1. | LEGAL PROCEEDINGS |
In
connection with the shareholder class actions filed in the United States
District Court for the Eastern District of Pennsylvania against the Company
in
May 2006 and consolidated in June 2006 under the caption “In re: Discovery
Laboratories Securities Litigation”, a Consolidated Amended Complaint was filed
by the Mizla Group, the lead plaintiffs, on August 9, 2006, individually and
on
behalf of a class of the Company’s investors who purchased the Company’s
publicly traded securities between March 15, 2004 and June 6, 2006. The
complaint names as defendants the Company, the Company’s Chief Executive
Officer, Robert J. Capetola and the Company’s former Chief Operating Officer,
Christopher J. Schaber. On September 14, 2006, the Company’s counsel filed a
Motion to Dismiss the Consolidated Amended Complaint and on November 1, 2006,
the court dismissed the Consolidated Amended Complaint, without prejudice,
and
granted plaintiffs leave
to
file an amended Consolidated Amended Complaint by November 30, 2006. The Company
has no information as to whether the plaintiffs plan to file an amended
complaint with the court.
Two
shareholder derivative complaints filed in May and June 2006, respectively,
in
the United States District Court for the Eastern District of Pennsylvania
against the Company’s Chief Executive Officer, Robert J. Capetola, and the
Company’s directors remain subject to a stipulation agreement between the
parties providing that the Company is not required to respond to these
consolidated complaints until 60 days following defendants’ answer or a
dispositive ruling on a motion to dismiss filed in response to the consolidated
amended complaint in the class actions, described above.
If
any of
these actions proceed, the Company intends to vigorously defend them. The
potential impact of such actions, all of which generally seek unquantified
damages, attorneys’ fees and expenses is uncertain. Additional actions based
upon similar allegations, or otherwise, may be filed in the future. There can
be
no assurance that an adverse result in any such proceedings would not have
a
potentially material adverse effect on the Company’s business, results of
operations and financial condition.
29
The
Company has from time to time been involved in disputes arising in the ordinary
course of business, including in connection with the termination of its
commercial programs (discussed in Note 7, above). Such claims, with or without
merit, if not resolved, could be time-consuming and result in costly litigation.
While it is impossible to predict with certainty the eventual outcome of such
claims, the Company believes they are unlikely to have a material adverse effect
on its financial condition or results of operations. However, there can be
no
assurance that the Company will be successful in any proceeding to which it
may
be a party.
| ITEM 1A. | RISK FACTORS |
The
following risks, among others, could cause our actual results, performance,
achievements or industry results to differ materially from those expressed
in
our forward-looking statements contained herein and presented elsewhere by
management from time to time.
The
risk
factors set forth below have been revised based on recent events related to
the
Company and described elsewhere in this report. These risk factors should be
read together with the factors discussed in Part I, Item 1A - Risk Factors
in
our Annual Report on Form 10-K for the year ended December 31,
2005.
The
risks
described in this report and in our Annual Report on Form 10-K are not the
only
risks we face. Additional risks and uncertainties not currently known to us
or
that we currently deem to be immaterial also may materially adversely affect
our
business, financial condition and/or operating results.
Refocusing
our business subjects us to risks and uncertainties.
Since
we
received our second Approvable Letter from the FDA, we have been reassessing
the
business environment, our position within the biotechnology industry and our
relative strengths and weaknesses. As a result of this reassessment, we have
implemented significant changes to our operations as part of our overall
business strategy. For example, we have reduced the size of our workforce and
made changes to senior management. Additional changes to our business will
be
considered as our management seeks to strengthen financial and operational
performance. These changes may be disruptive to our established organizational
culture and systems. In addition, consideration and planning of strategic
changes diverts management attention and other resources from day to day
operations.
We
may fail to realize the benefits that we expect from our cost-savings
initiatives.
We
have
undertaken and expect to continue to undertake cost-savings initiatives.
However, we cannot assure you that we will realize on-going cost savings or
any
other benefits from these initiatives. Even if we realize the benefits of our
cost savings initiatives, any cash savings that we achieve may be offset by
other costs, such as costs related to ongoing development activities and
pre-clinical and clinical studies. Staff reductions may reduce our workforce
below the level needed to effectively manage our business and service our
development programs. Our failure to realize the anticipated benefits of our
cost-savings initiatives could have a material adverse effect on our business,
results of operations and financial condition.
The
regulatory approval process for our products is expensive and time-consuming,
and the outcome is uncertain. We may not obtain required regulatory approvals
for the commercialization of our products.
To
sell
Surfaxin or any of our other products under development, we must receive
regulatory approvals for each product. The FDA and foreign regulators
extensively and rigorously regulate the testing, manufacture, distribution,
advertising, pricing and marketing of drug products like our products. This
approval process includes preclinical studies and clinical trials of each
pharmaceutical compound to establish the safety and effectiveness of each
product and the confirmation by the FDA and foreign regulators that, in
manufacturing the product, we maintain good laboratory and manufacturing
practices during testing and manufacturing. Even if favorable testing data
is
generated by clinical trials of drug products, the FDA or EMEA may not accept
or
approve an NDA or MAA filed by a pharmaceutical or biotechnology company for
such drug product. To market our products outside the United States, we also
need to comply with foreign regulatory requirements governing human clinical
trials and marketing approval for pharmaceutical products.
30
We
have
filed an NDA with the FDA for Surfaxin for the prevention of RDS in premature
infants. As part of the review of the Surfaxin NDA, the FDA, in January 2005,
issued a Form FDA 483 to our then contract manufacturer, Laureate. The FDA
cited
inspectional observations related to basic quality controls, process assurances
and documentation requirements that support the commercial production process
necessary to comply with cGMPs. The FDA issued an Approvable Letter to us in
February 2005 regarding our NDA. To address the Form FDA 483 inspectional
observations, we and Laureate implemented improved quality systems and
documentation controls believed to support the FDA’s regulatory requirements for
the approval of Surfaxin. In October 2005, the FDA accepted our responses to
the
Approvable Letter as a complete response thereby establishing April 2006 as
its
target to complete its review of our NDA. In April 2006, ongoing analysis of
data from Surfaxin process validation batches that were manufactured as a
requirement for our NDA, indicated that certain stability parameters had not
been achieved and, therefore, three additional process validation batches will
have to be produced. In September 2006, we announced that, although our
comprehensive investigation is ongoing, we believe we have identified a most
probable root cause of the process validation stability failures. Our
investigation continues, however, and may identify other contributing factors
or
causes for the process validation stability failure. There can be no assurance
that we have identified or will identify the definitive root cause of the
process validation stability failure. If we are unable to identify a definitive
root cause, we may not be able to manufacture our drug product successfully
within our expected timeline, if at all. The investigation is being conducted
in
compliance with FDA cGMP requirements, covers, among other things, manufacturing
processes, test methods, and drug substance suppliers. As part of the
investigation, in addition to a variety of audits, tests and experiments, we
have manufactured three “investigation batches” of Surfaxin that have passed the
critical release specification assays, with stability monitoring ongoing. These
investigation batches are not designated as process validation batches but
are
expected to provide significant data that will support our comprehensive
investigation report and a corrective action and preventative action (CAPA)
plan. Also in April 2006, the FDA issued a second Approvable Letter to us,
requesting certain information primarily focused on the CMC section of the
NDA.
The information predominately involves the further tightening of active
ingredient and drug product specifications and related controls. On September
28, 2006, we filed a briefing package and requested a meeting with the FDA.
The
purpose of this meeting is to clarify the issues identified by the FDA in the
second Approvable Letter and reach agreement with the FDA on the appropriate
path to potentially gain approval of Surfaxin for the prevention of RDS in
premature infants. The FDA has notified us that a meeting has been scheduled
for
December 21, 2006. Once we have achieved satisfactory Surfaxin process
validation stability testing over an acceptable period (currently contemplated
to be six months) and have finalized our response to the second Approvable
Letter, we will submit to the FDA our formal response to the second Approvable
Letter. At that time, the FDA will advise us if it will accept our response
to
the second Approvable Letter as a complete response and the time frame in which
it will complete its review. Even if the FDA accepts our response as a complete
response, the FDA might still delay its approval of our NDA or reject our NDA,
which would have a material adverse effect on our business.
We
filed
an MAA with the EMEA for clearance to market Surfaxin for the prevention and
rescue treatment of RDS in premature infants in Europe. At the time of the
Surfaxin process validation stability failure, we had responded to the Day
180
List of Outstanding Issues from the Committee for Medicinal Products for Human
Use (CHMP) and had met with the EMEA to discuss our response. Because our
manufacturing issues would not be resolved within the regulatory time frames
mandated by the EMEA, we determined in June 2006 to voluntarily withdraw the
MAA
for Surfaxin for the prevention and rescue treatment of RDS in premature
infants. We plan in the future to have further discussions with the EMEA and
develop a strategy to potentially gain approval for Surfaxin in Europe.
See
also
Item 2: “Management’s Discussion and Analysis of Financial Condition and Results
of Operation - Overview and Plan of Operations.”
Our
pending NDA for Surfaxin for the prevention of RDS in premature infants may
not
be approved by the FDA in a timely manner or at all, which would adversely
impact our ability to commercialize this product.
We
submitted an NDA to the FDA for Surfaxin for the prevention of RDS in premature
infants. In April 2006, we received a second Approvable Letter from the FDA.
Specifically, the FDA requested certain information primarily focused on the
CMC
section of the NDA. The information predominately involves the further
tightening of active ingredient and drug product specifications and related
controls. . Thereafter, we learned that ongoing analysis of data from Surfaxin
process validation batches that were manufactured as a requirement for our
NDA
indicated that certain stability parameters had not been achieved and,
therefore, three new Surfaxin process validation batches will have to be
produced. These events have caused us to revise our expectations concerning
the
timing of potential FDA approval of our NDA. We are conducting a comprehensive
investigation with a view to identify a definitive root cause of the process
validation stability failure and implement a corrective action and preventative
action (CAPA) plan. When we are satisfied that we have remediated our
manufacturing issues, we will manufacture new process validation batches and,
after we have achieved satisfactory Surfaxin process validation stability
testing over an acceptable period (currently contemplated to be six months)
and
have finalized our response to the second Approvable Letter, we will submit
to
the FDA our formal response to the second Approvable Letter. Nevertheless,
the
FDA may request additional information from us, including data from additional
clinical trials. Ultimately, the FDA may not approve Surfaxin for RDS in
premature infants. Any failure to obtain FDA approval or further delay
associated with the FDA’s review process would adversely impact our ability to
commercialize our lead product.
31
The
manufacture of our products is a highly exacting and complex process, and if
we
or one of our materials suppliers encounter problems manufacturing our products,
our business could suffer.
The
FDA
and foreign regulators require manufacturers to register manufacturing
facilities. The FDA and foreign regulators also inspect these facilities to
confirm compliance with cGMP or similar requirements that the FDA or foreign
regulators establish. We or our materials suppliers may face manufacturing
or
quality control problems causing product production and shipment delays or
a
situation where we or the supplier may not be able to maintain compliance with
the FDA’s cGMP requirements, or those of foreign regulators, necessary to
continue manufacturing our drug substance. Manufacturing or quality control
problems have already and may again occur at our Totowa facility or at our
materials suppliers. Such problems, including, for example, our recent product
stability testing program issues, require potentially complex, time-consuming
and costly investigations to determine the root causes of such problems and
may
also require detailed and time-consuming remediation efforts, which can further
delay the regulatory approval process. Any failure to comply with cGMP
requirements or other FDA or foreign regulatory requirements could adversely
affect our clinical research activities and our ability to market and develop
our products.
In
December 2005, we acquired Laureate’s clinical manufacturing facility in Totowa,
New Jersey. The facility has been qualified to produce appropriate clinical
grade material of our drug product for use in our ongoing clinical studies.
With
this acquisition, we now maintain a complete manufacturing facility and we
will
be manufacturing our products. We currently own certain specialized
manufacturing equipment, employ certain manufacturing managerial personnel,
and
we expect to invest in additional manufacturing equipment. However, we may
be
unable to produce Surfaxin and our other SRT drug candidates to appropriate
standards for use in clinical studies or commercialization. If we do not
successfully develop our manufacturing capabilities, it will adversely affect
the sales of our products.
In
connection with the development of Aerosurf, we expect to rely on third-party
contract manufacturers to manufacture the Chrysalis drug device products and
components to support our clinical studies and potential commercialization
of
Aerosurf. Certain of the drug device components must be manufactured in a
sterile environment, subject to ongoing monitoring of conformance to product
specifications of each device. The manufacturer must be registered with and
qualified by the FDA and must conduct its manufacturing activities in compliance
with cGMP requirements, or those of foreign regulators. We may be unable to
identify a qualified manufacturer to meet our requirements or the manufacturer
we identify may be unable to timely comply with FDA, or other foreign regulatory
agency, requirements to manufacture the drug product devices or such
manufacturer may not manufacture to our specifications for use in clinical
studies or, if approved, commercialization. If we do not successfully identify
and enter into a contractual agreement with drug device and components
manufacturers, it will adversely affect the timeline of our plans for
development, the development plan and, if approved, commercialization of
Aerosurf.
32
If
the parties we depend on for supplying our active drug substance and certain
manufacturing-related services do not timely supply these products and services,
it may delay or impair our ability to develop, manufacture and market our
products.
We
rely
on suppliers for our active drug substances and third parties for certain
manufacturing-related services to produce material that meets appropriate
content, quality and stability standards for use in clinical trials of our
products and, after approval, for commercial distribution. To succeed, clinical
trials require adequate supplies of drug substance and drug product, which
may
be difficult or uneconomical to procure or manufacture. The manufacturing
process for the drug product devices used in Aerosurf includes the integration
of a number of products, many of which are comprised of a large number of
subcomponent parts, that we expect will be produced by one or more
manufacturers. We and our suppliers may not be able to (i) produce our drug
substances, drug product or drug product devices to appropriate standards for
use in clinical studies, (ii) perform under any definitive manufacturing, supply
or service agreements with us or (iii) remain in business for a sufficient
time
to successfully produce and market our product candidates. If we do not maintain
important manufacturing and service relationships, we may fail to find a
replacement supplier or required vendor or develop our own manufacturing
capabilities which could delay or impair our ability to obtain regulatory
approval for our products and substantially increase our costs or deplete profit
margins, if any. If we do find replacement manufacturers and suppliers, we
may
not be able to enter into agreements with them on terms and conditions favorable
to us and, there could be a substantial delay before a new facility could be
qualified and registered with the FDA and foreign regulatory
authorities.
We
will need additional capital and our ability to continue all of our existing
planned research and development activities is uncertain. Any additional
financing could result in equity dilution.
We
will
need substantial additional funding to conduct our presently planned research
and product development activities. Based on our current operating plan, we
believe that our currently available working capital will be adequate to satisfy
our capital needs into mid-2007, before taking into account any amounts that
may
be available through the CEFF. Our future capital requirements will depend
on a
number of factors that are uncertain, including the results of our research
and
development activities, clinical studies and trials, competitive and
technological advances and the regulatory process, among others. We will likely
need to raise substantial additional funds through collaborative ventures with
potential corporate partners and through additional debt or equity financings.
We may also continue to seek additional funding through new capital lease
arrangements, if available. We may in some cases elect to develop products
on
our own instead of entering into collaboration arrangements. This would increase
our cash requirements for research and development.
We
have
not entered into arrangements to obtain any additional financing other than
the
CEFF with Kingsbridge, the PharmaBio loan and our capital equipment lease
financing arrangement with GECC, which expired on October 31, 2006. Our use
of
the CEFF is subject to certain conditions, discussed in “Management’s Discussion
and Analysis of Financial Condition and Results of Operations - Liquidity and
Capital Resources - Committed Equity Financing Facility” above. In addition,
Kingsbridge has the right under certain circumstances to terminate the CEFF,
including upon the occurrence of a material adverse event.
Our
equipment lease financing arrangement with GECC expired on October 31, 2006.
We
continue to engage in discussions with GECC, which has agreed in the near term
to discuss our financing needs on a month to month basis, and are considering
alternative arrangements with other financing entities, there is no assurance
that our discussions with GECC will be successful or that any alternative
arrangements will be successfully concluded. If we are successful in arranging
for property and lease financing arrangements, there is no assurance that such
arrangements will be on terms that are favorable to us or sufficient to meet
our
capital financing needs over the term of the arrangement. If we do not obtain
additional capital financing, we may not be able to execute on our business
plan, in particular our manufacturing strategy, and be forced to delay or scale
back our activities.
On
June
20, 2006, we announced that we have engaged Jefferies & Company, Inc., the
New York-based investment banking firm, to assist us in identifying and
evaluating strategic alternatives intended to generate additional funds and
enhance the future growth potential of our surfactant replacement therapy
pipeline and maximize shareholder value. We are considering multiple strategic
alternatives, including, but not limited to, potential business alliances,
commercial and development partnerships, financings, business combinations
and
other similar opportunities. No assurances can be given that this evaluation
will lead to any specific action or transaction or generate additional capital
for us.
33
If
we
seek additional financing, such additional financing could include unattractive
terms or result in significant dilution of stockholders’ interests and share
prices may decline. If we fail to receive additional funding or enter into
business alliances or other similar opportunities, we may have to delay, scale
back or discontinue certain of our research and development operations, and
consider licensing the development and commercialization of products that we
consider valuable and which we otherwise would have developed ourselves. If
we
are unable to raise required capital, we may be forced to limit many, if not
all, of our research and development programs and related operations, curtail
commercialization of our product candidates and, ultimately, cease operations.
See also “Risk Factors: Our Committed Equity Financing Facilities may have a
dilutive impact on our stockholders.”
Furthermore,
if the market price of our common stock declines as a result of the dilutive
aspects of such potential financings, we could cease to meet the financial
requirements to maintain the listing of our securities on The Nasdaq Global
Market. See “Risk
Factors: The market price of our stock may be adversely affected by market
volatility.”
Our
Committed Equity Financing Facilities may have a dilutive impact on our
stockholders.
The
issuance of shares of our common stock under the CEFF and upon exercise of
the
warrants we issued to Kingsbridge will have a dilutive impact on our other
stockholders and the issuance or even potential issuance of such shares could
have a negative effect on the market price of our common stock. In addition,
if
we access the CEFF, we will issue shares of our common stock to Kingsbridge
at a
discount of between 6% and 10% of the daily volume weighted average price of
our
common stock during a specified period of trading days after we access the
CEFF.
Issuing shares at a discount will further dilute the interests of other
stockholders.
To
the
extent that Kingsbridge sells shares of our common stock issued under the CEFF
to third parties, our stock price may decrease due to the additional selling
pressure in the market. The perceived risk of dilution from sales of stock
to or
by Kingsbridge may cause holders of our common stock to sell their shares,
or it
may encourage short sales of our common stock or other similar transactions.
This could contribute to a decline in the stock price of our common
stock.
We
may
not be able to meet the conditions we are required to meet under the CEFF and
we
may not be able to access any portion of the approximately 8.0 million shares
potentially available for issuance for future financings (not to exceed $42.5
million), subject to the terms and conditions of the CEFF.
In
addition, we are dependent upon the financial ability of Kingsbridge to fund
the
CEFF. Any failure by Kingsbridge to perform its obligations under the CEFF
could
have a material adverse effect upon us.
We
do not have sales and marketing experience and our lack of experience may
restrict our success in commercializing our product candidates.
We
do not
have experience in marketing or selling pharmaceutical products. As a result
of
our recent manufacturing problems, we discontinued our commercial activities,
which are no longer in our near-term plans. To achieve commercial success for
Surfaxin, or any other approved product, we will be dependent upon entering
into
arrangements with others to market and sell our products.
We
may be
unable to establish satisfactory arrangements for marketing, sales and
distribution capabilities necessary to commercialize and gain market acceptance
for Surfaxin or our other product candidates. To obtain the expertise necessary
to successfully market and sell Surfaxin, or any other product, will require
the
development of collaborative commercial arrangements and partnerships. Our
ability to make that investment and also execute our current operating plan
is
dependent on numerous factors, including, the performance of third party
collaborators with whom we may contract. Accordingly, we may not have sufficient
funds to successfully commercialize Surfaxin or any other potential product
in
the United States or elsewhere.
34
We
depend upon key employees and consultants in a competitive market for skilled
personnel. If we are unable to attract and retain key personnel, it could
adversely affect our ability to develop and market our
products.
We
are
highly dependent upon the principal members of our management team, especially
our Chief Executive Officer, Dr. Capetola, and our directors, as well as our
scientific advisory board members, consultants and collaborating scientists.
Many of these people have been involved in our formation or have otherwise
been
involved with us for many years, have played integral roles in our progress
and
we believe that they will continue to provide value to us. A loss of any of
our
key personnel may have a material adverse effect on aspects of our business
and
clinical development and regulatory programs.
In
order
to lower our cost structure and re-align our operations with business
priorities, in April 2006, we reduced our staff levels and reorganized our
corporate structure. The workforce reduction totaled 52 employees, representing
approximately 33% of our workforce, and was focused primarily on commercial
infrastructure, the development of which is no longer in our near-term plans.
Included in the workforce reduction were three senior executives. As a
consequence of this reduction in force, our dependence on our remaining
management team is increased. If we find it necessary or advisable to hire
additional managers, a portion of the expected cost savings from our recent
restructuring might not be realized.
To
retain
and provide incentives to certain of our key continuing executives, we entered
into amended and new employment agreements with our executive management and
other officers, which agreements provide for employment for a stated term,
subject to automatic renewal, severance payments in the event of termination
of
employment, enhanced severance benefits in the event of a change of control
and
equity incentives in the form of stock and option grants.
Although
these employment agreements generally include non-competition covenants and
provide for severance payments that are contingent upon the applicable
employee’s refraining from competition with us, the applicable noncompete
provisions can be difficult and costly to monitor and enforce. The loss of
any
of these persons’ services would adversely affect our ability to develop and
market our products and obtain necessary regulatory approvals. Further, we
do
not maintain key-man life insurance.
Our
future success also will depend in part on the continued service of our key
scientific and management personnel and our ability to identify, hire and retain
additional personnel. We experience intense competition for qualified personnel,
and the existence of non-competition agreements between prospective employees
and their former employers may prevent us from hiring those individuals or
subject us to suit from their former employers.
While
we
attempt to provide competitive compensation packages to attract and retain
key
personnel, some of our competitors are likely to have greater resources and
more
experience than we have, making it difficult for us to compete successfully
for
key personnel.
A
substantial number of our securities are eligible for future sale and this
could
affect the market price for our stock and our ability to raise
capital.
The
market price of our common stock could drop due to sales of a large number
of
shares of our common stock or the perception that these sales could occur.
As of
September 30, 2006 we had 62,374,235 shares of common stock issued and
outstanding.
We
have a
universal shelf registration statement on Form S-3 (File No. 333-128929), filed
with the SEC on October 11, 2005, for the proposed offering from time to time
of
up to $100 million of our debt or equity securities, of which $80 million is
remaining. We have no immediate plans to sell any securities under this
registration statement. However, we may issue securities from time to time
in
response to market conditions or other circumstances on terms and conditions
that will be determined at such time.
Additionally,
there are 375,000 shares of our common stock that are currently reserved for
issuance with respect to the Class B Investor Warrant and approximately 8.0
million shares of our common stock that are currently reserved for issuance
under the CEFF, including 490,000 shares reserved for issuance with respect
to
the Class C Investor Warrant. See “Risk Factors: Our Committed Equity Financing
Facility may have a dilutive impact on our stockholders.”
35
As
of
September 30, 2006, up to 12,407,431, shares of our common stock were issuable
upon exercise of outstanding options and warrants. Holders of our stock options
and warrants are likely to exercise them, if ever, at a time when we otherwise
could obtain a price for the sale of our securities that is higher than the
exercise price per security of the options or warrants. This exercise, or the
possibility of this exercise, may impede our efforts to obtain additional
financing through the sale of additional securities or make this financing
more
costly, and may reduce the price of our common stock.
The
failure to prevail in litigation or the costs of litigation, including
securities class action and patent claims, could harm our financial performance
and business operations.
We
are
potentially susceptible to litigation. For example, as a public company, we
are
subject to claims asserting violations of securities laws, as well as derivative
actions. In particular, in early May 2006, four shareholder class actions and
two derivative actions were filed in the United States District Court for the
Eastern District of Pennsylvania against the Company and its Chief Executive
Officer, Robert J. Capetola, Ph.D. Certain of the complaints also named other
officers of the Company and certain of its directors. The class actions were
consolidated under a Consolidated Amended Complaint, filed on August 9, 2006,
and on November 1, 2006, the court dismissed the Consolidated Amended Complaint
without prejudice and granted plaintiffs leave
to
file an amended Consolidated Amended Complaint by November 30, 2006. We have
no
information as to whether the plaintiffs plan to file an amended complaint
with
the court. Nevertheless, even if plaintiffs do not file a new complaint,
additional
actions may be filed against the Company arising out of the same or different
events. Although we will aggressively defend any such actions, an adverse result
in one or more of them could have a potentially material adverse effect on
the
Company’s business, results of operations and financial condition.
| ITEM 2. | UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS |
During
the three months ended September 30, 2006, pursuant to the exercise of
outstanding warrants and options, we issued an aggregate of 25,472 shares of
our
common stock at various exercise prices ranging from $.0026 to $1.50 per share
for an aggregate consideration equal to $12,045. We claimed the exemption from
registration provided by Section 4(2) of the Securities Act for these
transactions. No broker-dealers were involved in the sale and no commissions
were paid.
We
have a
voluntary 401(k) savings plan covering eligible employees. Effective January
1,
2003, we allowed for periodic discretionary matches of newly issued shares
of
our common stock with the amount of any such match determined as a percentage
of
each participant’s cash contribution. The total fair market value of our match
of our common stock to the 401(k) for the three months ended September 30,
2006
was $80,394, resulting in the issuance of 44,270 shares.
There
were no stock repurchases in the three and nine months ended September 30,
2006,
however, during the nine months ended September 30, 2006, 37,382 shares of
unvested restricted stock awards were cancelled and recorded as treasury stock.
| ITEM 3. | DEFAULTS UPON SENIOR SECURITIES |
None.
| ITEM 4. | SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS |
None.
| ITEM 5. | OTHER INFORMATION |
None.
36
ITEM
6. EXHIBITS
Exhibits
are listed on the Index to Exhibits at the end of this Quarterly Report. The
exhibits required by Item 601 of Regulation S-K, listed on such Index in
response to this Item, are incorporated herein by reference.
37
SIGNATURES
Pursuant
to the requirements of the Securities Exchange Act of 1934, the registrant
has
duly caused this report to be signed on its behalf by the undersigned thereunto
duly authorized.
|
Discovery
Laboratories, Inc.
(Registrant)
|
||
| |
|
|
| Date: November 9, 2006 | By: | /s/ Robert J. Capetola |
|
Robert
J. Capetola, Ph.D.
|
||
| President and Chief Executive Officer | ||
| |
|
|
| Date: November 9, 2006 | By: | /s/ John G. Cooper |
|
John G. Cooper |
||
|
Executive
Vice President and Chief Financial Officer
(Principal
Financial Officer)
|
||
38
INDEX
TO EXHIBITS
The
following exhibits are included with this Quarterly Report. All management
contracts or compensatory plans or arrangements, if any, are marked with an
asterisk.
|
Exhibit
No.
|
Description
|
Method
of Filing
|
||
|
3.1
|
Restated
Certificate of Incorporation of Discovery, dated September 18,
2002.
|
Incorporated
by reference to Exhibit 3.1 to Discovery’s Annual Report on Form 10-K for
the fiscal year ended December 31, 2002, as filed with the SEC on
March
31, 2003.
|
||
|
3.2
|
Certificate
of Amendment to the Certificate of Incorporation of Discovery, dated
as of
May 28, 2004.
|
Incorporated
by reference to Exhibit 3.1 to Discovery’s Quarterly Report on Form 10-Q
for the quarter ended June 30, 2004, as filed with the SEC on August
9,
2004.
|
||
|
3.3
|
Certificate
of Amendment to the Restated Certificate of Incorporation of Discovery,
dated as of July 8, 2005.
|
Incorporated
by reference to Exhibit 3.1 to Discovery’s Quarterly Report on Form 10-Q
for the quarter ended June 30, 2004, as filed with the SEC on August
8,
2005.
|
||
|
3.4
|
Amended
and Restated By-Laws of Discovery.
|
Incorporated
by reference to Exhibit 3.2 to Discovery’s Annual Report on Form 10-K for
the fiscal year ended December 31, 2003, as filed with the SEC on
March
15, 2004.
|
||
|
3.5
|
Certificate
of Designations, Preferences and Rights of Series A Junior Participating
Cumulative Preferred Stock of Discovery, dated February 6,
2004.
|
Incorporated
by reference to Exhibit 2.2 to Discovery’s Form 8-A, as filed with the SEC
on February 6, 2004.
|
||
|
4.1
|
Shareholder
Rights Agreement, dated as of February 6, 2004, by and between Discovery
and Continental Stock Transfer & Trust Company.
|
Incorporated
by reference to Exhibit 10.1 to Discovery’s Current Report on Form 8-K, as
filed with the SEC on February 6, 2004.
|
||
|
4.2
|
Form
of Class E Warrant.
|
Incorporated
by reference to Exhibit 4.1 to Discovery’s Current Report on Form 8-K, as
filed with the SEC on March 29, 2000.
|
||
|
4.3
|
Form
of Unit Purchase Option issued to Paramount Capital, Inc.
|
Incorporated
by reference to Exhibit 4.4 to Discovery’s Annual Report on Form 10-KSB
for the fiscal year ended December 31, 1999, as filed with the SEC
on
March 30, 2000.
|
||
|
4.4
|
Form
of Class A Investor Warrant.
|
Incorporated
by reference to Exhibit 4.1 to Discovery’s Current Report on Form 8-K, as
filed with the SEC on June 20, 2003.
|
||
|
4.5 |
Class
B Investor Warrant, dated July 7, 2004, issued to Kingsbridge Capital
Limited.
|
Incorporated
by reference to Exhibit 4.1 to Discovery’s Current Report on Form 8-K as
filed with the SEC on July 9, 2004.
|
E-1
|
Exhibit
No.
|
Description
|
Method
of Filing
|
||
|
4.6
|
Warrant
Agreement, dated as of November 3, 2004, by and between Discovery
and
QFinance, Inc.
|
Incorporated
by reference to Exhibit 4.1 of Discovery’s Quarterly Report on Form 10-Q,
as filed with the SEC on November 9, 2004.
|
||
|
4.7
|
Class
C Investor Warrant, dated April 17, 2006, issued to Kingsbridge
Capital
Limited
|
Incorporated
by reference to Exhibit 4.1 to Discovery’s Current Report on Form 8-K, as
filed with the SEC on April 21, 2006.
|
||
|
4.8
|
Registration
Rights Agreement, dated as of July 7, 2004, by and between Kingsbridge
Capital Limited and Discovery.
|
Incorporated
by reference to Exhibit 10.2 to Discovery’s Current Report on Form 8-K, as
filed with the SEC on July 9, 2004.
|
||
|
4.9
|
Registration
Rights Agreement, dated April 17, 2006, by and between Discovery
and
Kingsbridge Capital Limited.
|
Incorporated
by reference to Exhibit 10.2 to Discovery’s Current Report on Form 8-K, as
filed with the SEC on April 21, 2006.
|
||
|
4.10
|
Second
Amended and Restated Promissory Note, dated as of October 25, 2006,
issued
to PharmaBio Development Inc. (“PharmaBio”)
|
Incorporated
by reference to Exhibit 4.1 to Discovery’s Current Report on Form 8-K, as
filed with the SEC on October 26, 2006.
|
||
|
4.11
|
Warrant
Agreement, dated as of October 25, 2006, by and between Discovery
and
PharmaBio
|
Incorporated
by reference to Exhibit 4.2 to Discovery’s Current Report on Form 8-K, as
filed with the SEC on October 26, 2006.
|
||
|
10.1
|
Amendment
No.5 and Consent, dated as of October 25, 2006, to the Master Security
Agreement between General Electric Capital Corporation and
Discovery
|
Incorporated
by reference to Exhibit 10.3 to Discovery’s Current Report on Form 8-K, as
filed with the SEC on October 26, 2006.
|
||
|
10.2
|
Second
Amended and Restated Loan Agreement, dated as of December 10, 2001,
amended and restated as of October 25, 2006, by and between Discovery
and
PharmaBio
|
Incorporated
by reference to Exhibit 10.1 to Discovery’s Current Report on Form 8-K, as
filed with the SEC on October 26, 2006.
|
||
|
10.3
|
Second
Amended and Restated Security Agreement, dated as of December 10,
2001,
amended and restated as of October 25, 2006, by and between Discovery
and
PharmaBio
|
Incorporated
by reference to Exhibit 10.2 to Discovery’s Current Report on Form 8-K, as
filed with the SEC on October 26, 2006.
|
||
|
31.1
|
Certification
of Chief Executive Officer Pursuant to Rule 13a-14(a) of the Exchange
Act.
|
Filed
herewith.
|
||
|
31.2
|
Certification
of Chief Financial Officer and Principal Accounting Officer Pursuant
to
Rule 13a-14(a) of the Exchange Act.
|
Filed
herewith.
|
||
|
32.1
|
Certification
of Chief Executive Officer and Chief Financial Officer pursuant
to 18
U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
|
Filed
herewith.
|
E-2
Exhibit
31.1
CERTIFICATIONS
I,
Robert
J. Capetola, certify that:
1. I
have
reviewed this Quarterly Report on Form 10-Q of Discovery Laboratories, Inc.;
2. Based
on
my knowledge, this report does not contain any untrue statement of a material
fact or omit to state a material fact necessary to make the statements made,
in
light of the circumstances under which such statements were made, not misleading
with respect to the period covered by this report;
3. Based
on
my knowledge, the financial statements, and other financial information included
in this report, fairly present in all material respects the financial condition,
results of operations and cash flows of the registrant as of, and for, the
periods presented in this report;
4. The
registrant’s other certifying officer(s) and I are responsible for establishing
and maintaining disclosure controls and procedures (as defined in Exchange
Act
Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting
(as
defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and
have:
(a)
Designed
such disclosure controls and procedures, or caused such disclosure controls
and
procedures to be designed under our supervision, to ensure that material
information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the
period in which this report is being prepared;
(b) Designed
such internal control over financial reporting, or caused such internal control
over financial reporting to be designed under our supervision, to provide
reasonable assurance regarding the reliability of financial reporting and the
preparation of financial statements for external purposes in accordance with
generally accepted accounting principles;
(c) Evaluated
the effectiveness of the registrant’s disclosure controls and procedures and
presented in this report our conclusions about the effectiveness of the
disclosure controls and procedures, as of the end of the period covered by
this
report based on such evaluation; and
(d)
Disclosed
in this report any change in the registrant’s internal control over financial
reporting that occurred during the registrant’s most recent fiscal quarter (the
registrant’s fourth fiscal quarter in the case of an annual report) that has
materially affected, or is reasonably likely to materially affect, the
registrant’s internal control over financial reporting; and
5.
The
registrant’s other certifying officer(s) and I have disclosed, based on our most
recent evaluation of internal control over financial reporting, to the
registrant’s auditors and the audit committee of the registrant’s board of
directors (or persons performing the equivalent functions):
(a)
All
significant deficiencies and material weaknesses in the design or operation
of
internal control over financial reporting which are reasonably likely to
adversely affect the registrant’s ability to record, process, summarize and
report financial information; and
(b)
Any
fraud, whether or not material, that involves management or other employees
who
have a significant role in the registrant’s internal control over financial
reporting.
| |
|
|
| Date: November 9, 2006 | /s/ Robert J. Capetola | |
|
Robert J. Capetola, Ph.D. |
||
|
President
and Chief Executive
Officer
|
||
Exhibit
31.2
CERTIFICATIONS
I,
John
G. Cooper, certify that:
1. I
have
reviewed this Quarterly Report on Form 10-Q of Discovery Laboratories, Inc.;
2. Based
on
my knowledge, this report does not contain any untrue statement of a material
fact or omit to state a material fact necessary to make the statements made,
in
light of the circumstances under which such statements were made, not misleading
with respect to the period covered by this report;
3. Based
on
my knowledge, the financial statements, and other financial information included
in this report, fairly present in all material respects the financial condition,
results of operations and cash flows of the registrant as of, and for, the
periods presented in this report;
4. The
registrant’s other certifying officer(s) and I are responsible for establishing
and maintaining disclosure controls and procedures (as defined in Exchange
Act
Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting
(as
defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and
have:
(a)
Designed
such disclosure controls and procedures, or caused such disclosure controls
and
procedures to be designed under our supervision, to ensure that material
information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the
period in which this report is being prepared;
(b) Designed
such internal control over financial reporting, or caused such internal control
over financial reporting to be designed under our supervision, to provide
reasonable assurance regarding the reliability of financial reporting and the
preparation of financial statements for external purposes in accordance with
generally accepted accounting principles;
(c) Evaluated
the effectiveness of the registrant’s disclosure controls and procedures and
presented in this report our conclusions about the effectiveness of the
disclosure controls and procedures, as of the end of the period covered by
this
report based on such evaluation; and
(d)
Disclosed
in this report any change in the registrant’s internal control over financial
reporting that occurred during the registrant’s most recent fiscal quarter (the
registrant’s fourth fiscal quarter in the case of an annual report) that has
materially affected, or is reasonably likely to materially affect, the
registrant’s internal control over financial reporting; and
5.
The
registrant’s other certifying officer(s) and I have disclosed, based on our most
recent evaluation of internal control over financial reporting, to the
registrant’s auditors and the audit committee of the registrant’s board of
directors (or persons performing the equivalent functions):
(a)
All
significant deficiencies and material weaknesses in the design or operation
of
internal control over financial reporting which are reasonably likely to
adversely affect the registrant’s ability to record, process, summarize and
report financial information; and
(b)
Any
fraud, whether or not material, that involves management or other employees
who
have a significant role in the registrant’s internal control over financial
reporting.
| |
|
|
| Date: November 9, 2006 | /s/ John G. Cooper | |
|
John G. Cooper |
||
|
Executive
Vice President and Chief Financial
Officer
|
||
Exhibit
32.1
CERTIFICATIONS
Pursuant
to 18 U.S.C. § 1350, each of the undersigned officers of Discovery Laboratories,
Inc. (the “Company”) hereby certifies that, to his knowledge, the Company’s
Quarterly Report on Form 10-Q for the period ended September 30, 2006 (the
“Report”) fully complies with the requirements of Section 13(a) or 15(d) of the
Securities Exchange Act of 1934, and that the information contained in the
Report fairly presents, in all material respects, the financial condition and
results of operations of the Company.
| Date: November 9, 2006 | |||
| /s/ Robert J. Capetola | |||
|
Robert J. Capetola, Ph.D. |
|||
| President and Chief Executive Officer |
| /s/ John G. Cooper | |||
|
John G. Cooper |
|||
| Executive Vice President and Chief Financial Officer |
A
signed
original of this written statement required by Section 906 of the Sarbanes-Oxley
Act of 2002 has been provided to the Company and will be retained by the Company
and furnished to the SEC or its staff upon request.
This
certification is being furnished pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002 and shall not be deemed “filed” for purposes of Section 18 of the
Securities Exchange Act of 1934, or otherwise subject to the liability of that
section. This certification will not be deemed to be incorporated by reference
into any filing under the Securities Act of 1933 or the Securities Exchange
Act
of 1934.