SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
|X| QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2002
or
|_| 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 small business issuer as specified in its charter)
Delaware 94-3171943
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
350 South Main Street, Suite 307
Doylestown, Pennsylvania 18901
(Address of principal executive offices) (Zip Code)
(215) 340-4699
(Registrants' 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 |_|
As of August 9, 2002, 26,452,166 shares of Common Stock, par value $.001 per
share, were outstanding.
Transitional Small Business Disclosure Format: |_| Yes |X| No
DISCOVERY LABORATORIES, INC., AND SUBSIDIARY
(a development stage company)
Table of Contents
Page
----
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
CONDENSED CONSOLIDATED BALANCE SHEETS --
As of June 30, 2002 (unaudited) and December 31, 2001 ....Page 4
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited) --
For the Three Months Ended June 30, 2002 and 2001; for
the Six Months Ended June 30, 2002 and 2001; and
for the Period from May 18, 1993 (Inception) through
June 30, 2002 ............................................Page 5
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited) --
For the Six Months Ended June 30, 2002 and 2001; and
for the Period from May 18, 1993 (Inception) through
June 30, 2002 ............................................Page 6
Notes to Condensed Consolidated Financial Statements
-- June 30, 2002 (unaudited) .............................Page 7
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations ........................Page 8
Item 3. Disclosures about Market Risk ..............................Page 21
PART II - OTHER INFORMATION
Item 1. Legal Proceedings. .........................................Page 22
Item 2. Changes in Securities. .....................................Page 22
Item 3. Defaults Upon Senior Securities. ...........................Page 22
Item 4. Submission of Matters to a Vote of Security Holders. .......Page 22
Item 5. Other Information. .........................................Page 22
Item 6. Exhibits and Reports on Form 8-K. ..........................Page 22
Signatures ..........................................................Page 23
Page 2
Unless the context otherwise requires, all references to "we," "us," "our," and
the "Company" include Discovery Laboratories, Inc. ("Discovery"), and its
wholly-owned, presently inactive subsidiary, Acute Therapeutics, Inc.
Safe Harbor Statement Under the Private Securities Litigation Act of 1996
Certain statements set forth in this report and those incorporated by reference
herein which are not historical, including, without limitation, statements
concerning our research and development programs and clinical trials, the
possibility of submitting regulatory filings for our products under development,
the seeking of collaboration arrangements with pharmaceutical companies or
others to develop, manufacture and market products, the research and development
of particular compounds and technologies and the period of time for which our
existing resources will enable the Company to fund its operations, constitute
"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. We intend
that all forward-looking statements be subject to the safe-harbor provisions of
the Private Securities Litigation Reform Act of 1995. These forward-looking
statements are only predictions and reflect our views as of the date they are
made with respect to future events and financial performance. 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
inherent risks and uncertainties in developing products of the type we are
developing; possible changes in our financial condition; the progress of our
research and development (including the risk that our lead product candidate,
Surfaxin(R), will not prove to be safe or useful for the treatment of certain
indications); the impact of development of competing therapies and/or
technologies by other companies; our ability to obtain additional required
financing to fund our research programs; our ability to enter into agreements
with collaborators and the failure of collaborators to perform under their
agreements with us; the results of clinical trials being conducted by us; the
progress of the FDA approvals in connection with the conduct of our clinical
trials and the marketing of our products; the additional cost and delays which
may result from requirements imposed by the FDA in connection with obtaining the
required approvals; and the other risks and certainties detailed in Item 2:
"Management's Discussion and Analysis" and in the documents incorporated by
reference in this report.
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.
Page 3
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
DISCOVERY LABORATORIES, INC. AND SUBSIDIARY
(a development stage company)
Condensed Consolidated Balance Sheets
June 31, December 31,
2002 2001
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 2,901,000 $ 3,758,000
Available-for-sale marketable securities 10,692,000 12,938,000
Note receivable - current 2,000 2,000
Prepaid expenses and other current assets 1,601,000 1,580,000
------------ ------------
Total current assets 15,196,000 18,278,000
Property and equipment, net of accumulated depreciation 987,000 822,000
Note receivable 196,000 197,000
Other assets 99,000 768,000
------------ ------------
$ 16,478,000 $ 20,065,000
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses $ 1,670,000 $ 1,750,000
Capitalized lease - current 46,000 44,000
------------ ------------
Total current liabilities 1,716,000 1,794,000
Deferred revenue 1,901,000 615,000
Other liabilities 400,000 --
Capitalized lease 9,000 33,000
------------ ------------
Total liabilities 4,026,000 2,442,000
Stockholders' Equity:
Common stock, $.001 par value; 60,000,000 authorized; 26,406,766
and 25,546,293 shares issued and outstanding at June 30, 2002
and December 31, 2001, respectively 26,000 26,000
Additional paid-in capital 75,469,000 73,163,000
Unearned portion of compensatory stock options (95,000) (264,000)
Deficit accumulated during the development stage (62,792,000) (55,135,000)
Treasury stock (at cost; 38,243 shares of common stock) (239,000) (239,000)
Accumulated other comprehensive income 83,000 72,000
Total stockholders' equity 12,452,000 17,623,000
------------ ------------
$ 16,478,000 $ 20,065,000
============ ============
See notes to condensed consolidated financial statements Page 4
DISCOVERY LABORATORIES, INC. AND SUBSIDIARY
(a development stage company)
Condensed Consolidated Statements of Operations
(Unaudited)
May 18, 1993
Three Months Ended Six Months Ended (inception)
June 30, June 30, through
----------------------------- ----------------------------- June 30,
2002 2001 2002 2001 2002
------------ ------------ ------------ ------------ ------------
Revenues:
Research and development
collaborative contracts $ 783,000 $ 262,000 $ 1,020,000 $ 718,000 $ 3,078,000
------------ ------------ ------------ ------------ ------------
Expenses:
Write-off of acquired in-process
research and development
and supplies -- -- -- -- 13,508,000
Research and development 3,721,000 2,049,000 6,326,000 3,811,000 34,696,000
General and administrative 1,538,000 984,000 2,670,000 2,039,000 20,637,000
------------ ------------ ------------ ------------ ------------
Total expenses 5,259,000 3,033,000 8,996,000 5,850,000 68,841,000
------------ ------------ ------------ ------------ ------------
Operating loss (4,476,000) (2,771,000) (7,976,000) (5,132,000) (65,763,000)
Other income and expense:
Interest income, dividends, realized
gains, and other income 191,000 417,000 351,000 719,000 3,703,000
Minority interest in net loss of subsidiary -- -- -- -- 26,000
Interest expense (2,000) (1,000) (32,000) (2,000) (76,000)
------------ ------------ ------------ ------------ ------------
Net loss $ (4,287,000) $ (2,355,000) $ (7,657,000) $ (4,415,000) $(62,110,000)
============ ============ ============ ============ ============
Net loss per common share -
basic and diluted $ (0.16) $ (0.11) $ (0.29) $ (0.21)
Weighted average number of common
shares outstanding -
basic and diluted 26,394,013 21,075,269 26,113,947 20,973,418
See notes to condensed consolidated financial statements Page 5
DISCOVERY LABORATORIES, INC. AND SUBSIDIARY
(a development stage company)
Condensed Consolidated Statements of Cash Flows
(Unaudited)
May 18, 1993
Six Months Ended (inception)
June 30, through
----------------------------- June 30,
2002 2001 2002
------------ ------------ ------------
Cash flows from operating activities:
Net loss $ (7,657,000) $ (4,415,000) $(62,110,000)
Adjustments to reconcile net loss to net cash used in
operating activities:
Write-off of acquired in-process research
and development and supplies -- -- 13,508,000
Write-off of licenses -- -- 683,000
Depreciation and amortization 145,000 91,000 689,000
Compensatory stock options 169,000 302,000 3,343,000
Expenses paid using treasury stock and common stock 26,000 8,000 230,000
Loss on sale of property -- -- 4,000
Changes in: --
Prepaid expenses, inventory and other current assets (21,000) (177,000) (440,000)
Accounts payable and accrued expenses (80,000) (1,310,000) 1,537,000
Other liabilities 400,000 -- 400,000
Other assets (2,000) -- (23,000)
Proceeds from research and development
collaborative agreements 500,000 -- 1,855,000
Premium on sale of common stock
recorded as additional deferred revenue 1,333,000 -- 1,619,000
Amortization of deferred revenue (547,000) (395,000) (2,128,000)
Expenses paid on behalf of company -- -- 18,000
Employee stock compensation -- -- 42,000
Reduction of research and development supplies -- -- (161,000)
------------ ------------ ------------
Net cash used in operating activities (5,734,000) (5,896,000) (40,934,000)
------------ ------------ ------------
Cash flows from investing activities:
Purchase of property and equipment (282,000) (67,000) (2,033,000)
Proceeds from sale of property and equipment -- -- 575,000
Loan from related party -- -- (200,000)
Related party loan payments received 1,000 -- 2,000
Acquisition of licenses -- -- (711,000)
Purchase of marketable securities (5,243,000) (3,462,000) (49,178,000)
Proceeds from sale or maturity of marketable securities 7,500,000 4,923,000 38,974,000
Net cash payments on merger -- -- (1,670,000)
------------ ------------ ------------
Net cash provided by (used in) investing activities 1,976,000 1,394,000 (14,241,000)
------------ ------------ ------------
Cash flows from financing activities:
Proceeds from issuance of securities, net of expenses 2,923,000 1,002,000 58,267,000
Purchase of treasury stock -- -- (121,000)
Principal payments under capital lease obligation (22,000) (9,000) (70,000)
------------ ------------ ------------
Net cash provided by (used in) financing activities 2,901,000 993,000 58,076,000
------------ ------------ ------------
Net increase (decrease) in cash and cash equivalents (857,000) (3,509,000) 2,901,000
Cash and cash equivalents - beginning of period 3,758,000 7,281,000 --
------------ ------------ ------------
Cash and cash equivalents - end of period $ 2,901,000 $ 3,772,000 $ 2,901,000
============ ============ ============
Supplementary disclosure of cash flows information:
Interest Paid: $ (32,000) $ 2,000 $ 12,000
Noncash transactions:
Class H warrants issued/revalued $ (643,000) $ -- $ 125,000
Accrued dividends on Series C preferred stock -- -- 682,000
Series C preferred stock dividends paid using common stock -- -- 204,000
Preferred Stock issued for inventory -- -- 575,000
Equipment acquired through capitalized lease -- -- 125,000
Unrealized gain (loss) on marketable securities 11,000 (225,000) 83,000
Common stock and treasury stock issued in payment of services 26,000 -- 99,000
See notes to condensed consolidated financial statements Page 6
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 1 - THE COMPANY AND BASIS OF PRESENTATION
The Company
Discovery Laboratories, Inc. (the "Company"), is a development stage specialty
pharmaceutical company leveraging its platform technology in humanized lung
surfactants to develop novel respiratory therapies and pulmonary drug delivery
products. Surfactants are produced naturally in the lungs and are essential to
the lungs' ability to absorb oxygen.
The Company's humanized surfactant technology is being developed initially for
critical care patients with life-threatening respiratory disorders where there
are few, if any, approved therapies. These severe respiratory disorders
generally are associated with a lack of functional surfactant. The Company's
lead product, Surfaxin(R), is an engineered humanized surfactant and is
currently in two Phase 3 clinical trials for Respiratory Distress Syndrome in
premature infants (RDS), a Phase 3 clinical trial for Meconium Aspiration
Syndrome in full-term infants (MAS), and a Phase 2 clinical trial for Acute
Respiratory Distress Syndrome in adults (ARDS).
The Company is also performing research and development of aerosolized
formulations of its humanized surfactant technology to treat respiratory
conditions such as asthma and as a novel pulmonary drug delivery vehicle to
render drugs more effective when delivered to or via the respiratory tract.
Basis of Presentation
The accompanying unaudited condensed 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
six-month period ended June 30, 2002, are not necessarily indicative of the
results that may be expected for the year ended December 31, 2002. For further
information, refer to the consolidated financial statements and footnotes
thereto included in the Company's Annual Report on Form 10-KSB for the year
ended December 31, 2001.
The Company is a development stage company and has incurred substantial losses
since inception. To date, the Company has funded its operations primarily
through the issuance of equity. The Company expects to continue to expend
substantial amounts for continued product research, development, and initial
commercialization activities for the foreseeable future. Management's plans with
respect to funding this development are to secure additional capital through the
issuance of equity, if possible, and to secure collaborative arrangements that
will provide available cash funding for operations. Continuation of the Company
is dependent on its ability to obtain additional financing and, ultimately, on
its ability to achieve profitable operations. There is no assurance, however,
that such financing will be available or that the Company's efforts ultimately
will be successful.
All of the Company's current products under development are subject to license
agreements that will require the payment of future royalties.
Certain prior year balances have been reclassed to conform with the current
presentation. The reclassification had no effect on net income.
NOTE 2 - 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 and the conversion of convertible securities are not
included in the calculation of the net loss per share as their effect would be
antidilutive.
NOTE 3 - COMPREHENSIVE LOSS
Total comprehensive loss was approximately $4,155,000 and $7,646,000 for the
three and six months ended June 30, 2002, and approximately $2,628,000 and
4,640,000 for the three and six months ended June 30, 2001, respectively.
Page 7
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Overview
We are a specialty pharmaceutical company applying our technology in humanized
lung surfactants to develop potential novel respiratory therapies and pulmonary
drug delivery products. Surfaxin, our lead product, is currently in two Phase 3
clinical trials for Respiratory Distress Syndrome in premature infants, a Phase
3 clinical trial for Meconium Aspiration Syndrome in full-term infants and a
Phase 2 clinical trial for Acute Respiratory Distress Syndrome in adults. We are
also developing aerosolized formulations of our humanized surfactant to treat
respiratory conditions such as asthma and as a novel pulmonary drug delivery
vehicle to render drugs more effective when delivered to or via the respiratory
tract.
We are presently developing a dedicated sales and marketing capability through a
collaboration with Quintiles Transnational Corp. to commercialize Surfaxin in
the United States. We expanded our relationship with Laboratorios del Dr.
Esteve, S.A., by entering into a strategic alliance with Esteve to commercialize
Surfaxin in Europe, Central and South America, and Mexico. In the non-critical
care, ambulatory markets, we plan to establish strategic alliances for the
development and commercialization of our products.
Since our inception, we have incurred significant losses and, as of June 30,
2002, had a deficit accumulated during the development stage of approximately
$62.1 million (including historical results of predecessor companies). Most of
our expenditures to date have been for research and development activities and
general and administrative expenses. Research and development expenses represent
costs incurred for clinical trials, regulatory filings and manufacturing efforts
(including raw material costs). We expense our research and development costs as
they are incurred. General and administrative expenses consist primarily of
salaries and related expenses, rents and general corporate activities.
Plan of Operations
We expect to continue to incur increasing operating losses for the foreseeable
future, primarily due to our continued research and development activities
attributable to new and existing products, manufacturing, initial
commercialization, and general and administrative activities.
We anticipate that during the next 12 to 24 months we will:
(i) significantly increase our research, development and regulatory
activities. It is anticipated that the primary focus of our research
and development activities will be the several clinical trials for
Surfaxin indications and related regulatory filings. In the fall of
2001, we initiated two pivotal, landmark multinational Phase 3
trials for Respiratory Distress Syndrome in premature infants: a
1,500 patient trial and a 500 patient supporting trial. The majority
of our development resources are focused on these trials and we
anticipate completing the trials, announcing data and filing a New
Drug Application in the first half of 2003. For Acute Respiratory
Distress Syndrome in adults, we currently are conducting a Phase 2
dose-ranging safety and efficacy study of up to 110 patients in the
United States. In July 2002, we completed the dose escalation safety
and tolerability part of the study and are currently enrolling
patients in the final part of the trial. We expect data from the
Acute Respiratory Distress Syndrome trial to be available in the
later part of the second half of 2002 or early in the first quarter
of 2003. For Meconium Aspiration Syndrome in full-term infants, we
currently are conducting a Phase 3 clinical trial of up to 200
patients in the United States. Enrollment is ongoing but has been
slower than expected and completion is now anticipated for late
2003. Given our belief in the importance of the pivotal Phase 3
trial for Respiratory Distress Syndrome in premature infants to our
present development plan, resources have been and may continue to be
reallocated from the Meconium Aspiration Syndrome program to the
Respiratory Distress Syndrome program, as needed.
The research and development, clinical trial and regulatory process
is lengthy, expensive and uncertain and subject to numerous risks
including, without limitation, the risks discussed in "Risks Related
to Our Business-The clinical trial and regulatory approval process
for our products will be expensive and time consuming, and the
outcome is uncertain."
Page 8
(ii) conduct research and development of aerosolized formulations of our
humanized surfactant in order to develop new products intended to
treat respiratory conditions such as asthma and as a novel pulmonary
drug delivery vehicle to deliver drugs via the respiratory tract.
See "Risks Related to Our Business-The clinical trial and regulatory
approval process for our products will be expensive and time
consuming, and the outcome is uncertain."
(iii) invest in additional manufacturing capability in anticipation of
optimizing the production process for Surfaxin and to allow scale up
of the manufacturing process to meet our clinical and commercial
needs as they expand.
(iv) invest in additional general and administrative resources primarily
to support our business development initiatives, financial systems
and controls and management information technologies.
(v) invest in marketing and commercialization management infrastructure
to manage the strategic relationships with our collaborative
partners for the launch of Surfaxin, if approved, and the execution
of our "Discovery/Surfaxin" worldwide marketing strategy.
On December 10, 2001, we entered into a collaboration arrangement with
Quintiles, and its affiliate, PharmaBio Development Inc., to provide certain
commercialization services in the United States for Surfaxin for the treatment
of Respiratory Distress Syndrome in premature infants and Meconium Aspiration
Syndrome in full-term infants. Quintiles will hire and train a dedicated United
States sales force that will be branded in the market as ours. Quintiles made a
financial commitment to us that included a $3 million equity investment, a
secured, revolving credit facility of up to $8.5 to $10 million to fund Surfaxin
pre-launch activities and up to $70 million in post-launch funding to cover the
first seven years of U.S. sales and marketing costs. In return, Quintiles will
receive a commission on net sales of Surfaxin over a ten-year period. We may
also receive milestone payments from PharmaBio that would be used to offset
amounts owed under the credit facility. The Quintiles arrangement allows us to
retain product ownership and have sales and marketing expertise in place for the
commercialization of Surfaxin in the U.S., if approved. Additionally, the
arrangement allows for the specialty sales force to become ours at the end of
the seven-year term, with an option to acquire it sooner.
In March 2002, we expanded our existing alliance with Esteve to develop, market
and sell Surfaxin throughout Europe, Central and South America, and Mexico. In
connection with this new Esteve collaboration, Esteve purchased $4 million of
common stock (at a 50% premium over the average closing price for the 30 days
prior to the closing date) and paid us a non-refundable licensing fee of
$500,000. Esteve agreed to provide certain commercialization services for
Surfaxin for the treatment of Respiratory Distress Syndrome in premature
infants, Meconium Aspiration Syndrome in full-term infants and Acute Lung
Injury/Acute Respiratory Distress Syndrome in adult patients. We have agreed to
an exclusive supply agreement which provides that Esteve will purchase from us
all of its Surfaxin drug product requirements at an established transfer price
based on sales of Surfaxin by Esteve and/or its sublicensee(s). Esteve has also
agreed to sponsor certain clinical trial costs related to obtaining regulatory
approval in Europe for Acute Lung Injury/Acute Respiratory Distress Syndrome
indications. Esteve also agreed to make certain milestone payments to us upon
the attainment of European marketing regulatory approval of Surfaxin. The
license fees (including the premium paid for common stock) has been accounted
for as deferred revenue and will be recognized as revenue using a straight line
method through the anticipated date of FDA approval for the first Surfaxin
neonatal indication.
We will need to generate significant revenues from product sales and or related
royalties and transfer prices to achieve and maintain profitability. Through
June 30, 2002, we have yet to generate any revenues from product sales, and have
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 third party suppliers. Moreover, we may never achieve significant
revenues or profitable operations from the sale of any of our products or
technologies. See "Risks Related to Our Business-If we cannot raise additional
capital, we may need to discontinue our research and development activities. In
addition, any additional financing could result in equity dilution."
Through June 30, 2002, we had not generated taxable income. At December 31,
2001, net operating losses available to offset future taxable income for Federal
tax purposes were approximately $47.5 million. The future
Page 9
utilization of such loss carryforwards may be limited pursuant to regulations
promulgated under Section 382 of the Internal Revenue Code. In addition, as of
December 31, 2001, we had a research and development tax credit carryforward of
$846,000. The Federal net operating loss and research and development tax credit
carryforwards expire beginning in 2008 and continuing through 2021.
Results of Operations
Net loss for the three and six months ended June 30, 2002 were $4,287,000 ($0.16
per common share) and $7,657,000 ($0.29 per common share), respectively. Net
loss for the three and six months ended June 30, 2001 were $2,355,000 ($0.11 per
common share) and $4,415,000 ($0.21 per common share), respectively.
Revenues from research and development collaborative contracts for the three and
six months ended June 30, 2002 were $783,000 and $1,020,000, respectively.
Revenues from research and development collaborative contracts for the three and
six months ended June 30, 2001 were $262,000 and $718,000, respectively. Such
revenues are related to research and development funding associated with our
strategic alliance with Esteve, our Small Business Innovative Research "SBIR"
grant to develop Surfaxin for Acute Lung Injury/Acute Respiratory Distress
Syndrome in adults and our Orphan Products Development grant to develop Surfaxin
for Meconium Aspiration Syndrome in full-term infants .
Research and development expenses for the three and six months ended June 30,
2002 were $3,721,000 and $6,326,000, respectively. Research and development
expenses for the three and six months ended June 30, 2001 were $2,049,000 and
$3,811,000, respectively. This increase primarily reflects clinical trial costs
incurred for the Company's lead product, Surfaxin, currently in three Phase 3
trials and one Phase 2 trial, and research and development activities related to
our development of aerosolized formulations of our humanized surfactant to treat
respiratory conditions and as a pulmonary drug delivery vehicle.
General and administrative expenses for the three and six months ended June 30,
2002 were $1,538,000 and $2,670,000, respectively. General and administrative
expenses for the three and six months ended June 30, 2001 were $984,000 and
$2,039,000, respectively. General and administrative expenses consist primarily
of the costs of executive management, financial and accounting, business
development, legal, facility and other administrative costs. Included in general
and administrative costs for the first half of 2002 is approximately $400,000
for pre-launch commercialization activities (market research and analysis) for
Surfaxin conducted in connection with a collaboration arrangement with Quintiles
(for which funding is intended to be provided by the secured revolving credit
facility with PharmaBio (see "Liquidity and Capital Resources")); and a non-cash
compensation charge of approximately $346,000 related primarily to options
granted to non-employee directors under the Automatic Option Grant Program of
the Company's Amended and Restated 1998 Stock Option Plan and to modifications
of the terms of certain options previously granted under such Automatic Option
Grant Program and held by three departing members of the Board of the Directors
of the Company. Such modifications extend the exercisability of such options to
their respective stated expiration dates, notwithstanding their original terms.
Interest income for the three and six months ended June 30, 2002 was $191,000
and $351,000, respectively. Interest income for the three and six months ended
June 30, 2001 was $417,000 and $719,000, respectively. Interest income decreased
during the six months ended June 30, 2002 as compared to the same period of 2001
due to declines in interest rates and the average balance of marketable
securities.
Liquidity and Capital Resources
As of June 30, 2002, we had working capital of approximately $13.5 million as
compared to the working capital of approximately $17.2 million we had as of
March 31, 2002 and approximately $16.5 million we had as of December 31, 2001.
The decrease in working capital is due to funds used in our clinical trial and
research and development activities offset by funds received in connection with
the expansion, in March 2002, of our existing alliance with Esteve. We believe
our current working capital is sufficient to meet our planned research and
development activities into the second quarter of 2003. We will need additional
financing from investors or collaborators to complete research and development
and commercialization of our current product candidates under development.
In December 2001, we entered into a secured revolving credit facility of up to
$8.5 million to $10 million with PharmaBio to fund pre-marketing activities for
a Surfaxin launch in the United States. The credit facility is
Page 10
available for use until December 10, 2004, and monies become available in three
tranches upon satisfying certain conditions. In connection with the credit
facility, we issued to PharmaBio Class H warrants to purchase 320,000 shares of
common stock. The Class H warrants are exercisable at $3.03 per share (subject
to adjustment) and are exercisable proportionately only upon use of the credit
facility. To the extent the credit facility availability is increased to greater
than $8.5 million, for each $1 million increase, the amount of shares of common
stock issuable pursuant to the Class H warrants shall be increased by
approximately 38,000 shares.
Interest on amounts advanced under the credit facility will be payable quarterly
in arrears. We may repay principal amounts owed by us under the credit facility
from proceeds of milestone payments to be paid to us by PharmaBio upon the
achievement of certain corporate milestones. As of June 30, 2002, no amounts
were outstanding under the credit facility. We are obligated to use a
significant portion of the funds borrowed under the credit facility for
pre-launch marketing services to be provided by Quintiles and anticipate using
this credit facility to fund approximately $400,000 (currently classified as
"Other liabilities") of market research and analysis costs incurred in the first
half of 2002.
Our working capital requirements will depend upon numerous factors, including,
without limitation, the progress of our research and development programs,
clinical trials, timing and cost of obtaining regulatory approvals, timing and
cost of pre-launch marketing activities, levels of resources that we devote to
the development of manufacturing and marketing capabilities, levels of resources
that our collaboration partners devote to the development of sales and marketing
capabilities, technological advances, status of competitors, our ability to
establish collaborative arrangements with other organizations, the ability to
defend and enforce our intellectual property rights and the establishment of
additional strategic or licensing arrangements with other companies or
acquisitions.
Historically, the Company's working capital has been provided from the proceeds
of private financings:
Pursuant to the collaboration arrangement we entered into with Esteve on March
6, 2002, we issued 821,862 shares of common stock to Esteve at a purchase price
equal to $4.867 per share and received a licensing fee of $500,000, for
approximate aggregate proceeds of $4.5 million.
Pursuant to the collaboration arrangement we entered into with Quintiles and
PharmaBio on December 10, 2001, we issued to PharmaBio, for approximate net
aggregate proceeds of $2.7 million: (i) 791,905 shares of common stock at a
price equal to $3.79 per share; and (ii) Class G warrants to purchase 357,143
shares of common stock at an exercise price equal to $3.485 per share. The Class
G warrants have a ten-year term.
On October 1, 2001, we received approximately $7.3 million in net proceeds from
a private financing. In the financing, we issued 3,562,759 shares of common
stock and 712,553 Class F warrants to purchase shares of common stock at an
exercise price of $2.365 per share. The Class F warrants have a five-year term.
On April 27, 2001, we received approximately $1 million in gross proceeds in a
private offering of 296,560 shares of common stock at a per share price equal to
$3.37.
In March 2000, we received approximately $17,500,000 in net proceeds from the
sale of 37.74 units from a private placement offering. Each unit consisted of
76,923 shares of common stock and Class E warrants to purchase an additional
15,385 shares of common stock for $7.38 per share. The Class E warrants issued
in the offering aggregate approximately 581,000 shares and are exercisable
through March 2005.
In October 1999, in connection with our strategic alliance with Esteve, we
issued to Esteve in a private placement 317,164 shares of common stock at a
purchase price of $2.68 per share.
In July 1999, we raised approximately $2,231,000 in net proceeds in a private
placement offering of an aggregate of 2,024,792 shares of common stock and
2,024,792 Class D warrants to purchase common stock. All of the Class D warrants
have been exercised.
During March and April 1999, we raised $1.0 million in a private placement
offering of 826,447 shares of common stock and 569,026 Class C warrants to
purchase common stock at an exercise price of $2.15 per share. The Class C
warrants are exercisable through April 2006.
Page 11
We will require substantial additional funding to conduct our business,
including our expanded research and product development activities. Based on our
current operating plan, we believe that our currently available resources will
be adequate to satisfy our capital needs into the second quarter of 2003. Our
future capital requirements will depend on the results of our research and
development activities, clinical studies and trials, competitive and
technological advances and the regulatory process. 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.
We have not entered into any additional arrangements to obtain any additional
financing. The sale of additional equity and debt securities may result in
additional dilution to our stockholders, and we cannot be certain that
additional financing will be available in amounts or on terms acceptable to us,
if at all. If we fail to enter into collaborative ventures or to receive
additional funding, we may have to reduce significantly the scope of or
discontinue our planned research, development and commercialization activities,
which could significantly harm our financial condition and operating results.
Furthermore, we could cease to qualify for listing of our common stock on the
NASDAQ SmallCap Market if the market price of our common stock declines as a
result of the dilutive aspects of such potential financings. See "Risks Related
to Our Business."
Risks Related to Our Business
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.
Because we are a development stage company, we may not successfully develop and
market our products, and even if we do, we may not generate enough revenue or
become profitable.
We are a development stage company. Therefore, you must evaluate us in light of
the uncertainties and complexities present in a development stage biotechnology
company. We are conducting research and development on our product candidates.
As a result, we have not begun to market or generate revenues from the
commercialization of any of these products. To date, we have only generated
revenues from investments, research grants and collaborative research and
development agreements. We will need to engage in significant, time-consuming
and costly research, development, pre-clinical studies, clinical testing and
regulatory approval for our products under development prior to their
commercialization. In addition, pre-clinical or clinical studies may show that
our products are not effective or safe for one or more of their intended uses.
We may fail in the development and commercialization of our products. As of June
30, 2002, we have incurred a deficit accumulated during the development stage of
approximately $62.1 million, and we expect to continue to incur significant
increasing operating losses over the next several years. If we succeed in the
development of our products, we still may not generate sufficient or sustainable
revenues or we may not be profitable.
If we cannot raise additional capital, we may need to discontinue our research
and development activities. In addition, any additional financing could result
in equity dilution.
We may need substantial additional funding to conduct our research and product
development activities. Based on our current operating plan, we believe that our
currently available resources will be adequate to satisfy our capital needs into
the second quarter of 2003. Our future capital requirements will depend on the
results of our research and development activities, clinical studies and trials,
competitive and technological advances and the regulatory process. If our
operations do not become profitable before we exhaust our resources, 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 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.
However, we have not entered into arrangements to obtain any additional
financing, except for the credit facility with PharmaBio Development Inc., a
subsidiary of Quintiles. Any additional financing could include unattractive
terms or result in significant dilution of stockholders' interests and share
prices may decline. If we fail to enter into collaborative ventures or to
receive additional funding, we may have to delay, scale back or discontinue 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. Furthermore, we could
Page 12
cease to qualify for listing of our securities on the NASDAQ SmallCap Market if
the market price of our common stock declines as a result of the dilutive
aspects of such potential financings. See "Risks Related to Our Business-The
market price of our stock may be adversely affected by market volatility."
The clinical trial and regulatory approval process for our products will be
expensive and time consuming, and the outcome is uncertain.
In order to sell our products that are under development, we must receive
regulatory approvals for each product. The FDA and comparable agencies in
foreign countries 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 its safety and effectiveness and
confirmation by the FDA and comparable agencies in foreign countries that the
manufacturer maintains good laboratory and manufacturing practices (GMPs) during
testing and manufacturing. The process is lengthy, expensive and uncertain. It
is also possible that the FDA or comparable foreign regulatory authorities could
interrupt, delay or halt our clinical trials. If we, or any regulatory
authorities, believe that trial participants face unacceptable health risks, the
trials could be suspended or terminated. We also may not reach agreement with
the FDA and/or comparable foreign agencies on the design of clinical studies
necessary for approval. In addition, conditions imposed by the FDA and
comparable agencies in foreign countries on our clinical trials could
significantly increase the time required for completion of our clinical trials
and the costs of conducting the clinical trials.
To succeed, clinical trials require adequate supplies of drug substance and drug
product, which may be difficult or uneconomical to procure or manufacture, and
sufficient patient enrollment. Patient enrollment is a function of several
factors, including the size of the patient population, the nature of the
protocol, the proximity of the patients to the trial sites and the eligibility
criteria for the clinical trials. Delays in patient enrollment can result in
greater costs and longer trial timeframes. Patients may also suffer adverse
medical events or side effects that are common to this class of drug such as a
decrease in the oxygen level of the blood upon administration.
Clinical trials generally take two to five years or more to complete, and,
accordingly, our first product is not expected to be commercially available in
the United States until at least 2004, and our other product candidates will
take longer. The FDA has notified us that two of our intended indications for
Surfaxin, Meconium Aspiration Syndrome in full-term infants and Acute
Respiratory Distress Syndrome in adults, have been granted designation as "fast
track" products under provisions of the Food and Drug Administration
Modernization Act of 1997, and the FDA has awarded us an Orphan Products
Development Grant to support our development of Surfaxin for the treatment of
Meconium Aspiration Syndrome. Fast Track Status does not accelerate the clinical
trials nor does it mean that the regulatory requirements are less stringent. The
Fast Track Status provisions are designed to shorten the waiting period between
the time the New Drug Application is filed and the FDA's review of such
application for new drugs intended to treat serious or life-threatening
conditions. The FDA generally will review the New Drug Application for a drug
granted Fast Track Status within six months instead of the typical one to three
years. Our products may not, however, continue to qualify for expedited review
and our other drug candidates may fail to qualify for fast track development or
expedited review. Even though some of our drug candidates have qualified for
expedited review, the FDA may not approve them at all or any sooner than other
drug candidates that do not qualify for expedited review.
The FDA and comparable foreign agencies could withdraw any approvals we obtain.
Further, if there is a later discovery of unknown problems or if we fail to
comply with other applicable regulatory requirements at any stage in the
regulatory process, the FDA may restrict or delay our marketing of a product or
force us to make product recalls. In addition, the FDA could impose other
sanctions such as fines, injunctions, civil penalties or criminal prosecutions.
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. The FDA and foreign regulators have not
yet approved any of our products under development for marketing in the United
States or elsewhere. If the FDA and other regulators do not approve our
products, we will not be able to market our products.
Page 13
Our strategy, in many cases, is to enter into collaboration agreements with
third parties with respect to our products and we may require additional
collaboration agreements. If we fail to enter into these agreements or if we or
the third parties do not perform under such agreements, it could impair our
ability to commercialize our products.
Our strategy for the completion of the required development and clinical testing
of our products and for the manufacturing, marketing and commercialization of
our products, in many cases, depends upon entering into collaboration
arrangements with pharmaceutical companies to market, commercialize and
distribute our products. On March 6, 2002, we expanded our relationship with
Laboratorios Del Dr. Esteve, S.A., by entering into a collaboration arrangement
with Esteve for Surfaxin covering all of Europe, Central America and South
America, and Mexico. Esteve will be responsible for the marketing of Surfaxin
for the treatment of Respiratory Distress Syndrome in premature infants,
Meconium Aspiration Syndrome in full-term infants, and Acute Lung Injury/Acute
Respiratory Distress Syndrome in adults. Esteve will also be responsible for the
sponsorship of certain clinical trial costs related to obtaining European
Medicines Evaluation Agency approval for the commercialization of Surfaxin in
Europe for the Acute Lung Injury/Acute Respiratory Distress Syndrome
indications. We will be responsible for the remainder of the regulatory
activities relating to Surfaxin, including with respect to European Medicines
Evaluation Agency filings.
On December 10, 2001, we entered into an exclusive collaboration arrangement in
the United States with Quintiles, and its affiliate, PharmaBio, to
commercialize, sell and market Surfaxin in the United States for indications of
Respiratory Distress Syndrome in premature infants and Meconium Aspiration
Syndrome in full-term infants. As part of our collaboration with Quintiles,
Quintiles will build a sales force solely dedicated to the sale of Surfaxin upon
the approval of a New Drug Application for either of the two indications. If
Quintiles and we fail to devote appropriate resources to commercialize, sell and
market Surfaxin, sales of Surfaxin could be reduced. As part of the
collaboration, PharmaBio is obligated to provide us with certain financial
assistance in connection with the commercialization of Surfaxin, including, but
not limited to, a secured, revolving credit facility for at least $8.5 million
which may be increased to $10 million. A failure by us to repay amounts
outstanding under the credit facility would have a material adverse effect on
us. To obtain the benefits of such financing, we are obligated to meet certain
development and performance milestones. The failure by us to meet the
milestones, our failure to meet other terms and conditions of the financing
leading to PharmaBio's termination thereof or the failure of PharmaBio to
fulfill its obligation to partially fund the commercialization of Surfaxin, may
affect our ability to successfully market Surfaxin.
If Esteve, Quintiles or we breach or terminate the agreements that make up such
collaboration arrangements or Esteve or Quintiles otherwise fail to conduct
their Surfaxin-related activities in a timely manner or if there is a dispute
about their respective obligations, we may need to seek other partners or we may
have to develop our own internal sales and marketing capability for the
indications of Surfaxin which Esteve and/or Quintiles have agreed to assist in
commercializing. Accordingly, we may need to enter into additional collaboration
agreements and our success, particularly outside of the United States, may
depend upon obtaining additional collaboration partners. In addition, we may
depend on our partners' expertise and dedication of sufficient resources to
develop and commercialize our proposed products. We may, in the future, grant to
collaboration partners rights to license and commercialize pharmaceutical
products developed under collaboration agreements. Under these arrangements, our
collaboration partners may control key decisions relating to the development of
the products. The rights of our collaboration partners would limit our
flexibility in considering alternatives for the commercialization of our
products. If we fail to successfully develop these relationships or if our
collaboration partners fail to successfully develop or commercialize any of our
products, it may delay or prevent us from developing or commercializing our
products in a competitive and timely manner and would have a material adverse
effect on the commercialization of Surfaxin. See "Risks Related to Our
Business-Our lack of marketing and sales experience could limit our ability to
generate revenues from future product sales."
If we cannot protect our intellectual property, other companies could use our
technology in competitive products. If we infringe the intellectual property
rights of others, other companies could prevent us from developing or marketing
our products.
We seek patent protection for our drug candidates so as to prevent others from
commercializing equivalent products in substantially less time and at
substantially lower expense. The pharmaceutical industry places considerable
importance on obtaining patent and trade secret protection for new technologies,
products and processes. Our success will depend in part on our ability and that
of parties from whom we license technology to:
Page 14
- -- defend our patents and otherwise prevent others from infringing on our
proprietary rights;
- -- protect trade secrets; and
- -- operate without infringing upon the proprietary rights of others, both in
the United States and in other countries.
The patent position of firms relying upon biotechnology is highly uncertain and
involves complex legal and factual questions for which important legal
principles are unresolved. To date, the United States Patent and Trademark
Office has not adopted a consistent policy regarding the breadth of claims that
the United States Patent and Trademark Office allows in biotechnology patents or
the degree of protection that these types of patents afford. As a result, there
are risks that we may not develop or obtain rights to products or processes that
are or may seem to be patentable.
Even if we obtain patents to protect our products, those patents may not be
sufficiently broad and others could compete with us.
We, or the parties licensing technologies to us, have filed various United
States and foreign patent applications with respect to the products and
technologies under our development, and the United States Patent and Trademark
Office and foreign patent offices have issued patents with respect to our
products and technologies. These patent applications include international
applications filed under the Patent Cooperation Treaty. Our pending patent
applications, those we may file in the future or those we may license from third
parties may not result in the United States Patent and Trademark Office or
foreign patent office issuing patents. Also, if patent rights covering our
products are not sufficiently broad, they may not provide us with sufficient
proprietary protection or competitive advantages against competitors with
similar products and technologies. Furthermore, if the United States Patent and
Trademark Office or foreign patent offices issue patents to us or our licensors,
others may challenge the patents or circumvent the patents, or the patent office
or the courts may invalidate the patents. Thus, any patents we own or license
from or to third parties may not provide any protection against competitors.
Furthermore, the life of our patents is limited. We have licensed a series of
patents from Johnson & Johnson, Inc., and Ortho Pharmaceutical Corporation which
are important, either individually or collectively, to our strategy of
commercializing our surfactant technology. Such patents, which include relevant
European patents, expire on various dates beginning in 2009 and ending in 2017.
We have filed, and when possible and appropriate, will file, other patent
applications with respect to our products and processes in the United States and
in foreign countries. We may not be able to develop additional products or
processes that will be patentable or additional patents may not be issued to us.
See also "Risks Related to Our Business-If we cannot meet requirements under our
license agreements, we could lose the rights to our products."
Intellectual property rights of third parties could limit our ability to market
our products.
Our commercial success also significantly depends on our ability to operate
without infringing the patents or violating the proprietary rights of others.
The United States Patent and Trademark Office keeps United States patent
applications confidential while the applications are pending. As a result, we
cannot determine which inventions third parties claim in pending patent
applications that they have filed. We may need to engage in litigation to defend
or enforce our patent and license rights or to determine the scope and validity
of the proprietary rights of others. It will be expensive and time consuming to
defend and enforce patent claims. Thus, even in those instances in which the
outcome is favorable to us, the proceedings can result in the diversion of
substantial resources from our other activities. An adverse determination may
subject us to significant liabilities or require us to seek licenses that third
parties may not grant to us or may only grant at rates that diminish or deplete
the profitability of the products to us. An adverse determination could also
require us to alter our products or processes or cease altogether any related
research and development activities or product sales.
If we cannot meet requirements under our license agreements, we could lose the
rights to our products.
We depend on licensing arrangements with third parties to maintain the
intellectual property rights to our products under development. Presently, we
have licensed rights from Johnson & Johnson and Ortho Pharmaceutical, and the
Charlotte-Mecklenberg Hospital Authority. These agreements require us to make
payments and satisfy performance obligations in order to maintain our rights
under these licensing arrangements. All of these agreements last either
throughout the life of the patents, or with respect to other licensed
technology, for a number of years after the first commercial sale of the
relevant product.
Page 15
In addition, we are responsible for the cost of filing and prosecuting certain
patent applications and maintaining certain issued patents licensed to us. If we
do not meet our obligations under our license agreements in a timely manner, we
could lose the rights to our proprietary technology.
In addition, we may be required to obtain licenses to patents or other
proprietary rights of third parties in connection with the development and use
of our products and technologies. Licenses required under any such patents or
proprietary rights might not be made available on terms acceptable to us, if at
all.
We rely on confidentiality agreements that could be breached and may be
difficult to enforce.
Although we believe that we take reasonable steps to protect our intellectual
property, including the use of agreements relating to the non-disclosure of
confidential information to third parties, as well as agreements that purport to
require the disclosure and assignment to us of the rights to the ideas,
developments, discoveries and inventions of our employees and consultants while
we employ them, the agreements can be difficult and costly to enforce. Although
we seek to obtain these types of agreements from our consultants, advisors and
research collaborators, to the extent that they apply or independently develop
intellectual property in connection with any of our projects, disputes may arise
as to the proprietary rights to this type of information. If a dispute arises, a
court may determine that the right belongs to a third party, and enforcement of
our rights can be costly and unpredictable. In addition, we will rely on trade
secrets and proprietary know-how that we will seek to protect in part by
confidentiality agreements with our employees, consultants, advisors or others.
Despite the protective measures we employ, we still face the risk that:
- -- they will breach these agreements;
- -- any agreements we obtain will not provide adequate remedies for this type
of breach or that our trade secrets or proprietary know-how will otherwise
become known or competitors will independently develop similar technology;
and
- -- our competitors will independently discover our proprietary information
and trade secrets.
If the parties we depend on for manufacturing our pharmaceutical products do not
timely supply these products, it may delay or impair our ability to develop and
market our products.
We rely on outside manufacturers for our drug substance and other active
ingredients for Surfaxin and to produce material that meets appropriate
standards for use in clinical studies for our products. We will also rely on
outside manufacturers for production of our products after marketing approval.
We may also enter into arrangements with other manufacturers for the manufacture
of materials for use in clinical testing and after marketing approval.
Our outside manufacturers may not perform as they have agreed or may not remain
in the contract manufacturing business for a sufficient time to successfully
produce and market our product candidates. If we do not maintain important
manufacturing relationships, we may fail to find a replacement manufacturer or
to develop our own manufacturing capabilities. If we cannot do so, it could
delay or impair our ability to obtain regulatory approval for our products and
substantially increase our costs or deplete any profit margins. If we do find
replacement manufacturers, 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 may in the future elect to manufacture some of our products on our own.
Although we own certain specialized manufacturing equipment, are considering an
investment in additional manufacturing equipment and employ certain
manufacturing managerial personnel, we do not presently maintain a complete
manufacturing facility or manufacturing department and we do not anticipate
manufacturing on our own any of our products during the next 12 months. If we
decide to manufacture products on our own and do not successfully develop
manufacturing capabilities, it will adversely affect sales of our products.
In addition, the FDA and foreign regulatory authorities require manufacturers to
register manufacturing facilities. The FDA and corresponding foreign regulators
inspect these facilities to confirm compliance with good manufacturing practices
(GMPs) or similar requirements that the FDA or corresponding foreign regulators
establish. If our third-party foreign or domestic suppliers or manufacturers of
our products or, if we decide to manufacture our products on our own, we, fail
to comply with GMP requirements or other FDA and comparable foreign regulatory
requirements, it could adversely affect our ability to market and develop our
products.
Page 16
Our lack of marketing and sales experience could limit our ability to generate
revenues from future product sales.
We do not have marketing, sales or distribution experience or marketing or sales
personnel. As a result, we will depend on our collaboration with Quintiles for
the marketing and sales of Surfaxin for indications of Respiratory Distress
Syndrome in premature infants and Meconium Aspiration Syndrome in full-term
infants in the United States and with Esteve for the marketing and sales of
Surfaxin for the treatment of Respiratory Distress Syndrome in premature
infants, Meconium Aspiration Syndrome in full-term infants and Acute Lung
Injury/Acute Respiratory Distress Syndrome in adult patients in all of Europe,
Central America and South America, and Mexico. See "Risks Related to Our
Business-Our strategy, in many cases, is to enter into collaboration agreements
with third parties with respect to our products and we may require additional
collaboration agreements. If we fail to enter into these agreements or if we or
the third parties do not perform under such agreements, it could impair our
ability to commercialize our products." If we do not develop a marketing and
sales force of our own, then we will depend on arrangements with corporate
partners or other entities for the marketing and sale of our remaining products.
The sales and marketing of Surfaxin for indications of Respiratory Distress
Syndrome in premature infants, Meconium Aspiration Syndrome in full-term
infants, and Acute Lung Injury/Acute Respiratory Distress Syndrome in adult
patients in the relevant territories depends, in part, on Quintiles' and
Esteve's performance of their contractual obligations. The failure of either
party to do so would have a material adverse effect on the sales and marketing
of Surfaxin. We may not succeed in entering into any satisfactory third party
arrangements for the marketing and sale of our remaining products. In addition,
we may not succeed in developing marketing and sales capabilities, our
commercial launch of certain products may be delayed until we establish
marketing and sales capabilities or we may not have sufficient resources to do
so. If we fail to establish marketing and sales capabilities or fail to enter
into arrangements with third parties, in a timely manner, it will adversely
affect sales of our products.
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 these personnel may have a material adverse effect on aspects of
our business and clinical development and regulatory programs. We have an
employment agreement with Dr. Capetola that expires on December 31, 2005. We
also have employment agreements with other key personnel with termination dates
in 2003 and 2004. Although these employment agreements generally provide for
severance payments that are contingent upon the applicable employee's refraining
from competition with us, the loss of any of these persons' services would
adversely affect our ability to develop and market our products and obtain
necessary regulatory approvals, and the applicable noncompete provisions can be
difficult and costly to monitor and enforce. 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, including marketing and sales staff. 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.
Page 17
Our industry is highly competitive and we have less capital and resources than
many of our competitors, which may give them an advantage in developing and
marketing products similar to ours or make our products obsolete.
Our industry is highly competitive and subject to rapid technological innovation
and evolving industry standards. We compete with numerous existing companies
intensely in many ways. We intend to market our products under development for
the treatment of diseases for which other technologies and treatments are
rapidly developing and, consequently, we expect new companies to enter our
industry and that competition in the industry will increase. Many of these
companies have substantially greater research and development, manufacturing,
marketing, financial, technological, personnel and managerial resources than we
have. In addition, many of these competitors, either alone or with their
collaborative partners, have significantly greater experience than we do in:
- -- developing products;
- -- undertaking preclinical testing and human clinical trials;
- -- obtaining FDA and other regulatory approvals or products; and
- -- manufacturing and marketing products.
Accordingly, our competitors may succeed in obtaining patent protection,
receiving FDA or comparable foreign approval or commercializing products before
us. If we commence commercial product sales, we will compete against companies
with greater marketing and manufacturing capabilities who may successfully
develop and commercialize products that are more effective or less expensive
than ours. These are areas in which, as yet, we have limited or no experience.
In addition, developments by our competitors may render our product candidates
obsolete or noncompetitive.
Presently, there are no approved drugs that are specifically indicated for
Meconium Aspiration Syndrome in full-term infants or Acute Lung Injury/Acute
Respiratory Distress Syndrome in adults. Current therapy consists of general
supportive care and mechanical ventilation. Four products are specifically
approved for the treatment of Respiratory Distress Syndrome in premature
infants. CurosurfTM is a porcine lung extract that is marketed in Europe by
Chiesi Farmaceutici S.p.A., and in the United States by Dey Laboratories, Inc.
ExosurfTM is marketed by GlaxoSmithKline, plc, outside the United States and
contains only phospholipids (the fats normally present in the lungs) and
synthetic organic detergents and no stabilizing protein or peptides. SurvantaTM,
marketed by the Ross division of Abbot Laboratories, Inc., is an extract of
bovine lung that contains the cow version of surfactant protein B. Forrest
Laboratories, Inc., markets its calf lung surfactant, InfasurfTM in the United
States for the treatment of Respiratory Distress Syndrome in premature infants.
Although none of the four approved surfactants for Respiratory Distress Syndrome
in premature infants is approved for Acute Lung Injury or Acute Respiratory
Distress Syndrome in adults, which are significantly larger markets, there are a
significant number of other potential therapies in development for the treatment
of Acute Lung Injury/Acute Respiratory Distress Syndrome that are not
surfactant-related. Any of these various drugs or devices could significantly
impact the commercial opportunity for Surfaxin. We believe that engineered
humanized surfactants such as Surfaxin will be far less expensive to produce
than the animal-derived products approved for the treatment of Respiratory
Distress Syndrome in premature infants and will have no capability of
transmitting the brain-wasting bovine spongiform encephalopathy (commonly called
"mad-cow disease") or causing adverse immunological responses in young and older
adults.
We also face, and will continue to face, competition from colleges,
universities, governmental agencies and other public and private research
organizations. These competitors are becoming more active in seeking patent
protection and licensing arrangements to collect royalties for use of technology
that they have developed. Some of these technologies may compete directly with
the technologies that we are developing. These institutions will also compete
with us in recruiting highly qualified scientific personnel. We expect that
therapeutic developments in the areas in which we are active may occur at a
rapid rate and that competition will intensify as advances in this field are
made. As a result, we need to continue to devote substantial resources and
efforts to research and development activities.
If product liability claims are brought against us, it may result in reduced
demand for our products or damages that exceed our insurance coverage.
The clinical testing of, marketing and use of our products exposes us to product
liability claims in the event that the use or misuse of those products causes
injury, disease or results in adverse effects. Use of our products in clinical
trials, as well as commercial sale, could result in product liability claims. In
addition, sales of our products
Page 18
through third party arrangements could also subject us to product liability
claims. We presently carry product liability insurance with coverages of up to
$10,000,000 per occurrence and $10,000,000 in the aggregate, an amount we
consider reasonable and customary relating to our clinical trials of Surfaxin.
However, this insurance coverage includes various deductibles, limitations and
exclusions from coverage, and in any event might not fully cover any potential
claims. We may need to obtain additional product liability insurance coverage
prior to initiating other clinical trials. We expect to obtain product liability
insurance coverage before commercialization of our proposed products; however,
the insurance is expensive and insurance companies may not issue this type of
insurance when we need it. We may not be able to obtain adequate insurance in
the future at an acceptable cost. Any product liability claim, even one that was
not in excess of our insurance coverage or one that is meritless and/or
unsuccessful, could adversely affect our cash available for other purposes, such
as research and development. In addition, the existence of a product liability
claim could affect the market price of our common stock.
We expect to face uncertainty over reimbursement and healthcare reform.
In both the United States and other countries, sales of our products will depend
in part upon the availability of reimbursement from third party payors, which
include government health administration authorities, managed care providers and
private health insurers. Third party payors are increasingly challenging the
price and examining the cost effectiveness of medical products and services. In
addition, significant uncertainty exists as to the reimbursement status of newly
approved health care products. Our products may not be considered cost
effective. Adequate third party reimbursement may not be available to enable us
to maintain price levels sufficient to realize an appropriate return on our
investment in the research and development of our products.
The United States and other countries continue to propose and pass legislation
designed to reduce the cost of healthcare. Accordingly, legislation and
regulations affecting the pricing of our products may change before the products
are approved for marketing to the public. Adoption of new legislation and
regulations could further limit reimbursement for our products. If third party
payors fail to provide adequate coverage and reimbursement rates for our
products, the market acceptance of the products may be adversely affected. In
that case, our business and financial condition will suffer.
Directors, executive officers, principal stockholders and affiliated entities
own a significant percentage of our capital stock, and they may make decisions
that you do not consider to be in your best interest.
As of June 30, 2002, our directors, executive officers, principal stockholders
and affiliated entities beneficially owned, in the aggregate, approximately 28%
of our outstanding voting securities. As a result, if some or all of them acted
together, they would have the ability to exert substantial influence over the
election of our Board of Directors and the outcome of issues requiring approval
by our stockholders. This concentration of ownership may have the effect of
delaying or preventing a change in control of the Company that may be favored by
other stockholders. This could prevent transactions in which stockholders might
otherwise recover a premium for their shares over current market prices.
The market price of our stock may be adversely affected by market volatility.
The market price of our common stock, like that of many other development stage
pharmaceutical or biotechnology companies, has been and is likely to be
volatile. In addition to general economic, political and market conditions, the
price and trading volume of our stock could fluctuate widely in response to many
factors, including:
- -- announcements of the results of clinical trials by us or our competitors;
- -- adverse reactions to products;
- -- governmental approvals, delays in expected governmental approvals or
withdrawals of any prior governmental approvals or public or regulatory
agency concerns regarding the safety or effectiveness of our products;
- -- changes in U.S. or foreign regulatory policy during the period of product
development;
- -- developments in patent or other proprietary rights, including any third
party challenges of our intellectual property rights;
- -- announcements of technological innovations by us or our competitors;
- -- announcements of new products or new contracts by us or our competitors;
- -- actual or anticipated variations in our operating results due to the level
of development expenses and other factors;
Page 19
- -- changes in financial estimates by securities analysts and whether our
earnings meet or exceed the estimates;
- -- conditions and trends in the pharmaceutical and other industries;
- -- new accounting standards; and
- -- the occurrence of any of the risks described in these "Management's
Discussion and Analysis-Risks Related to Our Business."
Our common stock is listed for quotation on the NASDAQ SmallCap Market. For the
3-month period ended June 30, 2002, the price of our common stock has ranged
from $3.26 to $1.28. For the 6-month period ended June 30, 2002, the price of
our common stock has ranged from $4.19 to $1.28. We expect the price of our
common stock to remain volatile. The average daily trading volume in our common
stock varies significantly. For the 3-month period ending June 30, 2002, the
average daily trading volume in our common stock was 67,283 shares and the
average number of transactions per day was approximately 61. For the 6-month
period ending June 30, 2002, the average daily trading volume in our common
stock was 49,836 shares and the average number of transactions per day was
approximately 52. Our relatively low average volume and low average number of
transactions per day may affect the ability of our stockholders to sell their
shares in the public market at prevailing prices and a more active market may
never develop.
In addition, we may not be able to continue to adhere to the strict listing
criteria of the SmallCap Market. If our common stock were no longer listed on
the SmallCap Market, investors might only be able to trade in the
over-the-counter market in the Pink Sheets(R) (a quotation medium operated by
the National Quotation Bureau, LLC) or on the OTC Bulletin Board(R) of the
National Association of Securities Dealers, Inc. This would impair the liquidity
of our securities not only in the number of shares that could be bought and sold
at a given price, which might be depressed by the relative illiquidity, but also
through delays in the timing of transactions and reduction in media coverage.
In the past, following periods of volatility in the market price of the
securities of companies in our industry, securities class action litigation has
often been instituted against companies in our industry. If we face securities
litigation in the future, even if meritless or unsuccessful, it would result in
substantial costs and a diversion of management attention and resources, which
would negatively impact our business.
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 June 30, 2002, we had 26,406,766 shares of common stock outstanding. In
addition, as of June 30, 2002, up to approximately 8,612,000 shares of our
common stock were issuable on 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.
Provisions of our Certificate of Incorporation and Delaware law could defer a
change of our management which could discourage or delay offers to acquire us.
Provisions of our Certificate of Incorporation and Delaware law may make it more
difficult for someone to acquire control of us or for our stockholders to remove
existing management, and might discourage a third party from offering to acquire
us, even if a change in control or in management would be beneficial to our
stockholders. For example, our Certificate of Incorporation allows us to issue
shares of preferred stock without any vote or further action by our
stockholders. Our Board of Directors has the authority to fix and determine the
relative rights and preferences of preferred stock. Our Board of Directors also
has the authority to issue preferred stock without further stockholder approval.
As a result, our Board of Directors could authorize the issuance of a series of
preferred stock that would grant to holders the preferred right to our assets
upon liquidation, the right to receive dividend payments before dividends are
distributed to the holders of common stock and the right to the redemption of
the shares, together with a premium, prior to the redemption of our common
stock. In addition, our Board of Directors, without further stockholder
approval, could issue large blocks of preferred stock.
Page 20
ITEM 3. 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.
Page 21
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
None.
ITEM 2. CHANGE IN SECURITIES.
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
At an annual meeting of the stockholders of the Company, held on May 21, 2002,
the following matters were voted on by the stockholders: (i) the election of
five directors; (ii) the approval of Ernst and Young LLP as the Company's
independent auditors for the fiscal year ended December 31, 2002; (iii)
consideration and approval of an amendment to the 1998 Amended and Restated
Stock Incentive Plan (the "Plan") to increase the number of shares of Common
Stock available for issuance under the Plan from 4,150,000 to 5,150,000 shares;
and (iv) consideration and approval of an amendment to the Company's Restated
Certificate of Incorporation to increase the number of authorized shares of
Common Stock available for issuance by the Company from 35 million to 60
million.
(i) Election of Directors
For Withheld
--- --------
Robert J. Capetola, Ph.D. 18,965,669 312,572
Antonio Esteve, Ph.D. 19,137,529 140,712
Max Link, Ph.D. 19,203,999 74,242
Herbert H. McDade, Jr. 19,167,221 111,020
Marvin E. Rosenthale, Ph.D. 19,168,776 109,465
(ii) Approval of Independent Auditors
For Against Abstain
--- ------- -------
19,241,003 28,438 8,800
(iii) Amendment to the 1998 Amended and Restated Stock Incentive Plan
For Against Abstain Not Voted
--- ------- ------- ---------
18,065,732 1,114,240 98,269 7,118,525
(iv) Amendment to the Company's Restated Certificate of Incorporation
For Against Abstain Not Voted
--- ------- ------- ---------
18,836,050 434,791 7,400 7,118,525
ITEM 5. OTHER INFORMATION.
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits:
99.1 Certification of Chief Executive Officer
99.2 Certification of Chief Financial Officer
(b) Reports on Form 8-K:
None.
Page 22
SIGNATURES
In accordance with the requirements of the Exchange Act, the Registrant has
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
Discovery Laboratories, Inc.
(Registrant)
Date: August 13, 2002 /s/ Robert J. Capetola, Ph.D.
--------------------------------------------
Robert J. Capetola, Ph.D.
President/Chief Executive Officer
Date: August 13, 2002 /s/ John G. Cooper
--------------------------------------------
John G. Cooper
Sr. Vice President, Chief Financial Officer
(Principal Financial Officer)
Page 23
Exhibit 99.1
CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350
AS ADOPTED PURSUANT TO SECTION 906 OF THE
SARBANES-OXLEY ACT OF 2002
In connection with the quarterly report on Form 10-Q of Discovery
Laboratories, Inc. (the "Company"), for the period ended June 30, 2002 as filed
with the Securities and Exchange Commission on the date hereof (the "Report"),
I, Robert J. Capetola, President and Chief Executive Officer of the Company,
certify, pursuant to 18 U.S.C. ss. 1350, as adopted pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002, that:
1. the Report fully complies with the requirements of Section 13(a) or
15(d) of the Securities Exchange Act of 1934, as amended; and
2. the information contained in the Report fairly presents, in all
material respects, the financial condition and results of operations
of the Company.
/s/ Robert J. Capetola
-----------------------------------
Robert J. Capetola, Ph.D.
President and
Chief Executive Officer
Date: August 13, 2002
Exhibit 99.2
CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350
AS ADOPTED PURSUANT TO SECTION 906 OF THE
SARBANES-OXLEY ACT OF 2002
In connection with the quarterly report on Form 10-Q of Discovery
Laboratories, Inc. (the "Company"), for the period ended June 30, 2002 as filed
with the Securities and Exchange Commission on the date hereof (the "Report"),
I, John G. Cooper, Senior Vice President and Chief Financial Officer of the
Company, certify, pursuant to 18 U.S.C. ss. 1350, as adopted pursuant to Section
906 of the Sarbanes-Oxley Act of 2002, that:
1. the Report fully complies with the requirements of Section 13(a) or
15(d) of the Securities Exchange Act of 1934, as amended; and
2. the information contained in the Report fairly presents, in all
material respects, the financial condition and results of operations
of the Company.
/s/ John G. Cooper
---------------------------------
John G. Cooper
Senior Vice President,
Chief Financial Officer
Date: August 13, 2002