UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2004
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _____________ to ___________
Commission file number 000-26422
DISCOVERY LABORATORIES, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 94-3171943
(State or other jurisdiction (I.R.S. Employer Identification No.)
of incorporation or organization)
350 SOUTH MAIN STREET, SUITE 307
DOYLESTOWN, PENNSYLVANIA 18901
(Address of principal executive offices) (Zip Code)
(215) 340-4699
(Registrants' telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. [X] Yes [ ] No
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). [ ] Yes [X] No
As of April 30, 2004, 46,738,213 shares of common stock, par value $.001 per
share, were outstanding.
TABLE OF CONTENTS
PAGE
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
CONDENSED CONSOLIDATED BALANCE SHEETS --
As of March 31, 2004 (unaudited) and December 31, 2003 Page 4
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (unaudited) --
For the Three Months Ended March 31, 2004 and 2003 Page 5
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited) --
For the Three Months Ended March 31, 2004 and 2003 Page 6
Notes to Condensed Consolidated Financial Statements
- March 31, 2004 (unaudited) Page 7
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Page 10
Item 3. Quantitative and Qualitative Disclosures about Market Risk Page 31
Item 4. Controls and Procedures Page 32
PART II - OTHER INFORMATION
Item 1. Legal Proceedings. Page 33
Item 2. Changes in Securities and Use of Proceeds. Page 33
Item 3. Defaults Upon Senior Securities. Page 34
Item 4. Submission of Matters to a Vote of Security Holders. Page 34
Item 5. Other Information. Page 34
Item 6. Exhibits and Reports on Form 8-K. Page 34
Signatures Page 36
Page 2
Unless the context otherwise requires, all references to "we," "us," "our," and
the "Company" include Discovery Laboratories, Inc. ("Discovery"), and its
wholly-owned, presently inactive subsidiary, Acute Therapeutics, Inc.
SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION ACT OF 1995
Certain statements set forth in this report and any that are 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; delays in our preparation and filing of applications with the FDA
for regulatory approval; delays in the FDA's approval of any applications we
file with the FDA, including the NDA we filed in April 2004; potential rejection
of any applications we file with the FDA, including the NDA we filed in April
2004; 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), or other drug
candidates 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 the 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 uncertainties detailed in Item 2:
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and in any 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.
Page 3
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
DISCOVERY LABORATORIES, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED BALANCE SHEETS
MARCH 31, DECEMBER 31,
2004 2003
------------- -------------
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 23,564,000 $ 29,422,000
Note receivable - current 2,000 3,000
Prepaid expenses and other current assets 558,000 665,000
------------- -------------
Total current assets 24,124,000 30,090,000
Property and equipment, net of accumulated depreciation 2,878,000 2,414,000
Note receivable, net of current portion 192,000 192,000
Other assets 19,000 19,000
------------- -------------
Total Assets $ 27,213,000 $ 32,715,000
============= =============
LIABILITIES & STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses $ 4,362,000 $ 4,210,000
Credit facility with corporate partner 3,265,000 2,436,000
Capitalized lease - current portion 447,000 383,000
------------- -------------
Total current liabilities 8,074,000 7,029,000
Deferred revenue 538,000 672,000
Capitalized lease, net of current portion 833,000 711,000
------------- -------------
Total Liabilities 9,445,000 8,412,000
Stockholders' equity:
Common stock, $.001 par value; 60,000,000 authorized;
43,914,649 and 42,491,438 issued and outstanding at
March 31, 2004 and December 31, 2003, respectively 44,000 43,000
Additional paid-in capital 126,176,000 122,409,000
Unearned portion of compensatory stock options -- (2,000)
Accumulated deficit (105,730,000) (96,858,000)
Treasury stock (at cost; 282,902 and 167,179 shares at
March 31, 2004 and December 31, 2003, respectively) (2,722,000) (1,289,000)
------------- -------------
Total stockholders' equity 17,768,000 24,303,000
------------- -------------
Total Liabilities & Stockholders' Equity $ 27,213,000 $ 32,715,000
============= =============
Page 4
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
DISCOVERY LABORATORIES, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
THREE MONTHS ENDED
MARCH 31,
2004 2003
------------ ------------
Revenues:
Contracts, Licensing, Grants & Milestones $ 142,000 $ 393,000
Expenses:
Research & Development 6,710,000 3,844,000
General & Administrative 2,281,000 1,167,000
------------ ------------
Total Expenses 8,991,000 5,011,000
------------ ------------
Operating Loss (8,849,000) (4,618,000)
Other income and expenses:
Interest income, dividends, realized
gains, and other income 63,000 169,000
Interest expense (86,000) (56,000)
------------ ------------
Net Loss $ (8,872,000) $ (4,505,000)
============ ============
Net loss per common share - $ (0.20) $ (0.14)
basic and diluted
Weighted average number of common 43,320,268 32,856,526
shares outstanding -
basic and diluted
Page 5
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
DISCOVERY LABORATORIES, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
Three Months Ended
March 31,
----------------------------
2004 2003
------------ ------------
Cash flows from operating activities:
Net loss $ (8,872,000) $ (4,505,000)
Adjustments to reconcile net loss to net cash used
in operating activities:
Depreciation and amortization 116,000 86,000
Realized gains on marketable securities -- (42,000)
Compensatory stock options 53,000 (1,000)
Changes in:
Prepaid expenses and
other current assets 81,000 68,000
Accounts payable and accrued expenses 152,000 (446,000)
Other assets -- (2,000)
Amortization of deferred revenue (134,000) (180,000)
------------ ------------
Net cash used in operating activities (8,604,000) (5,022,000)
------------ ------------
Cash Flows from investing activities:
Purchase of property and equipment (301,000) (61,000)
Related party loan payments received 1,000 1,000
Purchase of marketable securities -- (133,000)
Proceeds from sale or maturity of marketable securities -- 3,478,000
------------ ------------
Net cash (used in) provided by investing activities (300,000) 3,285,000
------------ ------------
Cash Flows from financing activities:
Proceeds from issuance of securities, net of expenses 2,310,000 (66,000)
Proceeds from credit facility 829,000 198,000
Principal payments under capital lease obligation (93,000) (49,000)
------------ ------------
Net cash provided by financing activities 3,046,000 83,000
------------ ------------
Net decrease in cash and cash equivalents (5,858,000) (1,654,000)
Cash and cash equivalents - beginning of period 29,422,000 8,538,000
------------ ------------
Cash and cash equivalents - end of period $ 23,564,000 $ 6,884,000
============ ============
Supplementary disclosure of cash flows information:
Interest paid $ 70,000 $ 13,000
Noncash transactions:
Class H warrants revalued (26,000) --
Equipment acquired through capitalized lease 279,000 190,000
Unrealized loss on marketable securities -- (63,000)
Exchange of common stock for exercise of stock options 1,433,000 --
Page 6
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 1 - THE COMPANY AND BASIS OF PRESENTATION
THE COMPANY
Discovery Laboratories, Inc. is a biopharmaceutical company developing its
proprietary surfactant technology as Surfactant Replacement Therapies for
respiratory diseases. Surfactants are compositions produced naturally in the
lungs and are essential for breathing. 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 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 has filed a New Drug Application (NDA) with the United States Food and
Drug Administration (FDA) for clearance to market Surfaxin(R), Discovery's lead
product, for the prevention of Respiratory Distress Syndrome (RDS) in premature
infants. 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 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.
STOCK BASED EMPLOYEE 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
Page 7
employee compensation and the effect of the method used on the reported results.
We continue to account for our 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 shares of 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 our 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 periods ended March 31, 2004 and 2003 would have been as follows:
THREE MONTHS ENDED
MARCH 31,
--------------------------
2004 2003
----------- -----------
Net loss as reported $(8,872,000) $(4,505,000)
Additional stock-based employee compensation $ -- $ (315,000)
----------- -----------
Pro forma net loss $(8,872,000) $(4,820,000)
=========== ===========
Pro forma net loss per share $ (0.20) $ (0.15)
BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with accounting principles generally accepted in the
United States for interim financial information in accordance with the
instructions to Form 10-Q. Accordingly, they do not include all of the
information and footnotes required by accounting principles generally accepted
in the United States for complete financial statements. In the opinion of
management, all adjustments (consisting of normally recurring accruals)
considered for fair presentation have been included. Operating results for the
three-month period ended March 31, 2004, are not necessarily indicative of the
results that may be expected for the year ended December 31, 2004. For further
information, refer to the consolidated financial statements and footnotes
thereto included in our Annual Report on Form 10-K for the year ended December
31, 2003.
All of our current products under development are subject to license agreements
that will require the payment of future royalties.
Certain prior year balances have been reclassified to conform with the current
presentation.
Page 8
NOTE 2 - NET LOSS PER SHARE
Net loss per share is computed based on the weighted average number of common
shares outstanding for the periods. Common shares issuable upon the exercise of
options and warrants are not included in the calculation of the net loss per
share as their effect would be antidilutive.
NOTE 3 - COMPREHENSIVE LOSS
Total comprehensive loss was approximately $8,872,000 for the three months ended
March 31, 2004, and approximately $4,568,000 for the three months ended March
31, 2003.
NOTE 4 - NOTE RECEIVABLE
Note receivable pertains to a $200,000, 7% per annum mortgagor's note due from
one of our executive officers. 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 March 31,
2004 and December 31, 2003 was approximately $194,000 and $195,000,
respectively.
NOTE 5 - TREASURY STOCK
During the three months ended March 31, 2004, certain members of our management,
pursuant to terms set forth in our Amended and Restated 1998 Stock Incentive
Plan, tendered shares of common stock then held by such members in lieu of cash
for payment for the exercise of certain stock options previously granted to such
parties. For the three months ended March 31, 2004, 115,723 shares of our common
stock were tendered to us by such parties in lieu of cash at an average price of
$12.38 per share. These shares are accounted for as treasury stock. See Part II,
Item 2. Changes in Securities and Use of Proceeds.
NOTE 6 - SUBSEQUENT EVENTS
Filing of New Drug Application (NDA)
In April 2004, we submitted an NDA to the FDA for clearance to market
Surfaxin(R) for the prevention of RDS in premature infants. Surfaxin is a novel,
peptide-containing, humanized lung surfactant developed from Discovery's
proprietary Surfactant Replacement Technology platform.
The NDA filing is supported, in large part, by data from Discovery's two
positive Phase 3 RDS clinical trials. The principal trial was a landmark, 1,294
patient pivotal study that demonstrated Surfaxin's superiority to Exosurf(R), a
non-protein containing synthetic surfactant. In this pivotal trial, another
surfactant, Survanta(R), which is derived from cows and is the leading
surfactant used in the United States, served as a reference arm. The second
trial was a 252 patient supportive study that demonstrated Surfaxin's
non-inferiority to Curosurf(R), a pig-derived surfactant and the leading
surfactant used in Europe.
Page 9
Equity Financing
In April 2004, we completed an underwritten public offering of 2,200,000 shares
of common stock. The shares were priced at $11.00 per share resulting in our
receipt of gross and net proceeds equal to $24.2 million and approximately $22.7
million, respectively.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
Since our inception, we have incurred significant losses and, as of March 31,
2004, we had an accumulated deficit of approximately $106 million. 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, business and commercial development,
financial, legal and general corporate activities and related expenses. See
"Results of Operations."
We have funded our operations with working capital provided principally through
public and private equity financings and strategic collaborations. As of March
31, 2004, we had cash and investments of approximately $23.6 million, a $8.5
million secured revolving credit facility with PharmaBio Development, Inc., of
which $5.7 million was available for borrowing and $3.3 million was outstanding,
and a $4 million capital equipment lease financing arrangement, of which
approximately $2.6 million was available for borrowing and $1.4 million had been
used.
In April 2004, we completed an underwritten public offering of 2,200,000 shares
of common stock. The shares were priced at $11.00 per share resulting in our
receipt of gross and net proceeds equal to $24.2 million and approximately $22.7
million, respectively. See -"Liquidity and Capital Resources."
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 further develop our existing pipeline products and broaden
our 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, filed
an NDA with the FDA, and are preparing to file a Marketing
Page 10
Authorization Application (MAA) with the European Medicines Evaluation
Agency (EMEA). Also, 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 in such Phase 3 clinical trials. For
Acute Respiratory Distress Syndrome in adults, we are currently
conducting a Phase 2 dose-ranging safety and efficacy study of up to
110 patients in the United States. We expect to complete enrollment for
this trial in the second half of 2004. For Meconium Aspiration Syndrome
in full-term infants, we are currently conducting a Phase 3 clinical
trial in up to 200 patients and a Phase 2 clinical trial in up to 60
patients. 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 Phase 2 clinical trial in the second half of
2004. 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."
(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 at 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 and commercialization development initiatives,
financial systems and controls and management information technologies.
In October 2003, we entered into a Technology Transfer and Manufacturing
Agreement with a contract manufacturer, Laureate Pharma, L.P., which provides
for the establishment of a Surfaxin manufacturing line together with the
production of clinical and commercial drug supply in conformance with current
Page 11
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. In addition to our arrangement
with Laureate, we plan to conduct other activities in connection with the
implementation of our long term manufacturing strategy including evaluating and
establishing additional contract or Discovery-owned manufacturing facilities.
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 competitors'
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 Transnational Corp., 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 million 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 capabilities in place for the commercialization of Surfaxin in the
United States, if approved.
We have a strategic alliance with Laboratorios del Dr. Esteve S.A. 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 will pay certain clinical trial costs related to
obtaining regulatory approval in Europe for the indications of Acute Lung
Injury/Acute Respiratory Distress Syndrome will 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
March 31, 2004, we had not generated any revenues from any product sales, and
had not achieved profitability on a quarterly or annual basis. Our ability to
achieve profitability depends upon, among other things, our ability to develop
products, obtain regulatory approval for products under development and enter
into agreements for product development, manufacturing and commercialization. In
addition, our results are dependent upon the performance of our strategic
partners and 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.
Page 12
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 $91.6 million. 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 $1.9 million. The Federal net operating
loss and research and development tax credit carryforwards expire beginning in
2008 and continuing through 2021.
RESULTS OF OPERATIONS
Net loss for the three months ended March 31, 2004 was $8,872,000 ($0.20 per
common share). Net loss for the three months ended March 31, 2003 was $4,505,000
($0.14 per common share).
Revenues
Revenues from research and development collaborative agreements and grants for
the three months ended March 31, 2004 and 2003 were $142,000 and $393,000,
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 and a Small
Business Innovative Research (SBIR) grant to develop Surfaxin for Acute Lung
Injury/Acute Respiratory Distress Syndrome in adults. The decrease in the three
months ending March 31, 2004 reflects: (i) the conclusion, in 2003, of work
activities for our Small Business Innovative Research (SBIR) grant for research
for treatments of Acute Lung Injury/Acute Respiratory Distress Syndrome in
adults; 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.
Expenses
Research and development expenses for the three months ended March 31, 2004 and
2003 were $6,710,000 and $3,844,000, respectively, an increase of $2,866,000.
Included in research and development expenses for the three months ended March
31, 2004 was $1.4 million for manufacturing activities to support the production
of clinical and commercial drug supply of Surfaxin at Laureate's facility in
conformance with current Good Manufacturing Practices (cGMPs). The increase in
research and development expenses versus last year also reflects costs incurred
for (i) the development and regulatory efforts to complete two Phase 3 clinical
trials for Surfaxin for the treatment of Respiratory Distress Syndrome in
premature infants, preparation of a New Drug Application that was filed with the
FDA in April 2004, and continuation of the six and twelve month clinical
follow-up on all enrolled patients; (ii) activities in support of development of
our surfactant replacement therapy pipeline, including DSC-104 to potentially
treat patients with asthma (where we are currently preparing to initiate a Phase
2 clinical trial in the second half of 2004), and aerosolized formulations of
our humanized surfactant to potentially treat premature infants in Neonatal
Intensive Care Units suffering from Respiratory Dysfunction (where we are
preparing to initiate a clinical trial in the second half of 2004); and (iii)
the Phase 2 clinical trial for Surfaxin for the treatment of Acute Respiratory
Distress Syndrome in adults.
Page 13
General and administrative expenses for the three months ended March 31, 2004
and 2003 were $2,281,000 and $1,167,000, respectively, an increase of
$1,114,000. General and administrative expenses consist primarily of the costs
of executive management, business and commercial development, financial and
accounting, legal, facility and other administrative costs. Included in general
and administrative costs was approximately $936,000 and $200,000 for the three
months ended March 31, 2004 and 2003, respectively, related to pre-launch
commercialization activities for Surfaxin, of which $829,000 and $200,000,
respectively, were attributable to activities 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"). The increase in general and administrative expenses
versus the same period last year also reflects costs incurred primarily to
support corporate governance initiatives in compliance with the Sarbanes-Oxley
Act, legal activities related to the preparation and filing of patents in
connection with the expansion of our Surfactant Replacement Therapy pipeline,
and commercialization activities in preparation for potential approval and
launch of Surfaxin for RDS.
Other Income and Expense
Other income and expense (net) for the three months ended March 31, 2004 and
2003 was ($23,000) and $113,000, respectively. Interest income for the three
months ended March 31, 2004 and 2003 was $63,000 and $169,000. The decrease is
primarily due to a reduction in interest earned on our cash and cash equivalents
primarily due to a general reduction in market interest rates. Interest expense
for the three months ended March 31, 2004 and 2003 was $86,000 and $56,000,
respectively. The increase is due to interest expense associated with our
secured, revolving credit facility and capital lease financing arrangements. See
"Liquidity and Capital Resources."
LIQUIDITY AND CAPITAL RESOURCES
Cash and Cash Equivalents
As of March 31, 2004, we had cash and cash equivalents of approximately $23.6
million as compared to approximately $29.4 million as of December 31, 2003. As
of March 31, 2004, we had working capital of approximately $16.1 million as
compared to the working capital of approximately $23.1 million as of December
31, 2003. The decrease in working capital of $7 million from the previous
quarter is primarily due to: (i) $8.6 million of cash used in operations; (ii)
$2.4 million received from the exercise of outstanding options and warrants; and
(iii) $1.1 million from our secured, revolving credit facility and capital lease
financing arrangements. Also, in April 2004, we completed an underwritten public
offering of 2,200,000 shares of common stock. The shares were priced at $11.00
per share resulting in our receipt of gross and net proceeds equal to $24.2
million and approximately $22.7 million, respectively.
Secured, Revolving Credit Facility and Capital Lease Financing Arrangements
We have a secured revolving credit facility of up to $8.5 million to $10 million
with PharmaBio to fund pre-marketing activities for a Surfaxin launch in the
United States. The credit facility is available for use until December 10, 2004,
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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 March 31, 2004, the amount available under the credit facility
was approximately $5.7 million, of which $3.3 million, 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. 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 filed with the FDA in April 2004, and approves such NDA prior to
December 10, 2004. See "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 for up to $4
million. As of March 31, 2004, approximately $1.4 million had been used under
this financing arrangement.
Working Capital
With our capital resources as of March 31, 2004 and the net proceeds from our
April financing, 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, 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, our working capital has been provided from the proceeds of private
financing and strategic alliances:
In April 2004, we completed an underwritten public offering of 2,200,000 shares
of common stock. The shares were priced at $11.00 per share resulting in our
receipt of gross and net proceeds equal to $24.2 million and approximately $22.7
million, respectively.
In June 2003, we completed the sale of securities in a private placement to
selected institutional and accredited investors for net proceeds of
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approximately $25.9 million. 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 $11.9 million. 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 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 resulting in 2,506,117 shares issued and proceeds
of approximately $4.3 million.
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.
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 $2.7 million: (i) 791,905 shares of common stock at a
price equal to $3.79 per share; and (ii) Class G warrants to purchase 357,143
shares of common stock at an exercise price equal to $3.485 per share (subject
to adjustment). The Class G warrants had a ten-year term and we were entitled to
redeem the Class G warrants upon the attainment of certain exchange-related
price performance thresholds of the common stock. In February 2004, the price
performance criteria was met and we provided notice to PharmaBio of our
intention to redeem the Class G warrants. The Class G warrants were cashlessly
exercised resulting in the issuance of 249,726 shares. 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 $8.5 million, for each $1 million
increase, the amount of shares of common stock issuable pursuant to the Class H
warrants shall be increased by approximately 38,000 shares. The Class H warrants
had a ten-year term and we were entitled to redeem the Class H warrants upon the
attainment of certain exchange-related price performance thresholds of the
common stock. In April 2004, the price performance criteria was met and we
provided notice to PharmaBio of our intention to redeem the vested portion of
the Class H warrants. The vested portion of the Class H warrants were cashlessly
exercised resulting in the issuance of 160,318 shares.
In October 2001, we received approximately $7.3 million in net proceeds from a
private financing. In the financing, we issued 3,562,759 shares of common stock
and 712,553 Class F warrants to purchase shares of common stock at an exercise
price of $2.365 per share. The Class F warrants had a five-year term and we were
entitled to redeem the Class F warrants, with 20 days' prior written notice, for
Page 16
$.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 resulting
in 712,553 shares issued and proceeds of approximately $1.7 million.
In April 2001, we received approximately $1 million in proceeds in a private
offering of 296,560 shares of common stock at a per share price equal to $3.37.
Treasury Stock
During the three months ended March 31, 2004, certain members of our management,
pursuant to terms set forth in our Amended and Restated 1998 Stock Incentive
Plan, tendered shares of common stock then held by such members in lieu of cash
for payment for the exercise of certain stock options previously granted to such
parties. For the three months ended March 31, 2004, 115,723 shares of our common
stock were tendered to us by such parties in lieu of cash at an average price of
$12.38 per share. These shares are accounted for as treasury stock.
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 March 31, 2004, we have an accumulated
deficit of approximately $105,730,000, 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.
Page 17
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.
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.
Page 18
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 an 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
Page 19
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.
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.
In April 2004, we submitted an NDA to the FDA for clearance to market Surfaxin
for the prevention of RDS in premature infants. The FDA may not complete its
review in a timely manner. In addition, the FDA may request further data or
disapprove the NDA. If Surfaxin is not approved by the FDA for the prevention of
RDS in premature infants, if the review time is substantially prolonged or if
the FDA requires further clinical studies prior to approval, we have no
short-term alternative for generating substantial revenue or income. Surfaxin
may not be approved for the prevention of RDS because the FDA may find our
efficacy and safety data deficient or for other reasons. 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
Page 20
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.
IN ORDER TO CONDUCT OUR CLINICAL TRIALS WE NEED ADEQUATE SUPPLIES OF OUR DRUG
SUBSTANCE AND DRUG PRODUCT AND, FREQUENTLY, COMPETITORS' 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 transferred our
manufacturing capabilities from our single validated clinical manufacturing
facility, owned and operated by Akorn, Inc., to a new contract manufacturer,
Laureate Pharma L.P., and we are currently producing appropriate clinical grade
material of our drug substance that meets the standards for use in our ongoing
clinical studies. In the future, 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
Page 21
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.
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 $8.5 million,
which may be increased to $10 million. A failure by us to repay amounts
outstanding under the credit facility would have a material adverse effect on
Page 22
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.
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 our 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
Page 23
Office has not adopted a consistent policy regarding the breadth of claims that
the United States Patent and Trademark Office allows in biotechnology patents or
the degree of protection that these types of patents afford. As a result, there
are risks that we may not develop or obtain rights to products or processes that
are or may seem to be patentable.
EVEN IF WE OBTAIN PATENTS TO PROTECT OUR PRODUCTS, THOSE PATENTS MAY NOT BE
SUFFICIENTLY BROAD AND OTHERS COULD COMPETE WITH US.
We, 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 Inc. and Ortho Pharmaceutical Corporation which
are important, either individually or collectively, to our strategy of
commercializing our surfactant technology. Such patents, which include relevant
European patents, expire on various dates beginning in 2009 and ending in 2017
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
Page 24
parties may not grant to us or may only grant at rates that diminish or deplete
the profitability of the products to us. An adverse determination could also
require us to alter our products or processes or cease altogether any related
research and development activities or product sales.
IF WE CANNOT MEET REQUIREMENTS UNDER OUR LICENSE AGREEMENTS, WE COULD LOSE THE
RIGHTS TO OUR PRODUCTS.
We depend on licensing 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.
Page 25
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
Page 26
refraining from competition with us, the loss of any of these persons' services
would adversely affect our ability to develop and market our products and obtain
necessary regulatory approvals, and the applicable noncompete provisions can be
difficult and costly to monitor and enforce. Further, we do not maintain key-man
life insurance.
Our future success also will depend in part on the continued service of our key
scientific and management personnel and our ability to identify, hire and retain
additional personnel, including marketing and sales staff. We experience intense
competition for qualified personnel, and the existence of non-competition
agreements between prospective employees and their former employers may prevent
us from hiring those individuals or subject us to suit from their former
employers.
While we attempt to provide competitive compensation packages to attract and
retain key personnel, some of our competitors are likely to have greater
resources and more experience than we have, making it difficult for us to
compete successfully for key personnel.
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.
Page 27
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 million per occurrence and $10 million 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
Page 28
of our proposed products; however, the insurance is expensive and insurance
companies may not issue this type of insurance when we need it. We may not be
able to obtain adequate insurance in the future at an acceptable cost. Any
product liability claim, even one that was not in excess of our insurance
coverage or one that is meritless and/or unsuccessful, could adversely affect
our cash available for other purposes, such as research and development. In
addition, the existence of a product liability claim could affect the market
price of our common stock.
WE EXPECT TO FACE UNCERTAINTY OVER REIMBURSEMENT AND HEALTHCARE REFORM.
In both the United States and other countries, sales of our products will depend
in part upon the availability of reimbursement from third party payors, which
include government health administration authorities, managed care providers and
private health insurers. Third party payors are increasingly challenging the
price and examining the cost effectiveness of medical products and services.
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 March 31, 2004, our directors, executive officers, principal stockholders
and affiliated entities beneficially owned, in the aggregate, approximately 14%
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;
Page 29
- --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
three month period ended March 31, 2004, the price of our common stock has
ranged from $9.94 to $13.90. We expect the price of our common stock to remain
volatile. The average daily trading volume in our common stock varies
significantly. For the three month period ended March 31, 2004, the average
daily trading volume in our common stock was approximately 598,000 shares and
the average number of transactions per day was approximately 1,800. 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 March 31, 2004, we had 43,914,649 shares of common stock outstanding. In
addition, as of March 31, 2004, up to approximately 6,889,600 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 6.5 million
shares of common stock. In April 2004, we completed an underwritten public
offering of 2.2 million shares of common stock related to the shelf registration
statement. We have no immediate plans to sell the remaining securities under the
Page 30
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.
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. Our Shareholders Rights Agreement significantly impairs the
ability of third parties, under certain circumstances, 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 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our exposure to market risk is confined to our cash, cash equivalents and
available for sale securities. We place our investments with high quality
issuers and, by policy, limit the amount of credit exposure to any one issuer.
We currently do not hedge interest rate or currency exchange exposure. We
classify highly liquid investments purchased with a maturity of three months or
less as "cash equivalents" and commercial paper and fixed income mutual funds as
"available for sale securities." Fixed income securities may have their fair
market value adversely affected due to a rise in interest rates and we may
suffer losses in principal if forced to sell securities that have declined in
market value due to a change in interest rates.
Page 31
ITEM 4. CONTROLS AND PROCEDURES
(a) Evaluation of disclosure controls and procedures. In designing and
evaluating the disclosure controls and procedures, our management
recognized that any controls and procedures, no matter how well designed
and operated, can provide only reasonable assurance of achieving the
desired control objectives and our management necessarily was required to
apply its judgment in evaluating the cost-benefit relationship of possible
controls and procedures. Our principal executive and financial officers
reviewed and evaluated our disclosure controls and procedures (as defined
in Rule 13a-15 promulgated under the Securities Exchange Act of 1934) prior
to the filing of this Quarterly Report. Based on that evaluation, our
principal executive and financial officers concluded that our disclosure
controls and procedures are effective in timely providing them with
material information, as required to be disclosed in the reports we file
pursuant to the Exchange Act.
(b) Changes in internal controls. There were no significant changes in our
internal controls or other factors that could significantly affect those
controls subsequent to the date of our evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Page 32
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
None.
ITEM 2. CHANGE IN SECURITIES AND USE OF PROCEEDS.
Effective February 6, 2004, our Board of Directors declared a dividend of one
preferred stock purchase right for each share of our common stock to be issued
to stockholders of record as of that date. Each share of common stock that we
issue after such date through the expiration date of the Shareholders Rights
Agreement shall be issued with a tandem right. Each Right represents the right
to purchase one ten-thousandth of a share of our Series A Junior Participating
Cumulative Preferred Stock at an exercise price equal to $50 per right. A
summary of the principal terms of the Shareholders Rights Agreement is set forth
in our Current Report on Form 8-K and our Registration Statement on Form 8-A,
each as filed with the Commission on February 6, 2004.
In the quarter ended March 31, 2004, pursuant to the exercise of outstanding
warrants and options, we issued an aggregate of 1,534,797 shares of our common
stock at various exercise prices ranging from $0.51 per share to $12.75 per
share. We claimed the exemption from registration provided by Section 4(2) of
the Securities Act for these transactions. No broker/dealers were involved in
the sale and no commissions were paid by us.
We have a voluntary 401(k) savings plan covering eligible employees. Effective
January 1, 2003, we allowed for periodic discretionary matches of newly issued
Company Stock with the amount of any such match determined as a percentage of
each participant's cash contribution. The total match for the three months ended
March 31, 2004 was $34,000.
During the three months ended March 31, 2004, certain members of our management,
pursuant to terms set forth in our Amended and Restated 1998 Stock Incentive
Plan, tendered shares of common stock then held by such members in lieu of cash
for payment for the exercise of certain stock options previously granted to such
parties. For the three months ended March 31, 2004, 115,723 shares of our common
stock were tendered to us by such parties in lieu of cash at an average price of
$12.38 per share. These shares are accounted for as treasury stock. The
following table sets forth information regarding our receipt of shares of our
common stock on a monthly basis during the first quarter of fiscal year 2004:
Number of shares
received in lieu of
cash for the exercise Average price
of stock options per share
----------------------------- ---------------------
January 2004 97,226 12.44
February 2004 -- --
March 2004 18,497 12.08
------ -----
Total 115,723 12.38
Page 33
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
ITEM 5. OTHER INFORMATION.
SUBSEQUENT EVENTS
Filing of New Drug Application (NDA)
In April 2004, we submitted an NDA to the FDA for clearance to market Surfaxin
for the prevention of Respiratory Distress Syndrome (RDS) in premature infants.
The NDA filing is supported, in large part, by data from Discovery's two
positive Phase 3 RDS clinical trials. The principal trial was a landmark, 1,294
patient pivotal study that demonstrated Surfaxin's superiority to Exosurf, a
non-protein containing synthetic surfactant. In this pivotal trial, another
surfactant, Survanta, which is derived from cows and is the leading surfactant
used in the United States, served as a reference arm. The second trial was a 252
patient supportive study that demonstrated Surfaxin's non-inferiority to
Curosurf, a pig-derived surfactant and the leading surfactant used in Europe.
On May 2, 2004 we presented detailed results from the Surfaxin Phase 3 clinical
trials at the 2004 annual meeting of the Pediatric Academic Society (PAS) in San
Francisco.
Equity Financing
In April 2004, we completed an underwritten public offering of 2,200,000 shares
of common stock. The shares were priced at $11.00 per share resulting in our
receipt of gross and net proceeds equal to $24.2 million and approximately $22.7
million, respectively.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(A) EXHIBITS:
31.1 Section 302 Certification of Chief Executive Officer
31.2 Section 302 Certification of Chief Financial Officer
32.1 Section 906 Certification of Chief Executive Officer and Chief
Financial Officer
Page 34
(B) REPORTS ON FORM 8-K:
We filed three Current Reports on Form 8-K during the three months ended March
31, 2004. We filed a Current Report on February 6, 2004, reporting that our
Board of Directors had adopted a shareholder rights plan under which all
shareholders of record as of February 6, 2004, will receive rights to purchase
shares of a new series of preferred stock. We filed a Current Report on February
19, 2004, reporting that a conference call would take place to provide an
overview of the secondary endpoints from certain safety results from our two
Phase 3 clinical trials for Respiratory Distress Syndrome in premature infants
as well as an update on manufacturing. We filed a Current Report on March 30,
2004, reporting the initiation of an underwritten public offering of 2,200,000
shares of our common stock at a price of $11.00 per share.
Page 35
SIGNATURES, AND CERTIFICATIONS OF THE CHIEF EXECUTIVE OFFICER AND THE CHIEF
FINANCIAL OFFICER OF THE COMPANY.
Exhibits 31.1, 31.2 and 32.1 to this Quarterly Report on Form 10-Q include
Certifications of our Chief Executive Officer and our Chief Financial Officer.
The first two forms of Certification are required by Rule 13a-14 under the
Exchange Act in accordance with Section 302 of the Sarbanes-Oxley Act of 2002
(the "Section 302 Certifications"). The Section 302 Certifications include
references to an evaluation of the effectiveness of the design and operation of
our "disclosure controls and procedures" and our "internal controls and
procedures for financial reporting". Item 4 of Part I of this Quarterly Report
presents the conclusions of our Chief Executive Officer and our Chief Financial
Officer about the effectiveness of such controls based on and as of the date of
such evaluation (relating to Item 4 of the Section 302 Certifications), and
contain additional information concerning disclosures to our Audit Committee and
independent auditors with regard to deficiencies in internal controls and fraud
and related matters.
The second form of Certification is being furnished solely pursuant to section
906 of the Sarbanes-Oxley Act of 2002 (subsection (a) and (b) of section 1350,
chapter 63 of title 18, United States Code) and is not being filed as part of
this Form 10-Q or as a separate disclosure document. A signed original of such
written statement required by Section 906, or other document authenticating,
acknowledging or otherwise adopting the signature that appears in typed form
within the electronic version of this written statement required by Section 906,
has been provided to us and will be retained by us and furnished to the
Securities and Exchange Commission or its staff upon request.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Discovery Laboratories, Inc.
(Registrant)
Date: May 7, 2004 /s/ Robert J. Capetola
----------------------------------------------------
Robert J. Capetola, Ph.D.
President and Chief Executive Officer
Date: May 7, 2004 /s/ John G. Cooper
----------------------------------------------------
John G. Cooper
Executive Vice President and Chief Financial Officer
(Principal Financial Officer)
Page 36