UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
/X/ Annual Report pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the fiscal year ended December 31, 2003
-------------------------------------------
/ / 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 0-26422
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DISCOVERY LABORATORIES, INC.
- --------------------------------------------------------------------------------
(Exact name of registrant 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
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Name of each exchange
Title of each class on which registered
------------------- -------------------
None None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.001 par value and,
Preferred Stock Purchase Rights
(Title of class)
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 [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K (ss.229.405 of this chapter) is not contained herein, and will
not be contained, to the best of the registrant's knowledge, in definitive proxy
or information statements incorporated by reference in Part III of this Form
10-K or any amendment to this Form 10-K. / /
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). YES /X/ NO / /
The aggregate market value of shares of voting and non-voting common equity held
by non-affiliates of the registrant computed using the closing price of common
equity as reported on NASDAQ SmallCap Market under the symbol DSCO on June 30,
2003, the last business day of the registrant's most recently completed second
fiscal quarter, was approximately $285 million. For the purposes of determining
this amount only, the registrant has defined affiliates to include: (a) the
executive officers named in Part III of this Annual Report on Form 10-K; (b) all
directors of the registrant; and (c) each shareholder that has informed the
registrant by February 29, 2004 that it is the beneficial owner of 10% or more
of the outstanding shares of common stock of the registrant.
As of February 29, 2004, 43,697,370 shares of the registrant's common stock were
outstanding.
Portions of the information required by Items 10 through 13 of Part III of this
Annual Report on Form 10-K are incorporated by reference to the extent described
herein from our definitive proxy statement, which is expected to be filed by us
with the Commission within 120 days after the close of our 2003 fiscal year.
ii
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.
FORWARD LOOKING STATEMENTS
The statements set forth under Item 1: "Business" and elsewhere in this report,
including in Item 7: "Management's Discussion and Analysis of Financial
Condition and Results of Operations - Risks Related to Our Business" 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 us to fund our
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 results of clinical trials being
conducted by us and the risk that our lead product candidate, Surfaxin(R), will
not prove to be safe or useful for the treatment of certain indications);
clinical trials require adequate supplies of drug substance and drug product
which may be difficult or uneconomical to procure or manufacture; timely
obtaining sufficient patient enrollment in our clinical trials; 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 progress of FDA
approvals in connection with the conduct of our clinical trials and the
marketing of our products; the additional costs 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 7: "Management's
Discussion and Analysis of Financial Condition and Results of Operations - Risks
Related to Our Business," 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, whether as a result of new information,
future events or otherwise.
iii
DISCOVERY LABORATORIES, INC.
Table of contents to Form 10-K
For the Fiscal Year Ended December 31, 2003
PART I
ITEM 1. BUSINESS.......................................................................................1
ITEM 2. PROPERTIES....................................................................................17
ITEM 3. LEGAL PROCEEDINGS.............................................................................17
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS...........................................17
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.........................18
ITEM 6. SELECTED FINANCIAL DATA.......................................................................19
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.........20
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK....................................44
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA...................................................45
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE..........45
ITEM 9A. CONTROLS AND PROCEDURES.......................................................................45
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT............................................45
ITEM 11. EXECUTIVE COMPENSATION........................................................................45
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER
MATTERS.......................................................................................45
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS................................................45
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES........................................................45
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND
REPORTS ON FORM 8-K...........................................................................46
SIGNATURES................................................................................................47
iv
PART I
ITEM 1. BUSINESS.
COMPANY SUMMARY
We are a biopharmaceutical company developing our proprietary humanized lung
surfactant technology as Surfactant Replacement Therapies for respiratory
diseases. Surfactants are compositions produced naturally in the lungs and are
essential to the lungs' ability to absorb oxygen and to maintain proper airflow
through the respiratory system. The absence or depletion of surfactants is
involved in a number of respiratory diseases.
Our technology produces an engineered version of natural human lung surfactant
that is designed to closely mimic the essential properties of human lung
surfactant. We believe that our surfactant technology provides the opportunity,
for the first time, for pulmonary surfactants to be developed into a series of
respiratory therapies for critical care and other hospitalized patients where
there are few or no approved therapies available.
We recently completed two Phase 3 clinical trials of Surfaxin(R), our lead
product, for the treatment of Respiratory Distress Syndrome in premature infants
and are preparing to file new drug applications with the United States Food and
Drug Administration and other regulatory authorities in the rest of the world.
Our Surfactant Replacement Therapy is also in a Phase 2 clinical trial for the
treatment of Acute Respiratory Distress Syndrome in adults, as well as in a
Phase 3 and Phase 2 clinical trial for the treatment of Meconium Aspiration
Syndrome in full-term infants. In addition, we recently completed a successful
Phase 1b clinical trial in healthy volunteers and mild asthmatics and are
currently preparing to initiate a follow-on Phase 2 clinical trial evaluating
the safety, tolerability and efficacy of our humanized lung surfactant,
delivered as an inhaled aerosol (development name DSC-104), to treat patients
with asthma.
Presently, we are evaluating the development of other aerosolized formulations
of our humanized surfactant to potentially treat premature infants in Neonatal
Intensive Care Units in hospitals that are suffering from Respiratory
Dysfunction. We are also evaluating aerosolized formulations of our humanized
surfactant to potentially treat Acute Lung Injury, chronic obstructive pulmonary
disease (often referred to as COPD, which is a chronic condition of the lung
that prevents enough oxygen from reaching the blood), rhinitis, sinusitis
(infection of the sinuses), sleep apnea and otitis media (inner ear infection).
We are presently implementing a long-term commercial strategy which includes
manufacturing for the production of our humanized surfactant drug products to
meet anticipated clinical and commercial needs, and sales and marketing
capabilities to execute the launch of Surfaxin, if approved, in the U.S. and
Europe.
1
SURFACTANT TECHNOLOGY
Our humanized surfactant technology was invented at The Scripps Research
Institute and was exclusively licensed to Johnson & Johnson which, together with
its wholly-owned subsidiary, Ortho Pharmaceutical Corporation, developed it
further. We acquired the exclusive worldwide sublicense to the technology in
October 1996.
Surfactants are protein and lipid (fat) compositions that are produced naturally
in the lungs and are critical to all air-breathing mammals. They cover the
entire alveolar surface, or air sacs, of the lungs and the terminal conducting
airways which lead to the air sacs. Surfactants facilitate respiration by
continually modifying the surface tension of the fluid normally present within
the alveoli, or air sacs, that line the inside of the lungs. In the absence of
sufficient surfactant or should the surfactant degrade, these air sacs tend to
collapse, and, as a result, the lungs do not absorb sufficient oxygen. In
addition to lowering aveolar surface-tension, surfactants play other important
roles in human respiration including, but not limited to, lowering the surface
tension of the conducting airways and maintaining airflow and airway patency
(keeping the airways open and expanded). Human surfactants include four known
surfactant proteins, A, B, C and D. It has been established, through numerous
studies, that surfactant protein B (SP-B) is essential for respiratory function.
Presently, the FDA has approved surfactants as replacement therapy only for
Respiratory Distress Syndrome in premature infants, a condition in which infants
are born too soon and thus have an insufficient amount of their own natural
surfactant. The most commonly used of these approved replacement surfactants are
derived from pig and cow lungs. Though they are clinically effective, they have
drawbacks and cannot readily be scaled or developed to treat broader populations
for Respiratory Distress Syndrome in premature infants and other respiratory
diseases. There is presently only one approved synthetic surfactant available,
however, this product does not contain surfactant proteins, is not widely used
and is not actively marketed by its manufacturer.
Animal-derived surfactant products are prepared using a chemical extraction
process from minced cow and pig lung. Because of the animal-sourced materials
and the chemical extraction processes, there can potentially be significant
variation in production lots and, consequently, product quality specifications
must be broad. In addition, the protein levels of these animal-derived
surfactants are inherently lower than the protein levels of native human
surfactant. The production costs of these animal-derived surfactants are high,
relative to other analogous pharmaceutical products, generation of large
quantities is severely limited, and these products cannot readily be
reformulated for aerosol delivery to the lungs.
Our humanized surfactant product candidates, including Surfaxin, are engineered
versions of natural human lung surfactant and contain a humanized peptide,
sinapultide. Sinapultide is a 21 amino acid protein-like substance that is
designed to closely mimic the essential attributes of human surfactant protein B
(SP-B), the surfactant protein that is most important for the proper functioning
of the respiratory system. Our products have the ability to be precisely
formulated, either as a liquid instillate, aerosolized liquid or dry powder, to
address various medical indications.
2
We believe that our engineered humanized surfactant can be manufactured in
sufficient quantities, in more exact and consistent pharmaceutical grade
quality, less expensively than the animal-derived surfactants and has no
potential to cause adverse immunological responses in young and older adults,
all important attributes for our products to potentially meet significant unmet
medical needs. In addition, we believe that our engineered humanized surfactants
might possess other pharmaceutical benefits not currently found with the animal
surfactants such as longer shelf-life, reduced number of administrations to the
patient's lungs and elimination of the risk of animal-borne diseases including
the brain-wasting bovine spongiform encephalopathy (commonly called "mad-cow
disease").
Aerosolized Surfactant Formulations
Many respiratory diseases are associated with an inflammatory event that causes
surfactant dysfunction and a loss of patency of the conducting airways.
Scientific data supports the premise that the therapeutic use of surfactants in
aerosol form has the ability to reestablish airway patency, improve pulmonary
mechanics and act as an anti-inflammatory. Surfactant normally prevents moisture
from accumulating in the airways' most narrow sections and thereby maintains the
patency of the conducting airways.
We are currently developing aerosolized formulations of our humanized surfactant
to potentially treat patients who could benefit from surfactant-based therapy to
improve lung function and maintain proper airflow through the respiratory
system. Our aerosol development program is initially focused on surfactant-based
therapy for hospitalized patients suffering from severe acute asthma or Acute
Lung Injury. In addition, we believe that scientific rationale supports the
development of aerosolized formulations of our humanized surfactant to
potentially treat COPD, sinusitis, rhinitis, sleep apnea and otitis media (inner
ear infection).
The aerosolized formulations of our humanized surfactant that we are currently
developing are intended to be administered using various aerosol devices and, to
date, we have achieved the following important development objectives:
- -- full retention of the surface-tension lowering properties of a
functioning surfactant necessary to restore lung function and maintain
patency of the conducting airways;
- -- full retention of the surfactant composition upon aerosolization;
- -- drug particle size suitable for deposition in the deep-lungs;
- -- delivery rates to achieve therapeutic dosages in a reasonable time
period; and
- -- reproducible aerosol output and minimal waste of surfactant dose.
3
SURFACTANT THERAPY FOR RESPIRATORY MEDICINE
Products for the Neonatal Intensive Care Unit
Surfaxin for Respiratory Distress Syndrome in Premature Infants
Respiratory Distress Syndrome is a condition in which premature infants are born
with an insufficient amount of their own natural surfactant. Premature infants
born prior to 32 weeks gestation have not fully developed their own natural lung
surfactant and therefore need treatment to sustain life. This condition often
results in the need for the infant to undergo surfactant replacement therapy or
mechanical ventilation. Respiratory Distress Syndrome is experienced in
approximately half of the babies born between 28 and 32 weeks gestational age.
The incidence of Respiratory Distress Syndrome approaches 100% in babies born
less than 26 weeks gestational age. Surfaxin is the first humanized, protein
B-based agent that mimics the surface-active properties of human surfactant. To
treat premature infants suffering from Respiratory Distress Syndrome,
surfactants, including Surfaxin, are delivered in a liquid form and injected
through an endotracheal tube (a tube inserted into the infant's mouth and down
the trachea).
During 2003, we completed and announced successful results from both a landmark,
pivotal Phase 3 clinical trial and a supportive Phase 3 clinical trial of
Surfaxin for the treatment of Respiratory Distress Syndrome in premature
infants. We intend to use the results from these trials to form the basis for a
new drug application (NDA) for approval in the United States and to support
other regulatory applications in the rest of the world. Filing of the NDA is
anticipated in April 2004.
The pivotal Phase 3 trial enrolled 1,294 patients and was designed as a
multinational, multicenter, randomized, masked, controlled, prophylaxis,
event-driven, superiority trial to demonstrate the safety and efficacy of
Surfaxin over Exosurf(R), an approved, non-protein containing synthetic
surfactant. Survanta(R), a cow-derived surfactant and the leading surfactant
used in the United States, served as a reference arm in the trial. Key trial
results were assessed by an independent adjudication committee comprised of
leading neonatologists and pediatric radiologists. This committee provided a
consistent and standardized method for assessing critical efficacy data in the
trial. An independent Data Safety Monitoring Board (DSMB) was responsible for
monitoring the overall safety of the trial and no major safety issues were
identified. In accordance with the study's trial design, we continue to conduct
six and twelve month clinical follow-up on all enrolled patients.
The supportive, multinational Phase 3 clinical trial enrolled 252 patients and
was designed as a non-inferiority trial comparing Surfaxin to Curosurf(R), a
porcine (pig) derived surfactant and the leading surfactant used in Europe. This
trial demonstrated the overall safety and non-inferiority of Surfaxin to
Curosurf. In accordance with the study's trial design, we continue to conduct
six and twelve month clinical follow-up on all enrolled patients.
There are over 3,000,000 premature infants born annually worldwide. More than
850,000 of these premature infants are considered "very low birth weight"
infants (less than 1,250 grams), of which, approximately 700,000 are considered
at significant risk for Respiratory Distress Syndrome. Due to limitations
associated with the animal-derived surfactant products that are currently
approved to treat Respiratory Distress Syndrome in premature infants, access to
such therapy is mainly limited to the approximately 150,000 very low birth
weight infants born in the United States and Western Europe. This results in
hundreds of thousands of premature infants born in the world each year who need,
but do not receive, effective surfactant replacement therapy.
4
The FDA has granted us Orphan Drug Designation for Surfaxin for Respiratory
Distress Syndrome. Orphan drugs are pharmaceutical products that are intended to
treat diseases affecting fewer than 200,000 patients in the United States. The
Office of Orphan Product Development of the FDA grants certain advantages to the
sponsors of orphan drugs including, but not limited to, seven years of market
exclusivity upon approval of the drug, certain tax incentives for clinical
research and grants to fund testing of the drug. We are also seeking Orphan
Product designation from the European Medicines Evaluation Agency (the European
Union's regulatory approval agency that is similar to the FDA) for Surfaxin for
indications of Respiratory Distress Syndrome in premature infants.
Aerosolized Surfactant Replacement Therapy for Respiratory Dysfunction in
Premature Infants
Serious respiratory problems are some of the most prevalent medical issues
facing premature infants in Neonatal Intensive Care Units. On top of the
approximately 700,000 premature infants born annually worldwide at risk for
Respiratory Distress Syndrome, there are another approximately 1 million
premature infants, 300,000 of which are in the US and Europe, born annually at
risk for a range of other respiratory problems associated with surfactant
dysfunction. These infants are usually at a birth weight greater than 1,250
grams and neonatologists generally try to avoid mechanically ventilating these
patients because doing so requires intubation (the highly invasive process of
inserting a breathing tube down the patient's trachea). This reluctance is due
to the perceived risks by many neonatologists regarding the intubation of these
larger babies, such as the risk of trauma and the need of paralytic agents and
sedation. As a result, many neonatologists will only intubate in cases of severe
respiratory disease, where the benefits clearly outweigh the risks. We believe
that there is growing recognition by the neonatal medical community for the
potential utility of a non-invasive method of delivering surfactant replacement
therapy to treat premature infants suffering from Respiratory Dysfunctions
beyond Respiratory Distress Syndrome.
We are presently evaluating the development of aerosolized formulations of our
humanized surfactant administered via a nasal continuous positive airway
pressure or similar device as a non-invasive means to potentially treat
premature infants in Neonatal Intensive Care Units suffering from Respiratory
Dysfunction. We are preparing to initiate a Phase 2 dose escalation clinical
trial that we anticipate conducting at several leading neonatal clinics in the
U.S. in the second half of 2004.
Surfaxin for Meconium Aspiration Syndrome in Full-Term Infants
Meconium Aspiration Syndrome (often referred to as MAS) is an inflammatory
condition in which full-term infants are born with meconium in their lungs that
depletes the natural surfactant in their lungs. Meconium is a baby's first bowel
movement in its mother's womb and, when inhaled, Meconium Aspiration Syndrome
can occur. Meconium Aspiration Syndrome can be life-threatening as a result of
the failure of the lungs to absorb sufficient oxygen. There are no approved
therapies for this condition and the standard of care principally consists of
mechanical ventilation. Surfaxin has been shown to not only remove inflammatory
and infectious infiltrates from the lungs when using our proprietary lavage (or
"lung wash") but to also replenish the vital surfactant levels in the babies'
lungs.
5
Surfaxin is being evaluated in a Phase 3 clinical trial for the treatment of
Meconium Aspiration Syndrome in full-term infants. To our knowledge, Surfaxin is
the only product being developed worldwide to treat this syndrome. The trial is
designed for the enrollment of up to 200 infants at medical centers throughout
the United States to compare our proprietary Surfaxin lavage to the current
standard of care.
We also have initiated a Phase 2 clinical trial of our proprietary Surfaxin
lavage in up to 60 full-term infants for use as a prophylactic or early
treatment for patients who are at risk of developing Meconium Aspiration
Syndrome but have not shown symptoms of compromised respiratory function.
Surfaxin is administered as a liquid bolus through an endotracheal tube as well
as by our proprietary lavage ("lung-wash") technique. We believe an effective
and affordable surfactant prophylactic therapy could significantly lower the
risk to meconium-stained infants of chronic respiratory conditions and reduce
the need for costly and invasive mechanical ventilation.
We presently anticipate both of the trials for the treatment of Meconium
Aspiration Syndrome to be completed in 2005. See Item 7: "Management's
Discussion and Analysis of Financial Condition and Results of Operations - Risks
Related to our Business - The clinical trial and regulatory approval process for
our products is expensive and time consuming, and the outcome is uncertain."
There are presently no drug therapies approved for the treatment of Meconium
Aspiration Syndrome in full-term infants. An estimated 60,000 infants are born
in the United States and Europe that require treatment for MAS, however, a
significantly greater number of infants are born worldwide each year at risk.
The FDA has granted us Fast-Track Status and Orphan Drug Designation for
Surfaxin in this indication. We have also received Orphan Product designation of
Surfaxin for this indication from the European Medicines Evaluation Agency.
Products for the Critical Care Unit and other Hospital Settings
Surfaxin for Acute Respiratory Distress Syndrome in Adults
Acute Respiratory Distress Syndrome (often referred to as ARDS) is a
life-threatening disorder for which no approved therapies exist anywhere in the
world. It is characterized by an excess of fluid in the lungs and decreased
oxygen levels in the patient. One prominent characteristic of this disorder is
the destruction of surfactants naturally present in lung tissue. The conditions
are caused by illnesses including pneumonia and septic shock (a toxic condition
caused by infection) and events such as smoke inhalation, near drowning,
industrial accidents and other traumas.
6
We are presently conducting a Phase 2 open-label, controlled, multi-center
clinical trial of Surfaxin for the treatment of adults with Acute Respiratory
Distress Syndrome. Approximately 110 patients will receive high concentrations
of Surfaxin which will be administered via a proprietary sequential lavage
technique, or lung wash, where Surfaxin is delivered through a bronchoscope to
each of the 19 segments of the lung. The procedure is intended to cleanse and
remove inflammatory substances and debris from the lungs, while leaving
sufficient amounts of Surfaxin behind to help re-establish the lungs' capacity
to absorb oxygen. The objective is to restore functional surfactant levels and
to allow critically ill patients to be removed from mechanical ventilation
sooner.
We have completed Part A of this Phase 2 trial, a dose escalation safety and
tolerability study in 22 patients in four groups (of up to six patients per
group). In consultation with the trial's Independent Safety Review Committee,
comprised of three prominent pulmonologists, we determined that the Part A
portion of the trial procedure is generally safe and tolerable and that it was
appropriate for us to proceed onto the larger safety and efficacy portion of the
trial.
The last part of this Phase 2 trial, Part B, is designed to evaluate safety and
efficacy of Surfaxin in direct comparison to the current standard of care and
will be conducted at approximately 40 centers throughout North America. The
primary endpoint of Part B is to determine the incidence rate of patients
surviving and off mechanical ventilation at the end of day 28 with one of the
key secondary endpoints being all-cause mortality. The Phase 2 clinical trial is
anticipated to be completed in the second half of 2004.
The current standard of care for Acute Respiratory Distress Syndrome includes
placing patients on mechanical ventilators in intensive care units at a cost per
patient of approximately $8,500 per day, typically for an average of 21 to 28
days. There are estimated to be between 150,000 and 200,000 adults per year in
the United States suffering from Acute Respiratory Distress Syndrome with
similar numbers afflicted in Europe. Because there are no approved treatments
for these diseases, the mortality rate can range from 35% to 50%.
The FDA has granted us Fast-Track Status and Orphan Drug Designation for
Surfaxin for the treatment of Acute Respiratory Distress Syndrome in adults. The
European Medicines Evaluation Agency has granted us Orphan Product designation
for Surfaxin for the treatment of Acute Lung Injury in adults (which in this
circumstance is a larger patient population that encompasses Acute Respiratory
Distress Syndrome). We were awarded and received a $1 million Fast-Track Small
Business Innovative Research Grant by the National Institutes of Health to
develop Surfaxin for the treatment of Acute Respiratory Distress Syndrome and
Acute Lung Injury in adults.
Aerosolized Surfactant (development name DSC 104) for Severe, Acute Asthma
Asthma is a common disease characterized by sudden constriction and inflammation
of the lungs. Constriction of the upper airway system occurs when the airway
muscles tighten, while inflammation is a swelling of the airways usually due to
an allergic reaction caused by an airborne irritant. Both of these events cause
airways to narrow and may result in wheezing, shortness of breath and chest
tightness. Several studies have shown that surfactant damage and dysfunction is
a significant component of asthma -- airway constriction occurs when there is a
surfactant dysfunction in the airways of the deep lung of the type that develops
during an asthma attack. We believe that surfactant replacement therapy has the
potential to relieve the constriction in the airways associated with asthma.
7
According to information provided by the American Lung Association, asthma
afflicts more than 20,000,000 people in the United States and its incidence rate
continues to rise. Asthma is a chronic disease; it is prevalent in people of all
ages and an estimated 12,000,000 people have experienced an asthma attack within
the past year. In the United States alone, there are roughly 1,000,000 hospital
outpatient visits, approximately 1,800,000 emergency room visits and 9,300,000
physician visits each year due to asthma. Asthma ranks within the top 10
prevalent activity-limiting health conditions costing $14 billion in United
States healthcare costs annually.
Asthma may require life-long therapy to prevent or treat episodes. Ten percent
of patients are considered severe asthmatics and require moderate to high doses
of drugs. Currently available asthma medications include inhaled and oral
steroids, bronchodilators and leukotriene antagonists. Bronchodilators cannot be
used to control severe episodes or chronic, severe asthma. Oral steroids can
cause serious side effects when used for prolonged periods and, thus, are
typically limited to severe asthmatic episodes and chronic, severe asthma. We
believe that supplying surfactant as an inhaled aerosol may relieve airway
obstruction in the deep lung and lead to a more rapid improvement in asthmatic
symptoms.
We recently completed a Phase 1b clinical trial to evaluate the safety and lung
tolerability and deposition characteristics of our humanized lung surfactant,
delivered as an inhaled aerosol to treat individuals who suffer from asthma.
This masked, placebo-controlled, randomized, Phase 1b study included six healthy
subjects and eight mild-persistent asthmatic patients. Results demonstrated that
DSC-104 was safe and well tolerated, did not induce bronchospasm and was
deposited to both the central and peripheral regions of the lungs in the
mild-persistent asthmatic group and the healthy volunteers. We are presently
preparing a follow-on Phase 2 dose escalation clinical trial evaluating the
safety, tolerability and efficacy of DSC-104 to be conducted at several leading
asthma clinics in the United States that we anticipate initiating in the second
half of 2004.
Aerosolized Surfactant for Acute Lung Injury
Acute Lung Injury is associated with conditions that either directly or
indirectly injure the air sacs of the lung. Acute Lung Injury is a syndrome of
inflammation and increased permeability of the lungs with an associated
breakdown of the lungs' surfactant layer. The most serious manifestation of
Acute Lung Injury is Acute Respiratory Distress Syndrome.
Among the causes of Acute Lung Injury are complications typically associated
with certain major surgeries, mechanical ventilator induced lung injury (often
referred to as VILI), smoke inhalation, pneumonia and sepsis. There are an
estimated 1 million patients at risk in the United States for Acute Lung Injury
annually and there are no currently-approved therapies.
8
We are evaluating aerosolized formulations of our humanized surfactant to
potentially treat Acute Lung Injury. We believe that our proprietary humanized
aerosol surfactant may be effective as a preventive measure for patients at risk
for Acute Lung Injury. This prophylactic approach may result in fewer patients
requiring costly intensive care therapy, thereby eliminating long periods of
therapy and offering cost savings in the hospital setting.
STRATEGIC ALLIANCES
Quintiles Transnational Corp., and PharmaBio Development Inc.
We have a collaboration arrangement with Quintiles Transnational Corp., 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 is obligated to hire and train a dedicated United
States sales force that will be branded in the market as ours. PharmaBio has
agreed to fund up to $70 million of the sales force costs as well as other sales
and marketing costs for commercialization of Surfaxin in the United States for
seven years. Additionally, the collaboration allows for this specialty sales
force to become ours at the end of the seven year term, with an option to
acquire it sooner.
Under the collaboration, we will receive 100% of the revenues from sales of
Surfaxin and have agreed to pay PharmaBio a commission on net sales in the
United States of Surfaxin for the treatment of Respiratory Distress Syndrome in
premature infants and Meconium Aspiration Syndrome in full-term infants and all
"off-label" uses for 10 years following first launch of the product in the
United States. The collaboration allows us to retain product ownership and to
have sales and marketing expertise in place for the commercialization of
Surfaxin, if approved.
PharmaBio also extended to us a secured revolving credit facility of up to
$8,500,000 to $10,000,000 to fund pre-marketing activities associated with the
launch of Surfaxin in the United States as we achieve certain milestones. 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.
Principal amounts owed by us under the credit facility may be repaid out of the
proceeds of milestone payments to be paid to us by PharmaBio upon the
achievement of certain corporate milestones. See Item 7: "Management's
Discussion and Analysis of Financial Condition and Results of Operations -
Liquidity and Capital Resources - Secured, Revolving Credit Facility and Capital
Lease Arrangement."
Laboratorios del Dr. Esteve, S.A.
We have a strategic alliance with Laboratorios del Dr. Esteve to develop, market
and sell Surfaxin throughout Europe and Latin America. Esteve will 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. Our exclusive supply agreement with Esteve 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 the Acute Lung
Injury/Acute Respiratory Distress Syndrome indications. Esteve will make certain
milestone payments to us upon the attainment of European marketing regulatory
approval for Surfaxin. See Item 7: "Management's Discussion and Analysis of
Financial Condition and Results of Operations - Liquidity and Capital Resources
- - Secured, Revolving Credit Facility and Capital Lease Arrangement."
9
LICENSING ARRANGEMENTS; PATENTS AND PROPRIETARY RIGHTS
Patents and Proprietary Rights
Johnson & Johnson and The Scripps Research Institute
Our humanized surfactant platform technology, including Surfaxin, is based on
the proprietary peptide, sinapultide, (a 21 amino acid protein-like substance
that closely mimics the essential human lung protein SP-B). This technology was
invented at The Scripps Research Institute and was exclusively licensed to, and
further developed by, Johnson & Johnson and its wholly owned subsidiary, Ortho
Pharmaceutical. We have received an exclusive, worldwide sublicense from Johnson
& Johnson and Scripps for, and have rights to, a series of over 30 patents and
patent filings (worldwide) which are important, either individually or
collectively, to our strategy of commercializing our humanized surfactant
technology for the diagnosis, prevention and treatment of disease. The
sublicense gives us the rights to such patents for the life of the patents.
Patents covering our proprietary humanized surfactant technology that have been
issued or are pending worldwide include composition of matter, formulation,
manufacturing and uses, including the pulmonary lavage, or "lung wash"
techniques. Our most significant patent rights principally consist of five
issued United States patents: U.S. Patent No. 5,407,914; U.S. Patent No.
5,260,273; U.S. Patent No. 5,164,369; U.S. Patent No. 5,789,381; and U.S. Patent
No. 6,013,619 (along with corresponding issued and pending foreign patents).
These patents relate to engineered humanized pulmonary surfactants (including
Surfaxin), certain related peptides (amino acid protein-like substances) and
compositions, methods of treating respiratory distress syndromes with these
surfactants and compositions, and our proprietary pulmonary lavage method of
treating Respiratory Distress Syndrome with these surfactants. We also have
certain pending United States and foreign patent applications that relate to
methods of manufacturing certain peptides which may be used in the manufacture
of Surfaxin and other aspects of our humanized surfactant technology.
In June 2003, we were issued United States Patent No. 6,613,734, which covers a
wide variety of combinations of peptides, proteins and other molecules related
to our proprietary humanized pulmonary surfactant technology. The patent also
includes methods of making and using these molecules.
In October 2002, we were issued European Patent No. 59006, which covers claims
directed to compositions that contain sinapultide and related peptides for use
as a therapeutic surfactant for treating Respiratory Distress Syndrome and
related conditions. We also have an issued European Patent, No. 0350506,
covering certain other surfactant peptides.
10
U.S. Patent No. 6,013,619 was issued to Scripps and licensed to us, and covers
all known engineered (including Surfaxin), animal- or human-derived surfactants
for use in any form of pulmonary lavage for Respiratory Distress Syndromes. Our
proprietary pulmonary lavage techniques (using surfactant) include lavage via a
bronchoscope in adults as well as direct pulmonary lung lavage via an
endotracheal tube in newborn babies with Meconium Aspiration Syndrome.
Scientific rationale supports the premise that our proprietary lavage technique
may provide a clinical benefit to the treatment of Acute Lung Injury/Acute
Respiratory Distress Syndrome in adults and Meconium Aspiration Syndrome in
full-term infants by decreasing the amount of infectious and inflammatory debris
in the lungs, restoring the air sacs to a more normal state and possibly
resulting in patients getting off mechanical ventilation sooner.
Such patents, which include relevant European patents, expire on various dates
beginning in 2009 and ending 2017 or, in some cases, possibly later.
The Scripps Research Institute Research Agreement
We are parties with Scripps to a research funding and option agreement that
expires in February 2005, subject to termination by us at any time with 90 days
prior notice. Pursuant to this agreement, we fund a portion of Scripps' research
efforts and are entitled to an option to acquire an exclusive worldwide license
to the technology developed from the research program during the term of the
agreement. Scripps owns all of the technology that it developed pursuant to work
performed under the agreement. To the extent we do not exercise our option, we
have the right to receive 50% of the net royalty income received by Scripps for
inventions that we jointly develop under the agreement.
See Item 7: "Management's Discussion and Analysis of Financial Condition and
Results of Operations - Risks Related to Our Business": " - 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"; " -
Even if we obtain patents to protect our products, those patents may not be
sufficiently broad and others could compete with us"; " - Intellectual property
rights of third parties could limit our ability to market our products"; and " -
If we cannot meet requirements under our license agreements, we could lose the
rights to our products."
MANUFACTURING AND DISTRIBUTION - THIRD PARTY SUPPLIERS
Manufacturing
Our humanized surfactant product candidates must be manufactured in a sterile
environment and in compliance with current good manufacturing practice
requirements (cGMPs) set by the FDA and other relevant worldwide regulatory
authorities.
Our humanized surfactant product candidates are manufactured through the
combination of sinapultide, which is provided by BACHEM California, Inc., and
PolyPeptides Laboratories, Inc., and certain other active ingredients, including
certain lipids, that are provided by other suppliers such as Genzyme
Pharmaceuticals, a division of the Genzyme Corporation, and Avanti Polar Lipids.
11
Our humanized surfactant drug product, including Surfaxin, is manufactured using
the ingredients discussed above with our own specialized equipment under the
direction and supervision of our manufacturing and quality control personnel.
Until recently, our drug product was manufactured at the sterile facilities of
our primary contract manufacturer, Akorn, Inc., which was the only manufacturing
facility that we had validated to produce clinical material of our humanized
surfactant drug product, including Surfaxin. In October 2003, we transferred our
manufacturing capabilities from Akorn to a new contract manufacturer, Laureate
Pharma, L.P., to install and validate a manufacturing and filling line at their
facility for the production of clinical and commercial drug supply in
conformance with cGMPs. All steps required for production of cGMP material have
been completed and we are presently producing Surfaxin for our Phase 2 trial for
the treatment of Acute Respiratory Distress Syndrome.
We now anticipate that our manufacturing capabilities through Laureate should
allow sufficient commercial production of Surfaxin, if approved, to supply the
present worldwide demand for the treatment of Respiratory Distress Syndrome in
premature infants and Meconium Aspiration Syndrome in full-term infants. We
expect these capabilities to allow us to provide adequate supply of Surfaxin for
our planned clinical trials for the treatment of Acute Respiratory Distress
Syndrome in adults.
To support a long-term manufacturing strategy for the production of clinical and
commercial supply of our humanized surfactant drug product, we are evaluating
further development and scale-up of our current contract manufacturer,
alternative contract manufacturers and building our own manufacturing operations
in order to secure additional manufacturing capabilities to meet our production
needs as they expand. We will rely on outside manufacturers for production of
our products after marketing approval.
Should the proper financial and other resources be available, our manufacturing
process for our humanized surfactant drug product allows us to scale-up
production of our humanized surfactant drug product, including Surfaxin. The
scaling up of the currently-approved, animal-derived products is significantly
less efficient, if at all possible. By scaling up our production, we should be
able to produce sufficient drug products to potentially treat diseases with
larger patient populations, such as Acute Respiratory Disease Syndrome in
adults, Respiratory Dysfunction in premature infants, asthma, Acute Lung Injury,
COPD and other broader respiratory diseases and upper airway disorders.
Manufacturing or quality control problems could occur at Laureate or our other
contract manufacturers, causing production and shipment delays or a situation
where the contractor may not be able to maintain compliance with the FDA's GMP
requirements necessary to continue manufacturing our ingredients or drug
product. If any such suppliers or manufacturers of our products fail to comply
with cGMP requirements or other FDA and comparable foreign regulatory
requirements, it could adversely affect our clinical research activities and our
ability to market and develop our products. See Item 7: "Management's Discussion
and Analysis of Financial Condition and Results of Operations - Risks Related to
Our Business": " - 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"; and " - In order to
conduct our clinical trials we need adequate supplies of our drug substance and
drug product and competitor's drug product, which may not be readily available."
12
Distribution
Our collaboration agreement with Quintiles to provide certain commercialization
services in the United States for Surfaxin does not encompass distribution
services. We are currently evaluating third party distribution capabilities in
order to commercialize Surfaxin in the United States.
Our collaboration with Esteve provides that Esteve has the responsibility for
distribution throughout Europe and Latin America. See Item 7: "Management's
Discussion and Analysis of Financial Condition and Results of Operations - Risks
Related to Our Business - Our lack of marketing and sales experience could limit
our ability to generate revenues from future product sales."
COMPETITION
We are engaged in highly competitive fields of pharmaceutical research.
Competition from numerous existing companies and others entering the fields in
which we operate is intense and expected to increase. We expect to compete with,
among others, conventional pharmaceutical companies. Most of these companies
have substantially greater research and development, manufacturing, marketing,
financial, technological personnel and managerial resources than we do.
Acquisitions of competing companies by large pharmaceutical or health care
companies could further enhance such competitors' financial, marketing and other
resources. Moreover, competitors that are able to complete clinical trials,
obtain required regulatory approvals and commence commercial sales of their
products before we do may enjoy a significant competitive advantage over us.
There are also existing therapies that may compete with the products we are
developing. See Item 7: "Management's Discussion and Analysis of Financial
Condition and Results of Operations - Risks Related to Our Business - 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."
Presently, the FDA has approved surfactants as replacement therapy only for the
treatment of Respiratory Distress Syndrome in premature infants, a condition in
which infants are born with an insufficient amount of their own natural
surfactant. The most commonly used of these approved replacement surfactants are
derived from a chemical extraction process of pig and cow lungs. Curosurf(R) 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. Survanta(R) , marketed by the
Ross division of Abbott Laboratories, Inc., is derived from minced cow lung that
contains the cow version of surfactant protein B. Forest Laboratories, Inc.,
markets its calf lung surfactant extract, Infasurf(R), in the United States.
13
There is presently only one approved synthetic surfactant available, Exosurf(R),
marketed by GlaxoSmithKline, plc. However, this product does not contain any
surfactant proteins, is not widely used and its active marketing recently has
been discontinued by its manufacturer.
With respect to the development of lung surfactants for the treatment of other
respiratory diseases and upper airway disorders, with the exception of one
porcine-derived surfactant drug candidate under development by Leo Pharma A/S in
Denmark, we are not aware of any other lung surfactant currently under
development.
There are no drugs currently approved that are specifically indicated for the
treatment of Acute Respiratory Distress Syndrome in adults or Meconium
Aspiration Syndrome in full-term infants. Current therapy consists of general
supportive care and mechanical ventilation. There are a significant number of
other potential therapies in development for the treatment of Acute Respiratory
Distress Syndrome in adults that are not surfactant related. Any of these
various drugs or devices could significantly impact the commercial opportunity
for Surfaxin.
Our humanized surfactant product candidates, including Surfaxin, are engineered
versions of natural human lung surfactant and contain our humanized peptide,
sinapultide. We believe that our engineered humanized surfactant can be
manufactured less expensively than the animal-derived surfactants, in sufficient
quantities, in exact and consistent pharmaceutical grade quality, and has no
potential to cause adverse immunological responses in young and older adults,
all important attributes to potentially meet significant unmet medical needs.
Our products also have the ability to be more precisely formulated, such as in
the form of aerosolized liquids or dry powders to address various medical
indications. In addition, we believe that our engineered humanized surfactant
might possess other pharmaceutical benefits not currently found with the animal
surfactants such as longer shelf-life, reduced number of administrations to the
patient's lungs and elimination of the risk of animal-borne diseases including
the brain-wasting bovine spongiform encephalopathy (commonly called "mad-cow
disease").
GOVERNMENT REGULATION
The testing, manufacture, distribution, advertising and marketing of drug
products are subject to extensive regulation by federal, state and local
governmental authorities in the United States, including the FDA, and by similar
agencies in other countries. Any product that we develop must receive all
relevant regulatory approvals or clearances before it may be marketed in a
particular country.
The regulatory process, which includes preclinical studies and clinical trials
of each pharmaceutical compound to establish its safety and efficacy and
confirmation by the FDA that good laboratory, clinical and manufacturing
practices were maintained during testing and manufacturing, can take many years,
requires the expenditure of substantial resources and gives larger companies
with greater financial resources a competitive advantage over us. Delays or
terminations of clinical trials we undertake would likely impair our development
of product candidates. Delays or terminations could result from a number of
factors, including stringent enrollment criteria, slow rate of enrollment, size
of patient population, having to compete with other clinical trials for eligible
patients, geographical considerations and others.
14
The FDA review process can be lengthy and unpredictable, and we may encounter
delays or rejections of our applications when submitted. If questions arise
during the FDA review process, approval may take a significantly longer period
of time. Generally, in order to gain FDA approval, we first must conduct
preclinical studies in a laboratory and in animal models to obtain preliminary
information on a compound's efficacy and to identify any safety problems. The
results of these studies are submitted as part of an IND (Investigational New
Drug) application that the FDA must review before human clinical trials of an
investigational drug can start.
Clinical trials are normally done in three sequential phases and generally take
two to five years or longer to complete. Phase 1 consists of testing the drug
product in a small number of humans, normally healthy volunteers, to determine
preliminary safety and tolerable dose range. Phase 2 usually involves studies in
a limited patient population to evaluate the effectiveness of the drug product
in humans having the disease or medical condition for which the product is
indicated, determine dosage tolerance and optimal dosage and identify possible
common adverse effects and safety risks. Phase 3 consists of additional
controlled testing at multiple clinical sites to establish clinical safety and
effectiveness in an expanded patient population of geographically dispersed test
sites to evaluate the overall benefit-risk relationship for administering the
product and to provide an adequate basis for product labeling. Phase 4 clinical
trials may be conducted after approval to gain additional experience from the
treatment of patients in the intended therapeutic indication.
After completion of clinical trials of a new drug product, FDA and foreign
regulatory authority marketing approval must be obtained. A New Drug Application
submitted to the FDA generally takes one to three years to obtain approval. If
questions arise during the FDA review process, approval may take a significantly
longer period of time. The testing and approval processes require substantial
time and effort and we may not receive approval on a timely basis, if at all.
Even if regulatory clearances are obtained, a marketed product is subject to
continual review, and later discovery of previously unknown problems or failure
to comply with the applicable regulatory requirements may result in restrictions
on the marketing of a product or withdrawal of the product from the market as
well as possible civil or criminal sanctions. For marketing outside the United
States, we also will be subject to foreign regulatory requirements governing
human clinical trials and marketing approval for pharmaceutical products. The
requirements governing the conduct of clinical trials, product licensing,
pricing and reimbursement vary widely from country to country. None of our
products under development have been approved for marketing in the United States
or elsewhere. We may not be able to obtain regulatory approval for any such
products under development. Failure to obtain requisite governmental approvals
or failure to obtain approvals of the scope requested will delay or preclude us,
or our licensees or marketing partners, from marketing our products, or limit
the commercial use of our products, and thereby would have a material adverse
effect on our business, financial condition and results of operations. See Item
7: "Management's Discussion and Analysis of Financial Condition and Results of
Operations - Risks Related to Our Business": " - Our technology platform is
based solely on our proprietary humanized, engineered surfactant technology. Our
ongoing clinical trials for our lead surfactant replacement technologies may be
delayed, or fail, which will harm our business"; and " - The clinical trial and
regulatory approval process for our products is expensive and time consuming,
and the outcome is uncertain."
15
The FDA has granted us Fast-Track Approval Designation for the indications of
Acute Respiratory Distress Syndrome and Meconium Aspiration Syndrome. Fast-Track
Status facilitates the development and expedites the review of new drugs
intended for treatment of life-threatening conditions for which there are
presently no medical options or an unmet medical need by providing for the FDA's
review of the New Drug Application within six months following filing. We have
also received Orphan Drug Designation from the FDA's Office of Orphan Products
Development for Surfaxin as a treatment for Respiratory Distress Syndrome in
premature infants, Meconium Aspiration Syndrome in full-term infants, and Acute
Respiratory Distress Syndrome in adults. Surfaxin has received designation as an
Orphan Product for Meconium Aspiration Syndrome and Acute Lung Injury (which, in
this circumstance, encompasses Acute Respiratory Distress Syndrome) from the
European Medicines Evaluation Agency (EMEA).
EMPLOYEES
We have approximately 75 full-time employees, primarily employed in the United
States, Europe and Latin America. Our future success depends in significant part
upon the continued service of our key scientific personnel and executive
officers and our continuing ability to attract and retain highly qualified
scientific and managerial personnel. There is a competitive market for such
personnel and we may not be able to retain our key employees or attract,
assimilate or retain other highly qualified technical and managerial personnel
in the future. See Item 7: "Management's Discussion and Analysis of Financial
Condition and Results of Operations - Risks Related to Our Business - 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."
AVAILABLE INFORMATION
We file annual, quarterly and current reports, proxy statements and other
information with the Securities and Exchange Commission. You may read and copy
any document we file with the Commission at the Commission's public reference
rooms at 450 Fifth Street, N.W., Washington, D.C. 20549, 233 Broadway, New York,
New York 10279, and Citicorp Center, 500 West Madison Street, Suite 1400,
Chicago, Illinois 60661- 2511. Please call the Commission at 1-800-SEC-0330 for
further information on the public reference rooms. Our Commission filings are
also available to the public from the Commission's Website at
"http://www.sec.gov." We make available free of charge our annual, quarterly and
current reports, proxy statements and other information upon request. To request
such materials, please send an e-mail to ir@DiscoveryLabs.com or contact John G.
Cooper, our Executive Vice President, Chief Financial Officer at our address as
set forth above.
We maintain a Website at "http://www.DiscoveryLabs.com" (this is not a
hyperlink, you must visit this website through an Internet browser). Our Website
and the information contained therein or connected thereto are not incorporated
into this Annual Report on Form 10-K.
16
ITEM 2. PROPERTIES.
Our principal offices and quality control laboratory facility is located at 350
South Main Street, Suite 307, Doylestown, Pennsylvania 18901. The telephone
number of our executive office is (215) 340-4699 and the facsimile number is
(215) 340-3940. In January 2002, we established a research facility in Redwood
City, California, to develop aerosolized formulations of our proprietary
humanized surfactant. We lease all of these properties. In December 2003, we
closed our satellite office in the United Kingdom.
ITEM 3. LEGAL PROCEEDINGS.
We are not aware of any pending or threatened legal actions other than disputes
arising in the ordinary course of our business that would not, if determined
adversely to us, have a material adverse effect on our business and operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
No matters were submitted to a vote of security holders during the fourth
quarter of 2003.
17
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
Our common stock is traded on the Nasdaq SmallCap Market under the symbol
"DSCO." As of February 29, 2004, the number of stockholders of record of shares
of our common stock was approximately 186, and the number of beneficial owners
of shares of our common stock was approximately 12,000. As of February 29, 2004,
there were approximately 43,697,370 shares of our common stock issued and
outstanding.
The following table sets forth the quarterly price ranges of our common stock
for the periods indicated, as reported by Nasdaq.
Low High
----- -----
First Quarter 2002....................................$2.70 $4.19
Second Quarter 2002...................................$1.28 $3.26
Third Quarter 2002....................................$0.90 $1.97
Fourth Quarter 2002...................................$1.60 $3.20
First Quarter 2003....................................$1.32 $2.94
Second Quarter 2003...................................$1.56 $7.40
Third Quarter 2003....................................$6.12 $8.50
Fourth Quarter 2003 ..................................$5.40 $10.75
First Quarter 2004 (through February 29, 2004)........$10.00 $13.32
We have not paid dividends on our common stock. It is anticipated that we will
not pay dividends on our common stock in the foreseeable future.
Sales of Unregistered Securities
During the year ended December 31, 2003, we granted an aggregate of 1,112,000
options to our officers, directors, employees and consultants at various
exercise prices ranging from $1.70 per share to $9.17 per share. These
securities were offered and sold in reliance upon exemptions from registration
pursuant to Section 4(2) of the Securities Act of 1933 as transactions not
involving any public offering. No broker/dealers were involved in the sale and
no commissions were paid. The recipients of these options either received
adequate information about us or had access, through employment or other
relationships, to such information.
18
ITEM 6. SELECTED FINANCIAL DATA
Consolidated Statement of Operations Data:
(in thousands, except per share data)
For the year ended December 31,
----------------------------------------------------------------
2003 2002 2001 2000 1999
-------- -------- -------- -------- --------
Revenues from collaborative agreements $ 1,037 $ 1,782 $ 1,112 $ 741 $ 178
-------- -------- -------- -------- --------
Operating Expenses:
Research and development 19,750 14,347 8,007 7,494 2,869
General and administrative 5,722 5,458 5,067 5,145 2,421
-------- -------- -------- -------- --------
Total expenses 25,472 19,805 13,074 12,639 5,290
-------- -------- -------- -------- --------
Operating loss (24,435) (18,023) (11,962) (11,898) (5,112)
Other income and expense 155 580 816 1,037 154
-------- -------- -------- -------- --------
Net loss $(24,280) $(17,443) $(11,146) $(10,861) $ (4,958)
======== ======== ======== ======== ========
Net loss per common share - basic and diluted $ (0.65) $ (0.64) $ (0.51) $ (0.58) $ (0.66)
Weighted average number of common
shares outstanding 37,426 27,351 22,038 18,806 7,545
Consolidated Balance Sheet Data:
(in thousands)
For the year ended December 31,
-------------------------------------------------------
2003 2002 2001 2000 1999
------- ------- ------- ------- -------
ASSETS
Current Assets:
Cash/cash equivalents and
marketable securities $29,422 $19,152 $16,696 $18,868 $ 3,547
Prepaid expenses and other current assets 668 327 1,582 149 641
------- ------- ------- ------- -------
Total current assets 30,090 19,479 18,278 19,017 4,188
------- ------- ------- ------- -------
Property and equipment, net of depreciation 2,414 1,231 822 697 426
Other assets 211 352 965 3 18
------- ------- ------- ------- -------
Total assets $32,715 $21,062 $20,065 $19,717 $ 4,632
======= ======= ======= ======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Credit facility with corporate partner - current $ 2,436 $ -- $ -- $ -- $ --
Other current liabilities 4,593 3,202 1,794 2,399 440
------- ------- ------- ------- -------
Total current liabilities 7,029 3,202 1,794 2,399 440
------- ------- ------- ------- -------
Deferred revenue 672 1,393 615 851 1,036
Credit facility with corporate partner -- 1,450 -- -- --
Capitalized lease 711 256 33 31 48
------- ------- ------- ------- -------
Total liabilities 8,412 6,301 2,442 3,281 1,524
------- ------- ------- ------- -------
Stockholders' equity 24,303 14,761 17,623 16,436 3,108
------- ------- ------- ------- -------
Total liabilities and stockholders' equity $32,715 $21,062 $20,065 $19,717 $ 4,632
======= ======= ======= ======= =======
Common Stock, $0.001 par value, issued 42,491 32,818 25,546 20,871 9,689
======= ======= ======= ======= =======
19
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
This Item 7: "Management's Discussion and Analysis of Financial Condition and
Results of Operations" should be read in connection with our Consolidated
Financial Statements. See Item 15: "Exhibits, Financial Statement Schedules, and
Reports on Form 8-K."
Overview
We are a biopharmaceutical company developing our proprietary humanized lung
surfactant technology as Surfactant Replacement Therapies for respiratory
diseases. Surfactants are compositions produced naturally in the lungs and are
essential to the lungs' ability to absorb oxygen and to maintain proper airflow
through the respiratory system. The absence or depletion of surfactants is
involved in a number of respiratory diseases.
Our technology produces an engineered version of natural human lung surfactant
that is designed to closely mimic the essential properties of human lung
surfactant. We believe that our surfactant technology provides the opportunity,
for the first time, for pulmonary surfactants to be developed into a series of
respiratory therapies for critical care and other hospitalized patients where
there are few or no approved therapies available.
We recently completed two Phase 3 clinical trials of Surfaxin, our lead product,
for the treatment of Respiratory Distress Syndrome in premature infants and are
preparing to file new drug applications with the FDA and other regulatory
authorities in the rest of the world.
Our Surfactant Replacement Therapy is also in a Phase 2 clinical trial for the
treatment of Acute Respiratory Distress Syndrome in adults, as well as a Phase 3
and Phase 2 clinical trial for the treatment of Meconium Aspiration Syndrome in
full-term infants. In addition, we recently completed a successful Phase 1b
clinical trial in healthy volunteers and mild asthmatics and are currently
preparing to initiate a follow-on Phase 2 clinical trial evaluating the safety,
tolerability and efficacy of our humanized lung surfactant, delivered as an
inhaled aerosol (development name DSC-104), to treat patients with asthma.
Presently, we are evaluating the development of other aerosolized formulations
of our humanized surfactant to potentially treat premature infants in Neonatal
Intensive Care Units suffering from Respiratory Dysfunction. We are also
evaluating aerosolized formulations of our humanized surfactant to potentially
treat Acute Lung Injury, chronic obstructive pulmonary disease (often referred
to as COPD, which is a chronic condition of the lung that prevents enough oxygen
from reaching the blood), rhinitis, sinusitis (infection of the sinuses), sleep
apnea and otitis media (inner ear infection).
We are presently implementing a long-term commercial strategy which includes
manufacturing for the production of our humanized surfactant drug products to
meet anticipated clinical and commercial needs and sales and marketing
capabilities to execute the launch of Surfaxin in the U.S. and Europe, if
approved.
20
Since our inception, we have incurred significant losses and, as of December 31,
2003, we had an accumulated deficit of approximately $97,000,000 (including
historical results of predecessor companies). The majority of our expenditures
to date have been for research and development activities. Research and
development expenses represent costs incurred for scientific and clinical
personnel, 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
executive management, financial, business development, legal and general
corporate activities and related expenses. See Item 7: "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 and strategic
collaborations. As of December 31, 2003, we had cash and investments of
approximately $29,400,000, a secured revolving credit facility of $8,500,000 to
$10,000,000 with PharmaBio, of which $5,700,000 was available for borrowing and
$2,400,000 was outstanding, and a $4,000,000 capital equipment lease financing
arrangement of which approximately $962,000 was outstanding. See Item 7:
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Liquidity and Capital Resources."
Critical Accounting Policies
The preparation of financial statements, in conformity with accounting
principles generally accepted in the United States, requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.
We have identified below some of our more critical accounting policies and
changes to accounting policies. For further discussion of our accounting
policies see Note 2 "Summary of Significant Accounting Policies" in the Notes to
Consolidated Financial Statements. See Item 15: "Exhibits, Financial Statement
Schedules, and Reports on Form 8-K."
Revenue Recognition- research and development collaborative agreements
For up-front payments and licensing fees related to our contract research or
technology, we defer and recognize revenue as earned over the life of the
related agreement. Milestone payments are recognized as revenue upon achievement
of contract-specified events and when there are no remaining performance
obligations.
Revenue earned under our research and development collaborative agreement
contracts is recognized over a number of years as we perform research and
development activities. For up-front payments and licensing fees related to our
contract research or technology, we defer and recognize revenue as earned over
the estimated period in which the services are expected to be performed.
21
Research and Development Costs
Research and development costs are expensed as incurred. We will continue to
incur research and development costs as we continue to expand our product
development activities. Our research and development costs have included, and
will continue to include, expenses for internal development personnel, supplies
and facilities, clinical trials, regulatory compliance and reviews, validation
of processes and start up costs to establish commercial manufacturing
capabilities. By the time our product candidates are approved by the FDA and we
begin commercial manufacturing, we will no longer expense certain manufacturing
costs as research and development costs.
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, commercialization, and
general and administrative activities.
We anticipate that during the next 12 to 24 months we will:
(i) increase our research, development and regulatory activities in an
effort to develop a broad pipeline of potential Surfactant Replacement
Therapies for respiratory diseases.
We recently completed two Phase 3 clinical trials of Surfaxin for the
treatment of Respiratory Distress Syndrome in premature infants and we
are now preparing to file new drug applications with the FDA and other
regulatory authorities in the rest of the world. Filing of the NDA is
anticipated in April 2004. In accordance with the trial design for both
Phase 3 studies, we continue to conduct six and twelve month clinical
follow-up on all enrolled patients. 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.
We expect to have the results from this trial in the second half of
2004. For Meconium Aspiration Syndrome in full-term infants, we
currently are conducting a Phase 3 clinical trial in up to 200 patients
and a Phase 2 clinical trial in up to 60 patients. Both trials are
expected to be completed in 2005. We recently completed a successful
Phase 1b clinical trial intended to evaluate the tolerability and lung
deposition of our humanized lung surfactant, delivered as an inhaled
aerosol (development name DSC-104), to treat patients with asthma and
are currently preparing to initiate a follow-on Phase 2 clinical trial.
We are evaluating the development of aerosolized formulations of our
humanized surfactant to potentially treat premature infants in Neonatal
Intensive Care Units suffering from Respiratory Dysfunction and are
preparing to initiate a clinical trial in the second half of 2004. In
addition, we are evaluating the development of aerosolized formulations
of our humanized surfactant to potentially treat Acute Lung Injury,
COPD, rhinitis, sinusitis, sleep apnea and otitis media (inner ear
infection).
The drug development, clinical trial and regulatory process is lengthy,
expensive and uncertain and subject to numerous risks including,
without limitation, the following risks discussed in the "Risks Related
to Our Business" - "Our technology platform is based solely on our
proprietary humanized, engineered surfactant technology. Our ongoing
clinical trials for our lead surfactant replacement therapies may be
delayed, or fail, which will harm our business"; - "The clinical trial
and regulatory approval process for our products is expensive and time
consuming, and the outcome is uncertain."
22
(ii) invest in and support a long-term manufacturing strategy for
the production of our humanized surfactant drug product
including further development and scale-up of our current
contract manufacturer, alternative contract manufacturers and
building our own manufacturing operations in order to secure
additional manufacturing capabilities to meet production needs
as they expand.
(iii) invest in marketing and commercialization (including
distribution) resources to execute the launch of Surfaxin for
the treatment of Respiratory Distress Syndrome in premature
infants, if approved, and the execution of our
"Discovery/Surfaxin" worldwide sales and marketing strategy.
(iv) invest in additional general and administrative resources
primarily to support our business development initiatives,
financial systems and controls and management information
technologies.
We are currently implementing the initial phase of our long-term manufacturing
strategy through the recent selection of Laureate to become our current contract
manufacturer. In October 2003, we entered into a Technology Transfer and
Manufacturing Agreement with Laureate which provides for the establishment of a
Surfaxin manufacturing line together with the production of clinical and
commercial drug supply in conformance with current Good Manufacturing Practices
(cGMP). This agreement also encompasses plans for manufacturing scale-up and
enhancements, including additional equipment to support our anticipated
commercial-scale requirements of Surfaxin for the treatment of Respiratory
Distress Syndrome in premature infants and our anticipated clinical-scale
production requirements of Surfaxin for the treatment of Acute Respiratory
Distress Syndrome in adults. See "Risks Related to Our Business - In order to
conduct our clinical trials we need adequate supplies of our drug substance and
drug product and competitor's drug product, which may not be readily available";
and "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 have a collaboration arrangement with Quintiles, and its affiliate,
PharmaBio, 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 is
obligated to hire and train a dedicated United States sales force that will be
branded in the market as ours. Quintiles has committed to make available up to
$70,000,000 in post-launch funding to cover the first seven years of United
States sales and marketing costs. In return, Quintiles is entitled to receive a
commission on net sales of Surfaxin over a 10-year period. The Quintiles
arrangement allows us to retain product ownership and have sales and marketing
expertise in place for the commercialization of Surfaxin in the United States,
if approved.
23
We have a strategic alliance with Esteve to develop, market and sell Surfaxin
throughout Europe and Latin America. Esteve will 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. Our exclusive supply agreement with Esteve 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 the indications of Acute
Lung Injury/Acute Respiratory Distress Syndrome. Esteve also agreed to make
certain milestone payments to us upon the attainment of European marketing
regulatory approval for Surfaxin.
We will need to generate significant revenues from product sales and or related
royalties and transfer prices to achieve and maintain profitability. Through
December 31, 2003, we had no revenues from any 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 contract manufacturers and suppliers. Moreover, we may
never achieve significant revenues or profitable operations from the sale of any
of our products or technologies.
Through December 31, 2003, we had not generated taxable income. On December 31,
2003, net operating losses available to offset future taxable income for Federal
tax purposes were approximately $91,585,000. The future utilization of such loss
carryforwards may be limited pursuant to regulations promulgated under Section
382 of the Internal Revenue Code. In addition, we have a research and
development tax credit carryforward of $1,868,000. The Federal net operating
loss and research and development tax credit carryforwards expire beginning in
2008 and continuing through 2021.
Results of Operations
The net loss for the three years ended December 31, 2003, 2002 and 2001 was
$24,280,000 (or $0.65 per common share), $17,443,000 (or $0.64 per common share)
and $11,146,000 (or $0.51 per common share), respectively. These increased
losses were primarily the result of increasing research and development
expenditures as discussed below.
Revenue
Total revenues recognized for the three years ended December 31, 2003, 2002 and
2001 were $1,037,000, $1,782,000 and $1,112,000, respectively. These revenues
are associated with our research and development collaborative arrangements,
primarily our alliance with Esteve to develop, market and sell Surfaxin
throughout Europe and Latin America. Additional collaborative revenues relate to
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. The decrease in 2003 reflects: (i) the conclusion of our
Small Business Innovative Research (SBIR) grant for research for treatments of
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; and (ii) the extension of the amortization period and
related revenue recognition of the funding previously provided to us in
connection with our strategic alliance with Esteve.
24
Expenses
Research and development expenses for the three years ended December 31, 2003,
2002 and 2001 were $19,750,000, $14,347,000 and $8,007,000, respectively. The
increases primarily reflect costs incurred for the: (i) development and
regulatory efforts to complete the two Phase 3 clinical trials for Surfaxin for
the treatment of Respiratory Distress Syndrome in premature infants; (ii) Phase
2 clinical trial for Surfaxin for the treatment of Acute Respiratory Distress
Syndrome in adults; (iii) investment in our clinical, statistical and regulatory
infrastructure to manage the various development activities associated with our
surfactant replacement therapy pipeline; (iv) research and development
activities related to the development of aerosolized formulations of our
humanized lung surfactant; and (v) activities associated with the installation
and validation of our Surfaxin manufacturing and filling line at Laureate's
facility for the production of clinical and commercial drug supply in
conformance with current Good Manufacturing Practices (cGMPs).
General and administrative expenses for the three years ended December 31, 2003,
2002 and 2001 were $5,722,000, $5,458,000 and $5,067,000, respectively. General
and administrative expenses consist primarily of the costs of executive
management, financial and accounting, business and commercial development,
legal, facility and other administrative costs. Included in general and
administrative costs are approximately $986,000 and $1,450,000 for the years
ended December 31, 2003 and 2002, respectively, related to pre-launch
commercialization activities for Surfaxin conducted in connection with a
collaboration agreement with Quintiles (for which funding is provided by the
secured, revolving credit facility with PharmaBio, discussed below in "Liquidity
and Capital Resources"). Additionally, included in general and administrative
costs for the years ended December 31, 2003, 2002 and 2001, are non-cash
compensation charges of $192,000, $403,000 and $517,000, respectively. The 2003
non-cash compensation charge is primarily related to the grant of stock options
to non-employee members of our Board of Directors under our Amended and Restated
1998 Stock Option Plan and the vesting of certain stock options granted to
consultants. The 2002 and 2001 non-cash compensation charges primarily relate to
the grant of stock options to non-employee members of our Board of Directors
under our stock option plan and certain modifications to certain options held by
three departing members of our Board of Directors.
Other Income and Expense
Other income and expense (net) for the years ended December 31, 2003, 2002 and
2001 were $155,000, $580,000 and $816,000, respectively. Interest income for the
years ended December 31, 2003, 2002 and 2001 was $452,000, $724,000 and
$842,000, respectively, the decreases are primarily due to a reduction in
interest earned on our cash, cash equivalents and marketable securities
primarily due to a general reduction in earned market interest rates. Interest
expense for the years ended December 31, 2003, 2002 and 2001 was $297,000,
$144,000 and $26,000, respectively, the increases are due to interest expense
associated with our secured, revolving credit facility and capital lease
financing arrangements. See "Liquidity and Capital Resources."
25
Liquidity and Capital Resources
Cash, Cash Equivalents and Marketable Securities
As of December 31, 2003, we had cash, cash equivalents and marketable securities
of approximately $29,400,000 as compared to approximately $19,200,000 as of
December 31, 2002. As of December 31, 2003, we had working capital of
approximately $23,100,000 as compared to the working capital of approximately
$16,300,000 as of December 31, 2002. The increase in working capital is due to
the net proceeds of $34,700,000 received primarily from the sale of securities
and the exercise of certain options and warrants, offset by funds used for
operating activities and the classification to current liabilities of the
$2,400,000 outstanding as of December 31, 2003, under the secured, revolving
credit facility with PharmaBio, discussed below.
Secured, Revolving Credit Facility and Capital Lease Arrangement
We have a secured revolving credit facility of up to $8,500,000 to $10,000,000
with PharmaBio to fund pre-marketing activities for a Surfaxin launch in the
United States. The credit facility is available for use until December 10, 2004,
and monies become available in three tranches upon satisfying certain
conditions. We have satisfied the conditions for availability of the first two
tranches and at December 31, 2003, the amount available under the credit
facility was approximately $5,700,000, of which $2,400,000 was outstanding.
Interest on amounts advanced under the credit facility are payable quarterly in
arrears. Outstanding principal and interest due under the credit facility are
due and payable on December 10, 2004. Although 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,
there can be no assurance that we will achieve any of these milestones prior to
the repayment date, and doing so is not likely unless the FDA expedites the
review of the NDA for Surfaxin for the treatment of Respiratory Distress
Syndrome in premature infants that we expect to file with the FDA in April 2004,
and approves such NDA prior to December 10, 2004. See Item 7: "Management's
Discussion and Analysis of Financial Condition and Results of Operations - Risks
Related to our Business - The clinical trial and regulatory approval process for
our products is expensive and time consuming, and the outcome is uncertain." 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.
We have a capital lease financing arrangement with the Life Science and
Technology Finance Division of General Electric Capital Corporation. In
September 2003, the arrangement was increased to provide, subject to certain
conditions, up to an aggregate $4,000,000 in financing for capital purchases. As
of December 31, 2003, approximately $962,000 was outstanding under this
financing arrangement.
26
We believe our current working capital is sufficient to meet our planned
research and development and operational activities into 2005. We will need
additional financing from investors or collaborators to complete research and
development and commercialization of our current product candidates under
development.
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 and 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 and strategic alliances:
In June and July of 2003, our common stock attained certain price performance
thresholds on the Nasdaq SmallCap Market that permitted us to provide notice for
redemption (and thereby effectively compel the exercise thereof) to the holders
of three of our outstanding classes of warrants which represented, in aggregate,
the right to purchase approximately 3.6 million shares of common stock. Such
warrants (i.e., the Class I, Class F and Class C warrants) were previously
issued by us in connection with certain private placement financings that
occurred in November 2002, October 2001, and April 1999, respectively. Between
the dates of June 1, 2003, and September 12, 2003, holders of warrants
exercisable for approximately 3.6 million shares of common stock exercised such
warrants, in accordance with their respective terms, either cashlessly or for
cash, resulting in the issuance to the holders of approximately 3.3 million
shares of common stock and our receipt of aggregate cash proceeds equal to
approximately $6,100,000.
In June 2003, we completed the sale of securities in a private placement to
selected institutional and accredited investors for net proceeds of
approximately $25,900,000. We issued 4,997,882 shares of common stock and
999,577 Class A Investor warrants to purchase shares of common stock at an
exercise price equal to $6.875 per share. The Class A Investor warrants have a
seven-year term.
In November 2002, we completed the sale of securities in a private placement to
selected institutional and accredited investors for net proceeds of
approximately $11,900,000. We issued 6,397,517 shares of common stock and
2,878,883 Class I Warrants to purchase shares of Common Stock at an exercise
price of $2.425 per share. The Class I warrants had a five-year term and we were
entitled to redeem the Class I warrants, with 60 days' prior written notice, for
$.001, upon the attainment of certain exchange-related price performance
thresholds of the common stock. In June 2003, the price performance criteria was
met and we provided notice to the Class I warrant holders of our intention to
redeem the Class I warrants. All Class I warrants have been exercised.
27
Pursuant to our collaboration arrangement 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 net
aggregate proceeds of $4,450,000. See Item 1: "Business - Strategic Alliances."
Pursuant to the collaboration arrangement we entered into with Quintiles and
PharmaBio in December 2001, we issued to PharmaBio, for approximate net
aggregate proceeds of $2,000,000: (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 (subject to
adjustment). 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 availability of the credit facility. To
the extent the credit facility availability is increased to greater than
$8,500,000, for each $1,000,000 increase, the amount of shares of common stock
issuable pursuant to the Class H warrants shall be increased by approximately
38,000 shares. See Item 1: "Business - Strategic Alliances."
In October 2001, we received approximately $7,300,000 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 had a five-year term and we were
entitled to redeem the Class F warrants, with 20 days' prior written notice, for
$.001, upon the attainment of certain exchange-related price performance
thresholds of the common stock. In July 2003, the price performance criteria was
met and we provided notice to the Class F warrant holders of our intention to
redeem the Class F warrants. All Class F warrants have been exercised.
In April 2001, we received approximately $1,000,000 in proceeds in a private
offering of 296,560 shares of common stock at a per share price equal to $3.37.
Contractual Obligations
Our long-term contractual obligations include commitments and estimated purchase
obligations entered into in the normal course of business.
28
Payments due under contractual obligations at December 31, 2003, are as follows:
2004 2005 2006 2007 Total
--------------- --------------- ---------------- -------------- --------------
Credit facility with corporate
partner(1) 2,436,000 - - - 2,436,000
Capital lease obligations(1) 473,000 425,000 238,000 131,000 1,267,000
Operating lease obligations(2) 530,000 291,000 28,000 - 849,000
Purchase obligations(3) 554,000 - - - 554,000
Employment agreements(4) 1,820,000 1,567,000 - - 3,387,000
--------------- --------------- ---------------- -------------- --------------
Total 5,813,000 2,283,000 266,000 131,000 8,493,000
(1) See Item 7: "Management's Discussion and Analysis of Financial
Condition and Operations - Liquidity and Capital Resources - Secured
Revolving Credit Facility and Capital Lease Arrangement".
(2) Operating lease obligations include property rental agreements
discussed below.
(3) Purchase obligations include commitments of equipment and services for
the enhancement of our manufacturing capabilities for Surfaxin.
(4) See discussion below.
In addition to the contractual obligations above, we have certain milestone
payment obligations, aggregating $2,750,000, and royalty payment obligations to
Ortho Pharmaceuticals related to our product licenses.
Operating Lease Obligations
At December 31, 2003, we leased office and laboratory space in Doylestown,
Pennsylvania under leases which expire in September 2004, March 2005, and
September 2005. Additionally, the Company leased office and laboratory space in
Redwood City, California under a lease that expires February 2006, and office
space in Windsor, United Kingdom, under a lease which expired December 2003.
Employment Agreements
At December 31, 2003, we had employment agreements with six officers providing
for an aggregate annual salary of $1,440,000. The agreements expire on various
dates through December 2005, however, commencing on January 1, 2006, and on each
January 1st thereafter, the term of these agreements shall automatically be
extended for one additional year, unless at least 90 days prior to such January
1st date, we or the officer shall have given notice that it does not wish to
extend the agreement. We also had employment agreements with two other officers
that provide for an aggregate annual salary of $467,000. These agreements expire
in December 2005. All of the foregoing agreements provide for the issuance of
annual bonuses and the granting of options subject to approval by our Board of
Directors.
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,
including amounts currently available under our credit facility with PharmaBio,
and our capital lease financing arrangement with General Electric Capital
Corporation, will be adequate to satisfy our capital needs into 2005. Our future
capital requirements will depend on the results of our research and development
29
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. Other than our
credit facility with PharmaBio and our capital lease financing arrangement with
General Electric Capital Corporation, 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 - "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"; " - The market price of our stock may be adversely affected by
market volatility"; and " - 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."
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 biopharmaceutical 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 biopharmaceutical company, therefore, you must evaluate us in light of
the uncertainties and complexities present in such companies. We currently have
no products approved for marketing and sale and 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 our products. Our
long-term viability will be impaired if we are unable to obtain regulatory
approval for, or successfully market, our product candidates.
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 December 31, 2003, we have an
accumulated deficit of approximately $96,800,000, 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.
30
Our technology platform is based solely on our proprietary humanized, engineered
surfactant technology. Our ongoing clinical trials for our lead surfactant
replacement technologies may be delayed, or fail, which will harm our business.
Our humanized, engineered surfactant platform technology is based on the
scientific rationale for surfactant replacement therapy to treat life
threatening respiratory disorders and as the foundation for the development of
novel respiratory therapies and products. Our business is dependent upon the
successful development and approval of our product candidates based on this
platform technology. Recently we completed and announced top-line results from a
pivotal Phase 3 clinical trial and supportive Phase 3 clinical trial with our
lead product, Surfaxin, for the treatment of Respiratory Distress Syndrome in
premature infants. In addition, we are conducting a Phase 2 clinical trial for
the treatment of Acute Respiratory Distress syndrome in adults and a Phase 3 and
a Phase 2 clinical trial for the treatment of Meconium Aspiration Syndrome in
full-term infants. We recently completed a Phase 1b clinical trial to evaluate
the safety and tolerability of our humanized lung surfactant, delivered as an
inhaled aerosol to treat individuals who suffer from asthma.
Companies in the pharmaceutical and biotechnology industries have suffered
significant setbacks in advanced clinical trials, even after obtaining promising
results in earlier trials. Data obtained from tests are susceptible to varying
interpretations which may delay, limit or prevent regulatory approval. In
addition, we may be unable to enroll patients quickly enough to meet our
expectations for completing any or all of these trials. The timing and
completion of current and planned clinical trials of our product candidates
depend on, among other factors, the rate at which patients are enrolled, which
is a function of many factors, including:
- --the number of clinical sites;
- --the size of the patient population;
- --the proximity of patients to the clinical sites;
- --the eligibility criteria for the study;
- --the existence of competing clinical trials; and
- --the existence of alternative available products.
Delays in patient enrollment in clinical trials may occur, which would likely
result in increased costs, program delays or both.
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.
31
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 financial resources will be
adequate to satisfy our capital needs into 2005. 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 capital
lease transactions. 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, except
for the credit facility with PharmaBio and our capital equipment lease financing
arrangement with General Electric Capital Corporation. 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 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.
Furthermore, we could 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 is 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 the safety and effectiveness of
each product and the confirmation by the FDA and comparable agencies in foreign
countries that the manufacturer of the product maintains good laboratory and
manufacturing practices during testing and manufacturing. Although we are
involved in certain late-stage clinical trials, pharmaceutical and biotechnology
companies have suffered significant setbacks in advanced clinical trials, even
after promising results in earlier clinical trials or in preliminary findings
for such clinical trials. Further, even if favorable testing data is generated
by clinical trials of drug products, the FDA may not approve a NDA filed by a
pharmaceutical or biotechnology company for such drug product.
The approval process is lengthy, expensive and uncertain. It is also possible
that the FDA or comparable foreign regulatory authorities could interrupt, delay
or halt any one or more of our clinical trials. If we, or any regulatory
authorities, believe that trial participants face unacceptable health risks, any
one or more of our trials could be suspended or terminated. We also may not
reach agreement with the FDA and/or comparable foreign agencies on the design of
any one or more of the clinical studies necessary for approval. Conditions
imposed by the FDA and comparable agencies in foreign countries on our clinical
trials could significantly increase the time required for completion of such
clinical trials and the costs of conducting the clinical trials. Data obtained
from clinical trials are susceptible to varying interpretations which may delay,
limit or prevent regulatory approval.
32
Delays and terminations of the clinical trials we conduct could result from
insufficient patient enrollment. Patient enrollment is a function of several
factors, including the size of the patient population, stringent enrollment
criteria, the proximity of the patients to the trial sites, having to compete
with other clinical trials for eligible patients, geographical and geopolitical
considerations and others. 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 2005, and our other product candidates will
take longer. The FDA has notified us that two of our intended indications for
our humanized surfactant-based therapy, 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. The FDA has also granted us
Orphan Drug Designation for three of our intended indications for Surfaxin:
Acute Respiratory Distress Syndrome in adults; Respiratory Distress Syndrome in
infants; and Meconium Aspiration Syndrome in full-term infants. To support our
development of Surfaxin for the treatment of Meconium Aspiration Syndrome, the
FDA has awarded us an Orphan Products Development Grant. 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 expedite the FDA's review of 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,
if any. 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.
33
In order to conduct our clinical trials we need adequate supplies of our drug
substance and drug product and competitor's drug product, which may not be
readily available.
To succeed, clinical trials require adequate supplies of drug substance and drug
product, which may be difficult or uneconomical to procure or manufacture. We
rely on third party contract manufacturers for our drug substance and other
active ingredients for Surfaxin and to produce material that meets appropriate
standards for use in clinical trials of our products. We recently transferred
our manufacturing capabilities from our single validated clinical manufacturing
facility, owned and operated by Akorn to a new contract manufacturer, Laureate,
with the objective of producing appropriate clinical grade material of our drug
substance that meet the standards for use in our ongoing clinical studies.
Laureate may not be able to produce Surfaxin to appropriate standards for use in
clinical studies. A failure by Laureate to do so may delay or impair our ability
to obtain regulatory approval for Surfaxin. See also "Risks Related to Our
Business - 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."
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 of our products. Presently, Laureate is
our sole clinical manufacturing facility that has been qualified to produce
appropriate clinical grade material of our drug substance for use in our ongoing
clinical studies.
Laureate or other outside manufacturers may not be able to (i) produce our drug
substance to appropriate standards for use in clinical studies, (ii) perform
under any definitive manufacturing agreements with us or (iii) 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 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, 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.
34
The FDA and foreign regulatory authorities require manufacturers to register
manufacturing facilities. The FDA and corresponding foreign regulators also
inspect these facilities to confirm compliance with current Good Manufacturing
Practices (cGMPs) or similar requirements that the FDA or corresponding foreign
regulators establish. Manufacturing or quality control problems could occur at
the contract manufacturers causing product production and shipment delays or a
situation where the contractor may not be able to maintain compliance with the
FDA's current cGMP requirements necessary to continue manufacturing our drug
substance. Any failure to comply with cGMP requirements or other FDA and
comparable foreign regulatory requirements could adversely affect our clinical
research activities and our ability to market and develop our products.
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. We have a collaboration arrangement with Esteve for
Surfaxin covering all of Europe and Latin America. 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 commercialization
of Surfaxin in Europe for the indications of Acute Lung Injury/Acute Respiratory
Distress Syndrome. We will be responsible for the remainder of the regulatory
activities relating to Surfaxin, including with respect to European Medicines
Evaluation Agency filings.
We have entered into an exclusive collaboration arrangement in the United States
with Quintiles and PharmaBio to commercialize, sell and market Surfaxin in the
United States for indications of Respiratory Distress Syndrome and Meconium
Aspiration Syndrome. As part of our collaboration with Quintiles, Quintiles is
obligated to 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 has committed 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 $8,500,000
which may be increased to $10,000,000. 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
or other terms and conditions of the financing leading to PharmaBio's
termination thereof or the failure by PharmaBio to fulfill its obligation to
partially fund the commercialization of Surfaxin, may affect our ability to
successfully market Surfaxin.
35
If Esteve, Quintiles, PharmaBio or we breach or terminate the agreements that
make up such collaboration arrangements or Esteve, Quintiles or PharmaBio
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, Quintiles and/or
PharmaBio 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:
- -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.
36
Even if we obtain patents to protect our products, those patents may not be
sufficiently broad and others could compete with us.
We, and 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 and Ortho Pharmaceutical 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 or, in some cases,
possibly later. 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.
37
If we cannot meet requirements under our license agreements, we could lose the
rights to our products.
We depend on licensing agreements 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. These
agreements require us to make payments and satisfy performance obligations in
order to maintain our rights under these licensing agreements. 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.
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 the
applicable 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.
38
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, Meconium Aspiration
Syndrome and Acute Lung Injury/Acute Respiratory Distress Syndrome in adult
patients in all of Europe and Latin America. 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', PharmaBio's 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 with terms acceptable to us, if at all, 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, either 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
from 2004 through 2005. 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.
39
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.
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 the
treatment of 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.
40
Four products, three that are animal-derived and one that is a synthetic, are
specifically approved for the treatment of Respiratory Distress Syndrome in
premature infants. Exosurf(R) is synthetic and 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. This product, however, does not contain any
surfactant proteins, is not widely used and its active marketing recently has
been discontinued by its manufacturer. Curosurf(R) 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. Survanta(R), marketed by the Ross division of
Abbott Laboratories, Inc., is an extract of bovine lung that contains the cow
version of surfactant protein C. Forest Laboratories, Inc., markets its calf
lung surfactant, Infasurf(R) 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 these indications 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 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.
41
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.
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 December 31, 2003, our directors, executive officers, principal
stockholders and affiliated entities beneficially owned, in the aggregate,
approximately 15% 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 our 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 the United States 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;
42
- --actual or anticipated variations in our operating results due to the level of
development expenses and other factors;
- --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 this "Management's Discussion
and Analysis of Financial Condition and Results of Operations - Risks Related
to Our Business."
Our common stock is listed for quotation on the NASDAQ SmallCap Market. For the
12-month period ended December 31, 2003, the price of our common stock has
ranged from $1.32 to $10.75. We expect the price of our common stock to remain
volatile. The average daily trading volume in our common stock varies
significantly. For the 12-month period ended December 31, 2003, the average
daily trading volume in our common stock was approximately 401,301 shares and
the average number of transactions per day was approximately 735. 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 the 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 December 31, 2003, we had 42,491,438 shares of common stock outstanding. In
addition, as of December 31, 2003, up to approximately 8,753,000 shares of our
common stock were issuable upon exercise of outstanding options and warrants. On
December 19, 2003, we filed a Form S-3 shelf registration statement with the
Commission for the proposed offering from time to time of up to 6,500,000 shares
of common stock. We have no immediate plans to sell any securities under the
shelf registration. However, as the registration statement has been declared
effective by the Commission, 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.
43
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, Shareholders Rights Agreement
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, Shareholders Rights Agreement
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. We have adopted a shareholders rights agreement which under
certain circumstances would significantly impair the ability of third parties to
acquire control of us without prior approval of our Board of Directors thereby
discouraging unsolicited takeover proposals. The rights issued under the
shareholders rights agreement would cause substantial dilution to a person or
group that attempts to acquire us on terms not approved in advance by our Board
of Directors.
ITEM 7A. 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.
44
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
See Index to Consolidated Financial Statements on Page F-1.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
Not Applicable.
ITEM 9A. CONTROLS AND PROCEDURES
Our Chief Executive Officer, Chief Operating Officer, Chief Financial Officer
and Chief Accounting Officer, after evaluating the effectiveness of our
"disclosure controls and procedures" (as defined in Rules 13a-14(c) and
15d-14(c) of the Securities Exchange Act of 1934) as of the end of the fiscal
year ended December 31, 2003, have concluded that as of the time of such
evaluation, our disclosure controls and procedures were effective in ensuring
that information required to be disclosed by us in this annual report is
accumulated and communicated by our management, to allow timely decisions
regarding required disclosure.
There were no significant changes in our internal controls or other factors that
could significantly affect our disclosure controls and procedures subsequent to
the date of their evaluation and there were no corrective actions with regard to
significant deficiencies and material weaknesses.
PART III
The information required by Items 10 through 14 of Part III is incorporated by
reference to our definitive proxy statement to be filed with the Securities and
Exchange Commission within 120 days after the end of our fiscal year.
We have adopted a Code of Ethics that applies to our officers, including our
principal executive, financial and accounting officers, and our directors and
employees. We have posted the Code of Ethics on our Internet Website at
"http://www.DiscoveryLabs.com" (this is not a hyperlink, you must visit this
website through an Internet browser) under the Legal section. We intend to make
all required disclosures on a Current Report on Form 8-K concerning any
amendments to, or waivers from, our Code of Ethics with respect to our executive
officers and directors. Our Website and the information contained therein or
connected thereto are not incorporated into this Annual Report on Form 10-K.
45
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
(a) Exhibits
Exhibits are listed on the Index to Exhibits at the end of this Annual 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.
(b) Reports on Form 8-K
We filed three Current Reports on Form 8-K during the three months ended
December 31, 2003. We filed a Current Report on October 22, 2003, reporting the
initiation of a Technology Transfer and Manufacturing Agreement with Laureate as
part of the manufacturing facility transfer from Akorn to Laureate. We filed a
Current Report on November 25, 2003, reporting positive primary endpoint results
from the pivotal, multinational, landmark phase 3 superiority clinical trial of
Surfaxin for the treatment of Respiratory Distress Syndrome in premature
infants. We filed a Current Report on December 19, 2003, reporting the filing of
a Form S-3 shelf registration statement with the Commission for the proposed
offering from time to time of up to 6,500,000 shares of our common stock.
46
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
Date: March 15, 2004 By: /s/ Robert J. Capetola
----------------------------------
Robert J. Capetola, Ph.D.
President and
Chief Executive Officer
In accordance with the Exchange Act, this Report has been signed below by the
following persons on behalf of the registrant and in the capacities and on the
dates indicated.
Signature Name & Title Date
--------- ------------ ----
/s/ Robert J. Capetola Robert J. Capetola, Ph.D. March 15, 2004
- ----------------------------- President and Chief Executive Officer
/s/ John G. Cooper John G. Cooper March 15, 2004
- ----------------------------- Senior Vice President and Chief Financial Officer
/s/ Cynthia Davis Cynthia Davis March 15, 2004
- ----------------------------- Vice President, Administrative Operations and
Controller
(Principal Accounting Officer)
/s/ Herbert H. McDade, Jr. Herbert H. McDade, Jr. March 15, 2004
- ----------------------------- Chairman of the Board of Directors
/s/ Marvin E. Rosenthale Marvin E. Rosenthale, Ph.D. March 15, 2004
Director
/s/ Max E. Link Max E. Link, Ph.D. March 15, 2004
- ---------------------------- Director
/s/ Antonio Esteve Antonio Esteve, Ph.D. March 15, 2004
- ---------------------------- Director
47
EXHIBIT INDEX
EXHIBIT NO. DESCRIPTION
- ----------- -----------
3.1(16) Restated Certificate of Incorporation of Discovery, dated
September 18, 2002.
3.2* Amended and Restated By-laws of Discovery, as of December 12,
2003.
4.1(7) Class E Warrant issued to PharmaBio.
4.2(8) Unit Purchase Option issued to Paramount Capital, Inc., in
connection with the March 1999 private placement.
4.3(11) Form of Class G Warrant issued to PharmaBio.
4.4(1) Form of Class H Warrant issued to PharmaBio.
4.5(11) Form of Promissory Note issued to PharmaBio.
4.6(16) Promissory Note issued to General Electric Capital Corporation.
4.7(17) Form of Class A Investor Warrant.
10.1(1) Registration Rights Agreement, dated as of October 28, 1996,
between ATI, Johnson & Johnson Development Corporation and The
Scripps Research Institute.
10.2(3)+ Sublicense Agreement, dated as of October 28, 1996, between ATI,
Johnson & Johnson, Inc., and Ortho Pharmaceutical Corporation.
10.3(2) Restated 1993 Stock Option Plan of Discovery.
10.4(2) 1995 Stock Option Plan of Discovery.
10.5(18) Amended and Restated 1998 Stock Incentive Plan of Discovery
(amended as of July 15, 2003).
10.6(5) Indenture of Lease, dated as of July 1, 1998, between SLT1, LLC
and Discovery.
10.7(10) Amendment, dated as of September 15, 2000, to the Indenture of
Lease dated as of July 1, 1998, between SLT1, LLC and Discovery.
10.8(5) Registration Rights Agreement, dated as of June 16, 1998, among
Discovery, JJDC and Scripps.
48
10.9(5) Stock Exchange Agreement, dated as of June 16, 1998, between
Discovery and JJDC.
10.10(10) Employment Agreement, dated January 1, 2001, between Discovery
and Robert J. Capetola, Ph.D.
10.11(14) Employment Agreement, dated as of June 16, 2001, between
Discovery and Christopher J. Schaber.
10.12(14) Employment Agreement, dated as of June 16, 2001, between
Discovery and Cynthia Davis.
10.13(5) Form of Intellectual Property and Confidential Information
Agreement.
10.14(5) Form of Stock Purchase Agreement Under the 1998 Stock Incentive
Plan of Discovery.
10.15(6) Form of Notice of Grant of Stock Option.
10.16(8) Securities Purchase Agreement between Discovery and Laboratorios
P.E.N., S.A., dated October 26, 1999.
10.17(8)+ Research Funding and Option Agreement, dated as of March 1,
2000, between Discovery and Scripps.
10.18(14) Employment Agreement, dated as of December 1, 2001, between
Discovery and Ralph Niven, Ph.D.
10.19(14) Employment Agreement, dated as of December 11, 2001, between
Discovery and John G. Cooper.
10.20(14) Employment Agreement, dated as of August 15, 2000, between
Discovery and Deni M. Zodda, Ph.D.
10.21(12)+ Commercialization Agreement, dated as of December 10, 2001,
between Discovery and Quintiles.
10.22(12)+ Investment and Commission Agreement, dated as of December 10,
2001, between Discovery and PharmaBio.
10.23(12) Common Stock and Warrant Purchase Agreement, dated as of
December 10, 2001, between Discovery and PharmaBio.
49
10.24(12)+ Loan Agreement, dated as of December 10, 2001, between Discovery
and PharmaBio.
10.25(13)+ Sublicense and Collaboration Agreement, dated as of March 6,
2002, between Discovery and Laboratorios del Dr. Esteve.
10.26(13)+ Supply Agreement, dated as of March 6, 2002, between Discovery
and Esteve.
10.27(13) Common Stock Purchase Agreement, dated as of March 6, 2002,
between Discovery and Esteve.
10.28(15) Form of Common Stock and Warrant Purchase Agreement, dated
November 5, 2002, between Discovery and certain investors.
10.29(16) Master Security Agreement, dated December 23, 2002, between
Discovery and General Electric Capital Corporation.
10.30(16) Amendment, dated December 23, 2003, to the Master Security
Agreement between Discovery and General Electric Capital
Corporation.
10.31(19)+ Technology Transfer and Manufacturing Agreement dated as of
October 13, 2003, between Discovery and Laureate Pharma, L.P.
16.1(4) Letter dated as of January 28, 1998, from Ernst & Young LLP to
the Securities and Exchange Commission.
16.2(9) Letter dated January 9, 2001, from Eisner LLP, to the Securities
and Exchange Commission.
21.1(1) Subsidiaries of Discovery.
23.1* Consent of Ernst & Young LLP.
31.1* Certification of Chief Executive Officer Pursuant to Rule
13a-14(a) of the Exchange Act.
31.2* Certification of Chief Financial Officer and Principal
Accounting Officer Pursuant to Rule 13a-14(a) of the Exchange
Act.
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
50
(1) Incorporated by reference to Discovery's Annual Report on Form 10-KSB
for the year ending December 31, 1997.
(2) Incorporated by reference to Discovery's Registration Statement on Form
SB-2 (File No. 33-92-886).
(3) Incorporated by reference to Discovery's Registration Statement on Form
SB-2 (File No. 333-19375).
(4) Incorporated by reference to Discovery's Current Report on Form 8-K/A
dated January 16, 1998.
(5) Incorporated by reference to Discovery's Annual Report on Form 10-KSB
for the year ending December 31, 1998.
(6) Incorporated by reference to Discovery's Quarterly Report on Form
10-QSB for the quarter ending September 30, 1999.
(7) Incorporated by reference to Discovery's Current Report on Form 8-K
filed March 29, 2000.
(8) Incorporated by reference to Discovery's Annual Report on Form 10-KSB
for the year ending December 31, 1999.
(9) Incorporated by reference to Discovery's Amended Current Report on Form
8-K/A filed January 9, 2001.
(10) Incorporated by reference to Discovery's Annual Report on Form 10-KSB
for the year ending December 31, 2000.
(11) Incorporated by Reference to Discovery's Current Report on Form 8-K
filed December 19, 2001.
(12) Incorporated by Reference to Discovery's Amended Current Report on Form
8-K/A filed January 14, 2002.
(13) Incorporated by Reference to Discovery's Current Report on Form 8-K
filed March 8, 2002.
(14) Incorporated by Reference to Discovery's Annual Report on Form 10-KSB
for the year ending December 31, 2001.
(15) Incorporated by Reference to Discovery's Current Report on Form 8-K
filed November 12, 2002.
51
(16) Incorporated by Reference to Discovery's Annual Report on Form 10-K for
the year ending December 31, 2002.
(17) Incorporated by Reference to Discovery's Current Report on Form 8-K
filed June 30, 2003.
(18) Incorporated by reference to Discovery's Registration Statement on Form
S-8 (File No. 333-109274).
(19) Incorporated by Reference to Discovery's Current Report on Form 8-K
filed October 22, 2003.
+ Confidential treatment requested as to certain portions of these exhibits.
Such portions have been redacted and filed separately with the Commission.
52
DISCOVERY LABORATORIES, INC. AND SUBSIDIARY
CONTENTS
PAGE
----
CONSOLIDATED FINANCIAL STATEMENTS
Report of independent auditor F-2
Balance sheets as of December 31, 2003 and December 31, 2002 F-3
Statements of operations for the years ended
December 31, 2003, 2002, and 2001 F-4
Statements of changes in stockholders' equity for the years ended
December 31, 2003, 2002, and 2001 F-5
Statements of cash flows for the years ended
December 31, 2003, 2002, and 2001 F-6
Notes to consolidated financial statements:
Note 1 - The Company and Basis of Presentation F-7
Note 2 - Summary of Significant Accounting Policies F-8
Note 3 - Investments F-10
Note 4 - Note Receivable F-10
Note 5 - Property and Equipment F-10
Note 6 - Income Taxes F-11
Note 7 - License, Research Funding, and Commercialization Agreements F-12
Note 8 - Stockholders' Equity F-13
Note 9 - Stock Options F-15
Note 10 - 401(k) Match F-16
Note 11 - Commitments F-17
Note 12 - Related Party Transactions F-18
Note 13 - Selected Quarterly Financial Data (unaudited) F-19
F-1
REPORT OF INDEPENDENT AUDITORS
Board of Directors and Stockholders
Discovery Laboratories, Inc.
Doylestown, Pennsylvania
We have audited the accompanying consolidated balance sheets of Discovery
Laboratories, Inc. as of December 31, 2003, and 2002, and the related
consolidated statements of operations, changes in stockholders' equity and cash
flows for each of the three years in the period ended December 31, 2003. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Discovery
Laboratories, Inc. at December 31, 2003, and 2002, and the consolidated results
of its operations and its cash flows for each of the three years in the period
ended December 31, 2003, in conformity with accounting principles generally
accepted in the United States.
/s/ Ernst & Young LLP
Philadelphia, Pennsylvania
February 13, 2004
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, DECEMBER 31,
2003 2002
---------------- -----------------
ASSETS
Current assets:
Cash and cash equivalents $ 29,422,000 $ 8,500,000
Available-for-sale marketable securities -- 10,652,000
Note receivable - current 3,000 2,000
Prepaid expenses and other current assets 665,000 325,000
---------------- -----------------
Total current assets 30,090,000 19,479,000
Property and equipment, net of accumulated depreciation 2,414,000 1,231,000
Note receivable 192,000 195,000
Other assets 19,000 157,000
---------------- -----------------
Total Assets $ 32,715,000 $ 21,062,000
================ =================
See notes to consolidated financial statements F-2
DISCOVERY LABORATORIES, INC. AND SUBSIDIARY
LIABILITIES & STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses $ 4,210,000 $ 3,013,000
Credit facility with corporate partner - current portion 2,436,000 --
Capitalized lease - current portion 383,000 189,000
---------------- -----------------
Total current liabilities 7,029,000 3,202,000
Deferred revenue 672,000 1,393,000
Credit facility with corporate partner -- 1,450,000
Capitalized lease, net of current portion 711,000 256,000
---------------- -----------------
Total Liabilities 8,412,000 6,301,000
Shareholders' equity:
Common stock, $.001 par value; 60,000,000 authorized;
42,491,438 and 32,818,283 issued and outstanding
at December 31, 2003 and December 31, 2002, respectively 43,000 33,000
Additional paid-in capital 122,409,000 87,463,000
Unearned portion of compensatory stock options (2,000) (95,000)
Accumulated deficit (96,858,000) (72,578,000)
Treasury stock (at cost; 167,179 and 38,243 shares of common
stock at December 31, 2003, and 2002) (1,289,000) (239,000)
Accumulated other comprehensive income -- 177,000
---------------- -----------------
Total shareholders' equity 24,303,000 14,761,000
---------------- -----------------
Total Liabilities & Equity $ 32,715,000 $ 21,062,000
================ =================
See notes to consolidated financial statements F-3
DISCOVERY LABORATORIES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
YEAR ENDED DECEMBER 31,
2003 2002 2001
----------------- ----------------- -----------------
Revenues:
Contracts, Licensing, Milestones and Grants $ 1,037,000 $ 1,782,000 $ 1,112,000
Expenses:
Research & Development 19,750,000 14,347,000 8,007,000
General & Administrative 5,722,000 5,458,000 5,067,000
---------------- ---------------- -----------------
Total Expenses 25,472,000 19,805,000 13,074,000
---------------- ---------------- -----------------
Operating Loss (24,435,000) (18,023,000) (11,962,000)
Other income and expenses:
Interest income, dividends, realized
gains, and other income 452,000 724,000 842,000
Interest expense (297,000) (144,000) (26,000)
---------------- ---------------- -----------------
Net Loss $ (24,280,000) $ (17,443,000) $ (11,146,000)
================ ================ =================
Net loss per common share - basic and diluted $ (0.65) $ (0.64) $ (0.51)
Weighted average number of common
shares outstanding - basic and diluted 37,426,034 27,350,835 22,038,067
See notes to consolidated financial statements F-4
DISCOVERY LABORATORIES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
FOR YEARS ENDED DECEMBER 31, 2003, 2002, AND 2001
UNEARNED
ADDITIONAL PORTION OF
PAID-IN COMPENSATORY
COMMON STOCK CAPITAL STOCK OPTIONS
------------------------------------------------------------------
SHARES AMOUNT
------------------------------------------------------------------
BALANCE - JANUARY 1, 2001 20,871,112 $21,000 $60,891,000 ($347,000)
------------------------------------------------------------------
Comprehensive loss:
Net loss
Other comprehensive loss - unrealized loss on
marketable securities available-for-sale
Total comprehensive loss
Exercise of stock options 6,224 2,000
Common Stock issued in payment for services 10,902 42,000
Compensation charge on modification of options 109,000
Compensatory stock options and warrants granted/earned 325,000 83,000
Common Stock issued in April 2001 private financing 296,560 998,000
Common Stock and warrants issued in 3,562,759 4,000 7,256,000
October 2001 private financing
Common Stock and warrants issued in December 2001 1,000 3,540,000
791,905
Placement agent warrant exercise 6,831
Purchase of Treasury Stock
------------------------------------------------------------------
BALANCE - DECEMBER 31, 2001 25,546,293 26,000 73,163,000 (264,000)
------------------------------------------------------------------
Comprehensive loss:
Net loss
Other comprehensive loss - unrealized gain on
marketable securities available-for-sale
Total comprehensive loss
Exercise of stock options 77,925 60,000
Common Stock issued in lieu of payment for services 6,086 26,000
Compensation charge on modification of options 171,000
Compensation charge on vesting of options and warrants 63,000 169,000
Common Stock issued in March 2002 private financing 821,862 2,666,000
Private financing expenses (5,000)
Common Stock issued in November 2002 private financing 6,397,517 7,000 11,937,000
Change in value of Class H warrants (618,000)
Exercise of warrants 6,843
------------------------------------------------------------------
BALANCE - DECEMBER 31, 2002 32,856,526 33,000 87,463,000 (95,000)
------------------------------------------------------------------
Comprehensive loss:
Net loss
Other comprehensive loss - unrealized loss on
marketable securities available-for-sale
Total comprehensive loss
Exercise of stock options 993,001 1,000 1,940,000
Exercise of warrants 3,789,875 4,000 6,846,000
Compensatory stock options and warrants granted/earned 20,000 (17,000)
Compensation charge on modification of options 75,000
Compensation charge on vesting of options and warrants 79,000 25,000
Earned portion of compensatory stock options 10,000
Common Stock issued in June 2003 private financing 4,997,882 5,000 25,925,000
Common Stock issued in 401k Match 21,333 86,000
Change in value of Class H warrants 50,000
Purchase of Treasury Stock
------------------------------------------------------------------
BALANCE - DECEMBER 31, 2003 42,658,617 $43,000 $122,409,000 ($2,000)
==================================================================
ACCUMULATED
OTHER
ACCUMULATED COMPREHENSIVE
DEFICIT TREASURY STOCK LOSS TOTAL
---------------------------------------------------------------------------
SHARES AMOUNT
---------------------------------------------------------------------------
BALANCE - JANUARY 1, 2001 ($43,989,000) -26,743 ($213,000) $73,000 $16,436,000
---------------------------------------------------------------------------
Comprehensive loss:
Net loss (11,146,000) (11,146,000)
Other comprehensive loss - unrealized loss on (1,000) (1,000)
marketable securities available-for-sale
Total comprehensive loss
(11,147,000)
Exercise of stock options 2,000
Common Stock issued in payment for services 42,000
Compensation charge on modification of options 109,000
Compensatory stock options and warrants granted/earned 408,000
Common Stock issued in April 2001 private financing 998,000
Common Stock and warrants issued in 7,260,000
October 2001 private financing
Common Stock and warrants issued in December 2001 3,541,000
Placement agent warrant exercise -
Purchase of Treasury Stock (11,500) (26,000) (26,000)
---------------------------------------------------------------------------
BALANCE - DECEMBER 31, 2001 (55,135,000) (38,243) (239,000) 72,000 17,623,000
---------------------------------------------------------------------------
Comprehensive loss:
Net loss (17,443,000) (17,443,000)
Other comprehensive loss - unrealized gain on 105,000 105,000
marketable securities available-for-sale
Total comprehensive loss (17,338,000)
Exercise of stock options 60,000
Common Stock issued in lieu of payment for services 26,000
Compensation charge on modification of options 171,000
Compensation charge on vesting of options and warrants 232,000
Common Stock issued in March 2002 private financing 2,666,000
Private financing expenses (5,000)
Common Stock issued in November 2002 private financing 11,944,000
Change in value of Class H warrants (618,000)
Exercise of warrants -
---------------------------------------------------------------------------
BALANCE - DECEMBER 31, 2002 (72,578,000) (38,243) (239,000) 177,000 14,761,000
---------------------------------------------------------------------------
Comprehensive loss:
Net loss (24,280,000) (24,280,000)
Other comprehensive loss - unrealized loss on (177,000) (177,000)
marketable securities available-for-sale
Total comprehensive loss (24,457,000)
Exercise of stock options 1,941,000
Exercise of warrants 6,850,000
Compensatory stock options and warrants granted/earned 3,000
Compensation charge on modification of options 75,000
Compensation charge on vesting of options and warrants 104,000
Earned portion of compensatory stock options 10,000
Common Stock issued in June 2003 private financing 25,930,000
Common Stock issued in 401k Match 86,000
Change in value of Class H warrants 50,000
Purchase of Treasury Stock (128,936) (1,050,000) (1,050,000)
---------------------------------------------------------------------------
BALANCE - DECEMBER 31, 2003 ($96,858,000) (167,179) ($1,289,000) $ - $24,303,000
===========================================================================
See notes to consolidated financial statements F-5
DISCOVERY LABORATORIES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended
December 31,
2003 2002 2001
------------------ ----------------- ---------------
Cash flow from operating activities:
Net loss $ (24,280,000) $ (17,443,000) $ (11,146,000)
Adjustments to reconcile net loss to net cash used
in operating activities:
Depreciation and amortization 416,000 285,000 205,000
Realized (gains) losses on marketable securities (114,000) (174,000) 55,000
Compensatory stock options 192,000 403,000 517,000
Stock issued in 401(k) match 86,000 -- --
Expenses paid using treasury stock and Common Stock -- 26,000 42,000
Changes in:
Prepaid expenses, inventory and other current assets (340,000) 1,255,000 (876,000)
Accounts payable and accrued expenses 1,197,000 1,263,000 (632,000)
Other assets 103,000 (40,000) (18,000)
Proceeds from research and development -- --
collaborative agreements 1,833,000
Amortization of deferred revenue (721,000) (1,055,000) (791,000)
------------------ ----------------- ---------------
Net cash used in operating activities (23,461,000) (13,647,000) (12,644,000)
------------------ ----------------- ---------------
Cash flow from investing activities:
Purchase of property and equipment (606,000) (227,000) (257,000)
Loan to related party -- -- (200,000)
Related party loan payments received 2,000 2,000 1,000
Purchase of marketable securities (284,000) (8,569,000) (10,676,000)
Proceeds from sale or maturity of marketable securities 10,873,000 11,134,000 9,269,000
------------------ ----------------- ---------------
Net cash provided by (used in) investing activities 9,985,000 2,340,000 (1,863,000)
------------------ ----------------- ---------------
Cash flow from financing activities:
Proceeds from issuance of securities, net of expenses 34,721,000 14,665,000 11,033,000
Proceeds from credit facility with corporate partner 986,000 1,450,000 --
Purchase of treasury stock (1,050,000) -- (26,000)
Principal payments under capital lease obligation (259,000) (66,000) (23,000)
------------------ ----------------- ---------------
Net cash provided by financing activities 34,398,000 16,049,000 10,984,000
------------------ ----------------- ---------------
Net increase (decrease) in cash and cash equivalents 20,922,000 4,742,000 (3,523,000)
Cash and cash equivalents - beginning of year 8,500,000 3,758,000 7,281,000
------------------ ----------------- ---------------
Cash and cash equivalents - end of year $ 29,422,000 $ 8,500,000 $ 3,758,000
================== ================= ===============
Supplementary disclosure of cash flows information:
Interest Paid $ 167,000 $ 88,000 $ 26,000
Noncash transactions:
Class H warrants issued/revalued $ 50,000 $ (618,000) $ 768,000
Equipment acquired through capitalized lease 908,000 434,000 52,000
Unrealized gain (loss) on marketable securities (177,000) 105,000 (1,000)
See notes to consolidated financial statements. F-6
DISCOVERY LABORATORIES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2003
NOTE 1 - THE COMPANY AND BASIS OF PRESENTATION
Discovery Laboratories, Inc. is a biopharmaceutical company developing its
proprietary surfactant technology as Surfactant Replacement Therapies for
respiratory diseases including Respiratory Distress Syndromes in infants and
adults, Acute Lung Injury, asthma, Chronic Obstructive Pulmonary Disease and
upper airway disorders. Surfactants are compositions produced naturally in the
lungs and essential for breathing. Discovery's technology produces an engineered
version of natural human lung surfactant that is designed to provide the
essential properties of human lung surfactant. Discovery believes that through
its technology, pulmonary surfactants have the potential, for the first time, to
be developed into a series of respiratory therapies for critical care and other
hospitalized patients where there are few or no approved therapies available.
Discovery recently completed two Phase 3 clinical trials of Surfaxin(R), the
Company's lead product, for the treatment of Respiratory Distress Syndrome in
premature infants and is preparing to file new drug applications with the Food
and Drug Administration and other regulatory authorities in the rest of the
world. Discovery's Surfactant Replacement Therapy is also in a Phase 2 clinical
trial for Acute Respiratory Distress Syndrome in adults and a Phase 3 and Phase
2 clinical trial for Meconium Aspiration Syndrome in full-term infants.
Discovery recently completed a successful Phase 1b clinical trial and is
currently preparing to initiate a follow-on Phase 2 clinical trial evaluating
the safety, tolerability and efficacy of its humanized lung surfactant,
delivered as an inhaled aerosol (development name DSC-104), to treat patients
with asthma.
HISTORICAL FOUNDING TRANSACTIONS
The Company, formerly known as Ansan Pharmaceuticals, Inc. ("Ansan"), was
incorporated in Delaware on November 6, 1992. In November 1997, Ansan merged
with the predecessor company, Discovery Laboratories, Inc.
("Predecessor Discovery"), in a transaction accounted for as a reverse
acquisition with Predecessor Discovery as the acquirer for financial reporting
purposes. In October 1996, the Company invested in the stock of Acute
Therapeutics, Inc., a Delaware corporation ("ATI"). Such investment represented
75% of the voting securities of ATI. At the time of the investment, ATI held the
technology underlying the Company's proprietary humanized lung surfactant
technology and employed or engaged the management developing such technology.
Many of such management remain members of the Company's current management. In
June 1998, ATI merged with and into the Company at which time, the Company's
primary business objective was the development of the Company's proprietary
humanized lung surfactant technology. The Company currently maintains one
subsidiary, which is inactive.
MANAGEMENT'S PLANS AND FINANCINGS
The Company was considered to be a development-stage company through December
31, 2002. With the completion of two Phase 3 clinical trials in 2003, the
Company is no longer considered a development-stage enterprise. The Company has
incurred substantial losses since inception. To date, the Company has funded its
operations primarily through the issuance of equity and through strategic
alliances. The Company expects to continue to expend substantial amounts for
continued product research, development and commercialization activities for the
foreseeable future. Management's plans with respect to funding this development
are to secure additional equity, if possible, and to secure additional strategic
alliances that will provide available cash funding for operations and to focus
on increased commercialization efforts this year. 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.
F-7
DISCOVERY LABORATORIES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2003
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
CASH AND CASH EQUIVALENTS
The Company considers all highly liquid investments purchased with a
maturity of three months or less to be cash equivalents.
AVAILABLE-FOR-SALE MARKETABLE SECURITIES
The investments are classified as available for sale and are comprised
of shares of high quality fixed income commercial paper and mutual
funds. Investments are carried at fair market value. Realized gains and
losses are computed using the average cost of securities sold. Any
appreciation/depreciation on these investments is recorded as other
comprehensive income (loss) in the statements of changes in
stockholders' equity until realized.
PROPERTY AND EQUIPMENT
Property and equipment is recorded at cost. Depreciation of furniture
and equipment is computed using the straight-line method over the
estimated useful lives of the assets (five to seven years). Leasehold
improvements are amortized over the lower of the (a) term of the lease
or (b) useful life of the improvements.
USE OF ESTIMATES
The preparation of financial statements, in conformity with accounting
principles generally accepted in the United States, requires management
to make estimates and assumptions that affect the reported amounts of
assets and liabilities at the date of the financial statements and the
reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
LONG-LIVED ASSETS
Under Statement of Financial Accounting Standards (SFAS) No. 144, the
Company is required to recognize an impairment loss only if the
carrying amount of a long-lived asset is not recoverable from its
undiscounted cash flows and measure any impairment loss as the
difference between the carrying amount and the fair value of the asset.
No impairment was recorded during the years ended December 31, 2003 and
2002, as management of the Company believes the sum of its future
undiscounted cash flows will exceed the carrying amount of the assets.
RESEARCH AND DEVELOPMENT
Research and development costs are charged to operations as incurred.
REVENUE RECOGNITION - RESEARCH AND DEVELOPMENT COLLABORATIVE AGREEMENTS
The Company received nonrefundable fees from companies under license,
sublicense, collaboration and research funding agreements. The Company
initially records such funds as deferred revenue and recognizes
research and development collaborative contract revenue when the
amounts are earned, which occurs over a number of years as the Company
performs research and development activities. See Note 7 - License,
Research Funding and Commercialization Agreements for a detailed
description of the Company's revenue recognition methodology under
these agreements.
F-8
DISCOVERY LABORATORIES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2003
Additionally, the Company has been awarded grants from certain third
party organizations to help fund research for the drugs that the
Company is attempting to bring to full commercial use. Once research
and development expenditures qualifying under the grant are incurred,
grant reports are periodically completed and submitted to the granting
agency for review. If approved, the granting agency will then remit
payment to the Company. Such amounts are recorded as revenue upon
receipt.
STOCK-BASED COMPENSATION
The Financial Accounting Standards Board has issued Statement of
Financial Accounting Standards ("SFAS") No. 148, "Accounting for
Stock-Based Compensation - Transition and Disclosure". SFAS No. 148
amends SFAS No. 123, "Accounting for Stock-Based Compensation" to
provide alternative methods of transition to a voluntary change to the
fair value based method of accounting for stock-based employee
compensation. In addition, SFAS No. 148 amends the disclosure
requirements of SFAS 123 to require prominent disclosure in both annual
and interim financial statements about the method of accounting for
stock-based employee compensation and the effect of the method used on
the reported results. The Company continues to account for its stock
option plans in accordance with Accounting Principles Board Opinion No.
25, "Accounting for Stock Options Issued to Employees" and,
accordingly, recognizes compensation expense for the difference between
the fair value of the underlying Common Stock and the exercise price of
the option at the date of grant. The effect of applying SFAS No. 148 on
pro forma net loss is not necessarily representative of the effects on
reported net income or loss for future years due to, among other
things, (i) the vesting period of the stock options and (ii) the fair
value of additional stock options in future years. Had compensation
cost for the Company's stock option plans been determined based upon
the fair value of the options at the grant date of awards under the
plans consistent with the methodology prescribed under SFAS No. 148,
the pro forma net loss for the years ended December 31, 2003, 2002, and
2001 would have been as follows:
Years Ended December 31,
2003 2002 2001
---------------- ----------------- -----------------
Net Loss as reported $ (24,280,000) $ (17,443,000) $ (11,146,000)
Additional stock-based employee
compensation $ (3,738,000) $ (2,264,000) $ (2,090,000)
---------------- ----------------- -----------------
Pro forma net loss $ (28,018,000) $ (19,707,000) $ (13,236,000)
================ ================= =================
Pro forma net loss per share $ (0.75) $ (0.72) $ (0.60)
The weighted average fair value of the options granted were estimated on the
date of grant using the Black-Scholes option-pricing model with the following
weighted average assumptions:
Years Ended December 31,
2003 2002 2001
---------------- ----------------- -----------------
Expected dividend yield 0% 0% 0%
Expected stock price volatility 86% 95% 118%
Risk-free interest rate 2.4% 2.5% 4%
Expected option term 3.5 years 3.5 years 3.5 years
F-9
DISCOVERY LABORATORIES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2003
NET LOSS PER COMMON SHARE
Net loss per common share is computed pursuant to the provisions of
SFAS No. 128, "Earnings per Share", and is based on the weighted
average number of common shares outstanding for the periods. For the
years ended December 31, 2003, 2002, and 2001, 8,753,000, 4,032,000 and
5,211,000 common shares, respectively, are potentially issuable upon
the exercise of certain of the Company's stock options and warrants and
are not included in the calculation of net loss per share as the effect
would be anti-dilutive.
RECLASSIFICATION
Certain prior year balances have been reclassified to conform with the
current presentation.
NOTE 3 - INVESTMENTS
The available-for-sale marketable securities are as follows:
December 31,
2002 2001
--------------- ----------------
Cost $ 10,475,000 $ 12,866,000
Gross unrealized gain
178,000 131,000
Gross unrealized loss
(1,000) (59,000)
--------------- ----------------
Estimated fair value $ 10,652,000 $ 12,938,000
=============== ================
Included in the net loss for the years ended December 31, 2003, 2002, and 2001
were gross realized gains on available-for-sale securities of $114,000, $183,000
and $219,000 and gross realized losses of $0, $9,000 and $274,000, respectively.
NOTE 4 - NOTE RECEIVABLE
Note receivable pertains to a $200,000, 7% per annum mortgagor's note due from
an executive of the Company. This note is secured by a mortgage agreement dated
July 24, 2001. The note calls for monthly payments of principal and interest
over a 360-month period. The principal balance outstanding at December 31, 2003
and 2002 was approximately $195,000 and $197,000, respectively.
NOTE 5 - PROPERTY AND EQUIPMENT
Property and equipment as of December 31, 2003 and 2002 was comprised of the
following:
December 31,
2003 2002
--------------- ----------------
Leasehold Improvements $ 174,000 $ 144,000
Furniture 314,000 239,000
Equipment 2,217,000 1,600,000
Construction in Progress 792,000 --
--------------- ----------------
3,497,000 1,983,000
Accumulated Depreciation (1,083,000) (752,000)
--------------- ----------------
$2,414,000 $ 1,231,000
=============== ================
F-10
DISCOVERY LABORATORIES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2003
Depreciation expense for the years ended December 31, 2003, 2002, and 2001 was
$331,000, $252,000, and $184,000, respectively.
The equipment balance at December 31, 2003 and 2002 includes $1,468,000 and
$559,000, respectively, of property subject to a capital lease. The related
accumulated depreciation was $194,000 and $57,000 at December 31, 2003 and 2002,
respectively.
The balance of Construction in Progress primarily consists of new manufacturing
equipment related to the enhancement of our manufacturing capabilities for
Surfaxin. As of December 31, 2003 and 2002, the Company had additional
construction commitments outstanding totaling approximately $554,000 and
$188,000, respectively.
NOTE 6 - INCOME TAXES
Since its inception, the Company has never recorded a provision or benefit for
Federal and state income taxes.
The reconciliation of the income tax benefit computed at the Federal statutory
rates to the Company's recorded tax benefit for the years ended December 31,
2003, 2002, and 2001 are as follows:
December 31,
2003 2002 2001
-------------- ------------ ------------
Income tax benefit, statutory rates $ 8,255,000 $ 5,938,000 $ 3,783,000
State taxes on income,
net of federal benefit 2,015,000 1,088,000 698,000
Research and development tax credit 441,000 274,000 90,000
Other 92,000 (755,000) 3,000
-------------- ------------ ------------
Income tax benefit 10,803,000 6,545,000 4,574,000
Valuation allowance (10,803,000) (6,545,000) (4,574,000)
-------------- ------------ ------------
Income tax benefit $ -- $ -- $ --
============== ============ ============
The tax effects of temporary differences that give rise to deferred tax assets
and deferred tax liabilities, at December 31, 2003 and 2002, are as follows:
December 31,
2003 2002
------------ ------------
Long-term deferred tax assets:
Net operating loss carryforwards
(federal and state) $ 36,500,000 $ 25,526,000
Research and development tax credits
1,868,000 1,225,000
Other Accrued 70,000 --
Deferred Revenue 273,000 --
Capitalized research and development
122,000 222,000
------------ ------------
Total long-term deferred tax assets 38,833,000 26,973,000
------------ ------------
Long-term deferred tax liabilities:
Property and equipment (272,000) (108,000)
------------ ------------
Net deferred tax assets
38,561,000 26,865,000
Less: valuation allowance
(38,561,000) (26,865,000)
------------ ------------
$ -- $ --
============ ============
F-11
DISCOVERY LABORATORIES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2003
The Company was in a net deferred tax asset position at December 31, 2003 and
2002 before the consideration of a valuation allowance. Due to the fact that the
Company has never realized a profit, management has fully reserved the net
deferred tax asset since realization is not assured.
At December 31, 2003 and 2002, the Company had available carryforward net
operating losses for Federal tax purposes of approximately $91,585,000 and
$65,112,000, respectively, and a research and development tax credit
carryforward of $1,868,000 and $1,225,000, respectively. The Federal net
operating loss and research and development tax credit carryforwards expire
beginning in 2009 and continuing through 2022. At December 31, 2003, the Company
had available carryforward net operating losses of $2,627,000 related to stock
based compensation. Additionally, at December 31, 2003 and 2002, the Company had
available carryforward losses of approximately $82,483,000 and $51,385,000,
respectively, for state tax purposes. The utilization of the Federal net
operating loss carryforwards is subject to annual limitations in accordance with
Section 382 of the Internal Revenue Code. Certain state carryforward net
operating losses are also subject to annual limitations.
The difference between the accumulated deficit for financial reporting purposes
and the net operating loss carryforwards for tax purposes is primarily due to
the write-off of the acquired in-process research and development and supplies,
which were not deducted for tax purposes.
NOTE 7 - LICENSE, RESEARCH FUNDING, AND COMMERCIALIZATION AGREEMENTS
In March 2002, the Company expanded its existing alliance with Esteve to
develop, market and sell Surfaxin within Central and South America, Mexico and
Southern Europe. In connection with this new Esteve collaboration, Esteve
purchased 821,862 shares of Common Stock for an aggregate consideration of $4
million (at a 50% premium over the average closing price for the 30 days prior
to the closing date) and paid the Company 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. The Company has
agreed to an exclusive supply agreement which provides that Esteve will purchase
from the Company 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 indications in Acute Lung
Injury/Acute Respiratory Distress Syndrome. Further, Esteve also agreed to make
certain milestone payments to the Company upon the attainment of European
marketing regulatory approval of Surfaxin.
The Company has accounted for the license fees associated with this new Esteve
collaboration and the Esteve collaboration entered into in October 1999
(including the premium paid for Common Stock), the reimbursement of research and
development expenditures, and the advance payment for Surfaxin received from
Esteve to be used in clinical trials as deferred revenue. The balance in
deferred revenue at December 31, 2003 relates entirely to the license agreement
with Esteve for which the Company will recognize revenue using a straight line
method through the anticipated date of FDA approval for the first Surfaxin
neonatal indication.
On December 10, 2001, the Company entered into a collaboration arrangement with
Quintiles, and its affiliate, PharmaBio Development, Inc. ("PharmaBio"), whereby
Quintiles will provide pre- and post-launch marketing services for the
commercialization of Surfaxin for Respiratory Distress Syndrome in premature
infants and/or Meconium Aspiration Syndrome in full-term infants in the United
States. In connection therewith, the Company issued to PharmaBio for aggregate
consideration of $3 million: (i) 791,905 shares of Common Stock; (ii) Class G
warrants to purchase 357,143 shares of Common Stock at an exercise price equal
to $3.485 per share; and (iii) Class H warrants to purchase 320,000 shares of
Common Stock at an exercise price equal to $3.03 per share.
F-12
DISCOVERY LABORATORIES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2003
PharmaBio also committed to provide the Company with a secured revolving credit
facility (the "Credit Facility"), primarily for use to pay pre-launch marketing
services to be provided by Quintiles, subject to the Company satisfying certain
conditions, for up to $8.5 million, which may be increased to $10 million in
specified circumstances. To the extent the Credit Facility availability is
increased to greater than $8.5 million, for each $1 million dollar increase, the
amount of shares of Common Stock issuable pursuant to the Class H warrants will
be increased by approximately 38,000 shares. Principal amounts owed under the
Credit Facility may be paid out of the proceeds of milestone payments to be paid
by PharmaBio to the Company at certain intervals upon the achievement of certain
corporate milestones by the Company. At December 31, 2003 and 2002, $2,436,000
and $1,450,000, respectively, was outstanding under the Credit Facility.
The Company and Ortho Pharmaceuticals, Inc. ("Ortho Pharmaceuticals"), a
wholly-owned subsidiary of Johnson & Johnson, Inc., are parties to an agreement
granting an exclusive license of the Surfaxin technology to the Company in
exchange for certain license fees, future milestone payments (aggregating
$2,750,000) and royalties.
The Company and The Scripps Research Institute ("Scripps") are parties to a
research funding and option agreement which expires in February 2005, subject to
termination by the Company at any time with 90 days prior notice. Pursuant to
this agreement, the Company is obligated to fund a portion of Scripps' research
efforts and thereby has the option to acquire an exclusive worldwide license to
the technology developed from the research program during the term of the
agreement. Scripps owns all of the technology that it developed pursuant to work
performed under the agreement. To the extent the Company does not exercise its
option to technology developed under the agreement, the Company has the right to
receive 50% of the net royalty income received by Scripps for inventions that
are jointly developed under the agreement. Payments to Scripps under this
agreement were $649,000, $572,000 and $508,000 in 2003, 2002, and 2001,
respectively.
NOTE 8 - STOCKHOLDERS' EQUITY
2003 SHELF REGISTRATION STATEMENT
On December 19, 2003, the Company filed a Form S-3 shelf registration statement
with the Securities and Exchange Commission ("SEC") for the proposed offering
from time to time of up to 6,500,000 shares of its Common Stock. The Company has
no immediate plans to sell its securities under the shelf registration, however,
since the registration statement has been declared effective by the SEC, the
Company will be able to issue the securities from time to time in response to
market conditions or other circumstances on terms and conditions that will be
determined at such time.
2003 PRIVATE PLACEMENT
In June 2003, the Company completed the sale of securities in a private
placement to selected institutional and accredited investors for net proceeds of
approximately $259.9 million. The Company issued 4,997,882 shares of Common
Stock and 999,577 Class A Investor warrants to purchase shares of Common Stock
at an exercise price of $6.875 per share. The Class A Investor warrants have a
seven-year term. As of December 31, 2003, approximately 955,000 of the Class A
Investor warrants remain unexercised.
2002 PRIVATE PLACEMENT
In November 2002, the Company received approximately $11.9 million in net
proceeds from the sale of 6,397,517 shares of Common Stock and 2,878,883 Class I
warrants to purchase shares of Common Stock at an exercise price of $2.425 per
share. The Class I warrants are exercisable through November 5, 2007. In
connection with this private placement, the placement agent received fees of
approximately $766,000. All of the Class I warrants have been exercised.
F-13
DISCOVERY LABORATORIES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2003
2001 PRIVATE PLACEMENTS
In October 2001, the Company received approximately $7.3 million in net proceeds
from the sale of 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 are exercisable through September 30, 2006. In connection with
this private placement, the placement agent received fees of approximately
$360,000 and warrants to purchase 164,911 shares of Common Stock at $2.394 per
share. All of the Class F warrants have been exercised.
In April 2001, the Company received approximately $1 million in proceeds in a
private placement sale of 296,560 shares of Common Stock to a limited
partnership.
COMMON SHARES RESERVED FOR ISSUANCE
As of December 31, 2003 and 2002, the Company has reserved shares of Common
Stock for issuance as follows:
December 31,
2003 2002
----------- ----------
Stock option plans 5,587,000 4,908,000
401(k) discretionary match 129,000 --
2003 Shelf Registration Statement 6,500,000 --
Placement agent and underwriter warrants 1,017,000 1,610,000
Class C warrants (1999 private placement) -- 57,000
Class E warrants (2000 private placement) 549,000 581,000
Class F warrants (2001 private placement) -- 713,000
Class G warrants (2001 Quintiles Alliance) 357,000 357,000
Class H warrants (2001 Quintiles Credit Facility) 565,000 565,000
Class I warrants (2002 private placement) -- 2,879,000
Class A warrants (2003 private placement) 955,000 --
Other warrants -- 75,000
----------- ----------
16,659,000 11,745,000
TREASURY STOCK/COMMON STOCK ISSUED FOR SERVICES
The Company has a stock repurchase program wherein the Company may buy its own
shares on the open market and use such shares to settle indebtedness. Such
shares are accounted for as treasury stock.
During 2003, the Company acquired 128,936 shares of Common Stock for
approximately $1,050,000 from a related party in payment for the exercise of
certain stock options available to the related party. Such shares are accounted
for as treasury stock.
During 2002, the Company did not acquire, nor did it issue any Common Stock
accounted for as treasury stock.
F-14
DISCOVERY LABORATORIES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2003
During 2001, the Company acquired 11,500 shares of Common Stock for
approximately $26,000. Such shares are accounted for as treasury stock. In
addition, during 2001, the Company issued 10,902 shares of Common Stock in lieu
of cash payments for services and rent.
NOTE 9 - STOCK OPTIONS
In March 1998, the Company adopted its 1998 Stock Incentive Plan, which includes
three equity programs (the "1998 Plan"). Under the Discretionary Option Grant
Program, options to acquire shares of the Common Stock may be granted to
eligible persons who are employees, non-employee directors, consultants and
other independent advisors. Pursuant to the Stock Issuance Program, such
eligible persons may be issued shares of the Common Stock. Under the Automatic
Option Grant Program, eligible non-employee directors will automatically receive
option grants at periodic intervals at an exercise price equal to the fair
market value per share on the date of the grant. Options granted under the 1998
Plan expire no later than 10 years from the date of the grant.
The 1998 Plan was successively amended at each of the Annual Meeting of
Stockholders for the years 2003, 2002, and 2001, to increase the maximum number
of shares of Common Stock reserved for issuance over the term of the plan by
1,420,000 shares, 1,000,000 shares and 1,150,000 shares, respectively. After
giving effect to these amendments, there are currently 6,570,000 shares of
Common Stock reserved for issuance over the term of the plan. In addition, in
2002 the Board of Directors approved amendments to the 1998 Plan that (i)
increased the exercise price of options granted to non-employee directors
pursuant to the Automatic Option Grant Program from 60% to 100% of the fair
market value per share on the date of the grant and (ii) removed the Plan
Administrator's authority to effect the cancellation and regrant of any
outstanding options under the Discretionary Option Grant Program.
A summary of the Company's stock option activity and related information is as
follows:
Weighted Average
Weighted Average Remaining
Price Per Share Shares Exercise Price Contractual Life
-------------------- -------------- ------------------- --------------------
Balance at January 1, 2001 $0.0026 - $7.00 3,106,166 $3.42 8.37 years
Options granted 2.10 - 5.25 1,255,000 2.55
Options exercised 0.3205 - 0.87 (6,224) 0.47
Options forfeited 2.10 - 5.19 (107,983) 4.13
--------------
Balance at December 31, 2001 0.0026 - 7.00 4,246,959 3.15 8.01 years
Options granted 1.26 - 3.65 1,786,000 2.14
Options exercised 0.0821 - 2.10 (77,925) 0.77
Options forfeited .3205 - 7.00 (349,850) 3.34
--------------
Balance at December 31, 2002 0.0026 - 5.375 5,605,184 2.85 7.81 years
Options granted 1.70 - 9.17 1,111,750 6.75
Options exercised 0.0026 - 4.22 (993,001) 1.95
Options forfeited 0.1923 - 5.06 (168,611) 2.76
--------------
Balance at December 31, 2003 0.0026 - 9.17 5,555,322 3.80 7.44 years
F-15
DISCOVERY LABORATORIES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2003
The following table provides further detail with regard to the options
outstanding and exercisable at December 31, 2003:
Weighted Weighted Average
Average Price Remaining
Price per share Shares per Share Contractual Life
- ------------------------- ------------------ -------------------- --------------------------
$0.0026 - $2.00 1,120,910 $1.56 7.60 years
$2.01 - $4.00 2,029,614 $2.67 7.64 years
$4.00 - $6.00 1,545,798 $4.62 5.82 years
$6.01 - $8.00 205,000 $7.28 9.65 years
$8.01 - $10.00 654,000 $8.09 9.70 years
The following table pertains to options granted and exercisable at less than
fair value:
December 31,
2003 2002 2001
------------ ----------- -----------
Weighted average exercise price $2.09 $2.00 $2.11
Weighted average fair value $3.49 $3.33 $3.53
Included in the options outstanding, are options to purchase 117,200 shares of
Common Stock (at an exercise price of $4.44) granted during 1998, which vest
upon the Company achieving specified milestones and expire in June 2008. In
December 2002, the related milestones were achieved.
In December 2002, the Board of Directors approved the issuance of options to
management to purchase up to 800,000 shares of Common Stock at an exercise price
of $2.75 per share. Such options had been subject to the approval of the
Company's shareholders, which was obtained at the time of the Company's Annual
Meeting of Shareholders for 2003. Accordingly, such options are now included in
the options outstanding at December 31, 2002. Such options shall vest in their
entirety upon the fourth anniversary of the date of grant or at such earlier
time, if ever, upon the receipt by the Company of a New Drug Application (NDA)
approval by the United States Food and Drug Administration for Surfaxin for
either Respiratory Distress Syndrome in premature infants, Meconium Aspiration
Syndrome in full-term infants, or Acute Respiratory Distress Syndrome in adults.
In December 2003, the Board of Directors approved the issuance of options to
management to purchase up to 1,464,500 shares of Common Stock at an exercise
price of $9.17 per share. Such options are expressly subject to the requisite
approval of the Company's shareholders, to be obtained no later than the
Company's Annual Meeting of Shareholders for 2004, for an amendment to the 1998
Plan authorizing an increase in the number of shares issuable under the plan in
an amount equal to or greater than the aggregate amount of such options.
Accordingly, such options are not included in the options outstanding at
December 31, 2003. Provided the shareholders of the Company approve such
amendment, such options shall vest over a three year period from the date of the
grant.
NOTE 10 - 401(K) MATCH
The Company has a voluntary 401(k) savings plan covering eligible employees.
Effective January 1, 2003, the Company allows for periodic discretionary matches
as a percentage of each participant's contributions in newly issued Company
stock. The total match for the year ending December 31, 2003 was $119,000.
F-16
DISCOVERY LABORATORIES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2003
NOTE 11 - COMMITMENTS
The Company's long-term contractual obligations include commitments and
estimated purchase obligations entered into in the normal course of business.
Payments due under contractual obligations at December 31, 2003 are as follows:
2004 2005 2006 2007 Total
---------- ---------- --------- --------- ----------
Credit facility with corporate partner (1) 2,436,000 -- -- -- 2,436,000
Capital lease obligations (2) 473,000 425,000 238,000 131,000 1,267,000
Operating lease obligations (3) 530,000 291,000 28,000 -- 849,000
Purchase obligations (4) 554,000 -- -- -- 554,000
Employment agreements (1) 1,820,000 1,567,000 -- -- 3,387,000
---------- ---------- --------- --------- ----------
Total 5,813,000 2,283,000 266,000 131,000 8,493,000
(1) See further discussion below.
(2) Capital leases obligations primarily relate to a capital lease
financing arrangement with General Electric Capital Corporation
discussed below.
(3) Operating lease obligations include property rental agreements
discussed below.
(4) Purchase obligations include commitments of equipment and services for
the enhancement of our manufacturing capabilities for Surfaxin.
In addition to the contractual obligations above, the Company has future
milestone commitments, aggregating $2,750,000, and royalty obligations to Ortho
Pharmaceuticals, a wholly-owned subsidiary of Johnson & Johnson, Inc., related
to the Company's product licenses.
The Company has a secured revolving credit facility of up to $8.5 to $10 million
with PharmaBio to fund pre-marketing activities for a Surfaxin launch in the
United States. The credit facility is available for use until December 10, 2004,
and monies become available in three tranches upon satisfying certain
conditions. The Company has satisfied the conditions for availability of the
first two tranches and at December 31, 2003, the amount available under the
credit facility was approximately $5.7 million, of which $2.4 million was
outstanding. Interest on amounts advanced under the credit facility will be
payable quarterly in arrears. Outstanding principal and interest due under the
credit facility are due and payable on December 10, 2004. Although the Company
may be able to repay principal amounts owed under the credit facility from
proceeds of milestone payments to be paid by PharmaBio upon the achievement of
certain corporate milestones, there can be no assurance that the Company will
achieve any of these milestones prior to the repayment date, and doing so is not
likely unless the FDA expedites the review of the NDA for Surfaxin for the
treatment of Respiratory Distress Syndrome in premature infants that the Company
expects to file with the FDA in April 2004, and approves such NDA prior to
December 10, 2004. The Company is obligated to use a significant portion of the
funds borrowed under the credit facility for pre-launch marketing services to be
provided by Quintiles.
Th Company has a capital lease financing arrangement with the Life Science and
Technology Finance Division of General Electric Capital Corporation that
provides, subject to certain conditions, for up to $1 million in financing for
capital purchases. In 2003, the arrangement was increased to provide, subject to
certain conditions, up to an aggregate $4 million in financing for capital
purchases. As of December 31, 2003, approximately $962,000 was outstanding under
this financing arrangement.
At December 31, 2003, the Company had employment agreements with six officers
providing for an aggregate annual salary of $1,567,000. The agreements expire in
December 2005, however, commencing on January 1, 2006, and on each January 1st
thereafter, the term of these agreements shall automatically be extended for one
additional year, unless at least 90 days prior to such January 1st date, the
Company or the Executive shall have given notice that it does not wish to extend
the agreement. The Company also had employment agreements with two other
executives that provide for an aggregate annual salary of $340,000, which expire
in June and November 2004. All of the foregoing agreements provide for the
issuance of annual bonuses and the granting of options subject to approval by
the Board of Directors.
F-17
DISCOVERY LABORATORIES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2003
At December 31, 2003, the Company leased office and laboratory space in
Doylestown, Pennsylvania under leases which expire in September 2004, March 2005
and September 2005. Additionally, the Company leased office and laboratory space
in Redwood City, California under a lease that expires February 2006 and office
space in Windsor, United Kingdom under a lease, which expired December 2003.
Payments made under these leases for the years ended December 31, 2003, 2002,
and 2001 were $590,000, $481,000 and $273,000 respectively.
Aggregate future minimum annual rents for these leases are as follows:
2004 $ 530,000
2005 291,000
2006 28,000
-----------
$ 849,000
===========
The Company entered into agreements to lease manufacturing, laboratory and
office equipment, which are being accounted for as capital leases. Future
minimum lease payments for these leases are as follows:
2004 473,000
2005 425,000
2006 238,000
2007 131,000
-----------
1,267,000
Less amounts representing interest (173,000)
-----------
$ 1,094,000
===========
NOTE 12 - RELATED PARTY TRANSACTIONS
In November 2001, the Company entered into an agreement with Clinical Data
Management, Inc. (CDM), replacing an earlier similar agreement, to perform
duties associated with processing data for the Company's ongoing clinical
trials. Such agreement expired on November 14, 2002 pursuant to its terms and
the Company has not entered into any further arrangements with CDM. CDM is
wholly-owned by the spouse of the Company's President and Chief Executive
Officer. Payments made to CDM and its owner for the years ended December 31,
2002 and 2001 were approximately $289,000, $221,000 respectively. There were no
such payments made in 2003.
In March 2002, the Company expanded its existing relationship with Esteve by
entering into an agreement to expand the territory covered by the collaboration
arrangement entered into with Esteve in October 1999. Pursuant to this
agreement, Esteve purchased 821,862 shares of the company's Common Stock at
$4.867 per share for $4 million in cash and paid a non-refundable licensing fee
of $500,000. A member of the Company's board of directors is an executive
officer of Esteve.
F-18
DISCOVERY LABORATORIES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2003
NOTE 13 - SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
The following table contains unaudited statement of operations information for
each quarter of 2003 and 2002. The operating results for any quarter are not
necessarily indicative of results for any future period.
2003 QUARTERS ENDED: (in thousands, except per share data)
- --------------------------------------------------------------------------------------------------------
Mar. 31 June 30 Sept. 30 Dec. 31 Total Year
-------- -------- -------- --------- ----------
Revenues from collaborative agreements $ 393 $ 263 $ 198 $ 183 $ 1,037
Operating Expenses:
Research and development 3,844 4,011 5,096 6,799 19,750
General and administrative 1,167 1,137 1,375 2,043 5,722
-------- -------- -------- --------- ---------
Total expenses 5,011 5,148 6,471 8,842 25,472
-------- -------- --------- --------- ---------
Operating loss (4,618) (4,885) (6,273) (8,659) (24,435)
Other income and expense 113 36 54 (48) 155
-------- -------- -------- --------- ---------
Net loss $ (4,505) $ (4,849) $ (6,219) $ (8,707) $ (24,280)
======== ======== ======== ========= =========
Net loss per common share - basic and diluted $ (0.14) $ (0.14) $ (0.15) $ (0.21) $ (0.65)
Weighted average number of common
shares outstanding 32,857 33,487 41,084 42,391 37,426
2002 QUARTERS ENDED: (in thousands, except per share data)
- ---------------------------------------------------------------------------------------------------------
Mar. 31 June 30 Sept. 30 Dec. 31 Total Year
-------- -------- -------- --------- ----------
Revenues from collaborative agreements $ 237 $ 783 $ 368 $ 394 $ 1,782
-------- -------- -------- --------- ---------
Operating Expenses:
Research and development 2,605 3,721 3,475 4,546 14,347
General and administrative 1,132 1,538 1,633 1,155 5,458
-------- -------- -------- --------- ---------
Total expenses 3,737 5,259 5,108 5,701 19,805
-------- -------- -------- --------- ---------
Operating loss (3,500) (4,476) (4,740) (5,307) (18,023)
Other income and expense 130 189 211 50 580
-------- -------- -------- --------- ---------
Net loss $ (3,370) $ (4,287) $ (4,529) $ (5,257) $ (17,443)
======== ======== ======== ========= =========
Net loss per common share - basic and diluted $ (0.13) $ (0.16) $ (0.17) $ (0.17) $ (0.64)
Weighted average number of common
shares outstanding 25,834 26,394 26,441 30,717 27,351
F-19